Pension Plan Funding, Risk Sharing and Technology Choice

The paper presents an analysis of the impact of pension plan funding on workers’ saving and portfolio behaviour. It shows that the impact of pension plan funding and asset allocation on the economy’s technology choices depends upon the constraints facing worker’s in the capital market. The failure of equivalence propositions between defined benefit and defined contribution pension plans derives from the existence of borrowing and short-sales constraints. The two types of plan force workers against the constraints differently yielding an asymmetric impact on risk taking and technological choice in the economy and thereby on the equity premium. The outcome of the market economy is a risk sharing arrangement between the workers and rentiers. This leaves open the question of how best to share risk between generations. The argument that defined contribution pensions and individual savings are an effective market solution to risk sharing may conflict with the institutional arrangements needed to manage effective intergenerational risk smoothing.