Saving, Funding And Economic Growth

ing from the question whether pension reform indeed boosts saving, it is useful to also view pension reform more broadly as aiding financial development, which may also stimulate growth. As background we may cite extensive work that suggests financial development aids growth, and in particular that equity market development is a positive factor for growth (such as Demirguc-Kunt and Levine (1996), Levine and Zervos (1998)). Underlying mechanisms include increasing liquidity and thus facilitating financing of long term, high return projects; increasing incentives to acquire information about firms; facilitating the tying of management compensation to share prices via stock options; and facilitating take-overs to resolve corporate governance difficulties. Demirguc-Kunt and Maksimovic (1998) show that access to an active stock market also increases firms' ability to borrow at long maturities, especially in developing financial markets. Furthermore, access to a range of securities in domestic currency should limit the incentive for companies to borrow in foreign currency, which was a feature of the vulnerability exposed by the recent Asian crisis. A quantitative impact of development of pension funds on capital markets, abstracting from potential increases in saving, must arise mainly from differences in behaviour from the personal sector. Pension funds in most cases hold a greater proportion of equities and bonds than households. These differences can be explained partly by time horizons, which for households are relatively short, whereas given the long term nature of liabilities, pension funds may concentrate portfolios on long term assets yielding the highest returns. But given their size, pension funds also have a comparative advantage in compensating for the increased risk by pooling and diversifying across assets whose returns are imperfectly correlated, an advantage linked also to lower transactions costs for large deals and ability to invest in large indivisible assets such as property. Unlike banks, they tend to rely on more on public than private information in investment and hence seek relatively liquid assets. However, owing to economies of scale, specialisation, links to investment banks etc. their information may be typically superior to that of private individuals. The implication is that even if saving and wealth did not increase, a switch to funding would increase the supply of long term funds to capital markets. There will be increases in the supply of equities, long term corporate bonds and securitised debt instruments and a reduction in bank deposits, so long as individuals do not adjust the liquidity of their portfolios to fully offset effects of growth of pension funds and so long as the macroeconomic environment favours long term financing. A priori, one can argue that full offsetting is unlikely, especially if pension assets are defined benefit and/or implicitly substitute for highly-illiquid implicit social security wealth. Empirical work by King and DicksMireaux (1988) found no such offset for Canada, while Davis (1988) obtained similar results for the G-5. Certainly there is a correlation in OECD countries between equity market capitalisation and the size of the pension fund sector. Simple estimation for the EU-15, the US, Japan and Canada gives a 6 Differences in portfolios link to a variety of factors, notably regulation and historical developments.