Available online at www.sciencedirect.

com

Regional Science and Urban Economics 37 (2007) 649 – 669

www.elsevier.com/locate/regec

Beveridge versus Bismarck public-pension systems

in integrated markets ☆
Martin Kolmar
University of St. Gallen, Varnbüelstrasse 14, CH-9000 St. Gallen, Switzerland
Received 26 October 2006; accepted 15 January 2007
Available online 31 January 2007

Abstract

The two basic systems according to which pay-as-you-go-financed public-pension systems can be
organized are the (Anglo-Saxon) Beveridge system and the (continental) Bismarck system. An ideal
Beveridge system provides flat-rate benefits, whereas an ideal Bismarck system provides earnings-related
benefits. This paper analyzes the circumstances under which a Beveridge system can be sustainable in
systems competition with a Bismarck system. The analysis reveals a much more complicated redistributive
structure of the pension systems than only between high and low incomes. As a consequence, the
sustainability depends on growth rates, and equilibria can exist where, contrary to the first intuition, even
poor individuals prefer a Bismarck and rich individuals prefer a Beveridge system.
© 2007 Elsevier B.V. All rights reserved.

JEL classification: H55; H73; R23

Keywords: Market integration; System competition; Pension systems

1. Introduction

The integration of goods and factor markets leads goods and factors to their most productive
use, and it allows reaching gains from specialization that have so far been unattainable. In
addition, inefficient institutional structures come under pressure to reform. However, a number of
authors have argued that the invisible hand does not necessarily lead to better and more efficient
institutions. On the contrary, market integration may threaten the ability of the state to provide

☆
I thank Richard Arnott, Friedrich Breyer, Volker Meier, Hans Jürgen Rösner, the participants of the 2003 meeting of
the committee for social policy of the Verein für Socialpolitik, and three anonymous referees for valuable comments on an
earlier version of the paper.
E-mail address: martin.kolmar@unisg.ch.

0166-0462/$ - see front matter © 2007 Elsevier B.V. All rights reserved.
doi:10.1016/j.regsciurbeco.2007.01.003
650 M. Kolmar / Regional Science and Urban Economics 37 (2007) 649–669

public goods and insurance, and to redistribute between different groups even though there is
market failure and these activities are supported by a majority of the population. For example,
under the heading “New Systems Competition”, Sinn (2003) strongly argues in favor of this latter,
less optimistic view of globalization, and his view is supported by a number of studies
demonstrating that existing tax and policy principles that have more or less efficiently evolved in
closed economies create substantial externalities in integrated markets. See Cremer et al. (1996),
Oates (1999), and Wilson (1999) who survey different aspects of this literature.
The basic scepticism concerning the welfare-enhancing consequences of market integration is
based on a very simple argument that Sinn (2003) calls the “selection principle”: ideally, the
provision of certain goods or services by the state is a reaction to an underlying market failure so
that the re-introduction of competitive forces between jurisdictions will most probably be harmful.
That the provision of certain activities by the state can always be best understood as a reaction
to market failure can be disputed for a number of reasons and in a number of cases. However, it is
clear that the state plays a vital role in the field of pay-as-you-go (PAYG) financed pension
systems, which are substantial pillars of most welfare states. And exactly because the existence of
PAYG pension systems depends on the ability of the state to exercise compulsion, their existence
is threatened by the exit-option of individuals in integrated markets. See Breyer and Kolmar
(2002), Casarico and Devillanova (2003), von Hagen and Walz (1995), Homburg and Richter
(1993), Kolmar (2001), and Razin and Sadka (1999) who analyze different aspects of the problem.
One specific feature of the existing literature is that it models systems competition only for the
case of competing countries that have pension systems with identical structures. This restriction
provides a useful starting point for the analysis, but does by far not exhaust the meaning of “systems
competition.” On the contrary, it can be argued that systems competition only becomes relevant
when different institutional arrangements have evolved in different countries. These different
arrangements may reflect different value judgements, different means of effectively reaching the
same goals, or different degrees of effectiveness of the existing systems. Only in the latter case can it
be argued that the elimination of specific systems due to market integration is welfare enhancing. In
the former two cases any competitive advantage of some systems over others could be considered as
being unfair, the promotion of market integration being itself a value judgement that is hard to justify.
One specific aspect of this discussion is the competition between the different system
philosophies of the Beveridge-type and Bismarck-type social security systems, see Cremer and
Pestieau (2003) for redistribution, and Goerke (2001) for insurance on labor markets. Roughly
speaking, an ideal Bismarck system does not redistribute across different income groups, whereas
such redistribution is performed in a Beveridge system. At first glance, systems competition
between Beveridge and Bismarck countries favors the Bismarck system because with mobile
workers the poor would be attracted by the Beveridge and the rich would be attracted by the
Bismarck system. Cremer and Pestieau (2003) call this ‘conventional wisdom’.
If this conventional wisdom were true, one could very well argue that market integration leads
to unfair results because it would favor one way of organizing economic activity over another
despite the fact that both ways might simply reflect differences in value judgements and not
ineffective modes of organization. It is therefore of crucial importance to see whether and, if so,
under what circumstances, this conjecture is correct.
Cremer and Pestieau (2003) analyze the interplay between Beveridge and Bismarck social-
insurance systems in a static framework.1 They analyze the redistributive abilities of a utilitarian

1
Such a static framework can be applied, e.g. to the insurance against the unemployment risk, fully funded public-
pension systems, or general redistribution.
 M. Kolmar / Regional Science and Urban Economics 37 (2007) 649–669 651

government in the presence of mobility and different system philosophies among countries. The
individuals can be either high-skilled or low-skilled, and the intuition is that low-skilled workers
tend to prefer a Beveridge system, whereas high-skilled workers tend to prefer a Bismarck
system. The bottomline of their analysis is that systems competition need by far be not be as
disastrous as the selection principle would predict. One important insight gained from their paper
is that labor mobility does not necessarily lead to the weakening or even the destruction of the
Beveridge system.
In order to better understand the importance of their result, one has to ask for the crucial
assumptions of the model. First, only the low-skilled workers are mobile in their analysis. The
result is not robust with respect to an extension that allows both types of workers to migrate.
However, the restriction to a static framework is not crucial to some extent. Their model is
consistent with an inter-temporal interpretation if one restricts attention to fully-funded social-
security systems. However, their findings do not necessarily carry over to the case of PAYG
social-security systems, since the individual (also called virtual) rate of return of a PAYG system
depends on the number of future members of the system which makes the optimal choice of a
place of work interdependent between generations. These systems and the mobility of all types of
workers are therefore the focus of the present paper.
The problem addressed in this paper gains additional relevance because of the current approach
to a coordinated social policy within the European Union. The current approach towards coor-
dinated and harmonized social policies is the so-called open method of coordination. Compared to
the earlier approaches, the new aspect of the open method of coordination is that it claims to respect
different traditions and approaches to social policy that coexist in the European Union. The main
idea is that the member states define measures for the evaluation of the performance of their
systems, in order to implement something like yardstick competition between the systems (Borras
and Jacobsson, 2004). In the end, according to the idea, it shall lead to an evolutionary selection of
the most effective systems. One of the primary goals of this approach in the field of pension
policies is the creation of sustainable and fair pension systems that respect national traditions
(Hartwig and Meyer, 2002). The crucial assumption that underlies the whole approach, however, is
that no principal incompatibility between competing systems exists. If such a basic incompatibility
existed, it is not guaranteed that the most effective system would be successful.
Hence, the compatibility of different traditions of and approaches to the welfare state is very
important for a general evaluation of the method of open coordination. Beveridge and Bismarck
systems are incompatible if a Beveridge system cannot survive when confronted with a Bismarck
system because of a self-selection of income groups. In such a scenario the survival of the
Bismarckian model would not be a result of a more-efficient institutional structure, but of
differences in the value judgements and approaches to generate a just distribution of incomes
between the competing countries.
Our results broadly support the findings of Cremer and Pestieau (2003) that there is no
unambiguous theoretical evidence about a dismantling of Beveridge systems in the presence of
Bismarck systems. A self-selection of income groups can be a result of systems competition, but
the pattern of potential equilibria is much more complicated, depending on demographic,
technological, as well as political variables. It might even be the case that a counter-intuitive
dismantling of the Beveridge systems occurs where only the rich stay within this system, whereas
the poor prefer to work in the Bismarck country. The reason for this more complicated picture is
intuitive. The general finding that market integration makes it difficult to redistribute between
different types of individuals if the individuals can avoid redistribution by migration still holds, of
course. However, the analysis shows that different pension systems may perform much more
652 M. Kolmar / Regional Science and Urban Economics 37 (2007) 649–669

complex redistributive patterns than just between rich and poor, so that the net beneficiaries are
not immediately evident. For example, Beveridge systems not only redistribute between rich and
poor, but also between fast-growing and slow-growing income groups. Hence, it may turn out that
rich individuals are net beneficiaries of such a system, depending on the organization of the
competing Bismarck system. With these exceptions, however, our analysis strongly supports the
conventional wisdom that Bismarck systems will challenge the survival of Beveridge systems for
the empirically most relevant organization structures and population-rate and wage-rate growth
rates.
The paper proceeds as follows. The model is presented in Section 2. The equilibria of
different competing pension systems are characterized in Section 3, and Section 4 conclude the
analysis.

2. The model

We consider two small countries, i, j, producing under conditions of constant returns to scale
using capital and labor. Both are embedded in the world economy by fully integrated capital
markets. Labor is completely and costlessly mobile within and between the countries but
completely immobile with respect to the rest of the world.2 These assumptions imply that the
capital-market interest factor, Rt, is determined on the world capital-market and is exogenous
from the point of view of a single country i, j. In addition, given constant returns to scale, the
wage rate wt is also exogenous from the point of view of a single country i, j because of the
factor-price frontier.
We consider a two-overlapping-generations model in discrete time and with exogenous
population growth. The lifetime of an individual is divided into two periods, working life and
retirement. Each individual can choose its place of work at the beginning of its working life. The
place of work determines its membership in a pension system that determines contributions as
well as benefits. We denote the total working population in both countries by Nt = Lit + Ljt = Nit + Njt.
The vector {Lit, Ljt } is the birth-determined distribution between the countries, whereas {Nit, Njt}
is the distribution of workers between the countries.
In order to be able to analyze the effects of different pension systems on the migration patterns
we have to introduce heterogeneous individuals. We assume that individuals are identical with the
exception of labor productivity. Productivity is reflected by the ability of individuals to generate
wage income. To be more specific we assume that individuals inelastically supply one unit of
labor and are either high skilled or low skilled, k = h, l, with associated wage rates wht and wlt,
wht N wlt. The growth factors of wages are denoted by gkt+1: = wkt+1 / wkt, k = h, l.
We can disaggregate the total working population of a given period t, Nt, into high- (h) and
low-skilled (l ) individuals, Nt = Lih
t
+ Lilt + Ljh
t
+ Ljlt = Nih
t
+ Nilt + Njh
t
+ Njlt.
From the point of view of a pension system it is only the distribution of workers that matters.
Hence, given the above specifications we can distinguish between four different population-
growth factors that might be relevant for the pension systems:

• The average population-growth factor is equal to mt = Nt / Nt−1.

• The average population-growth factor in country i is equal to mit = Nit / Nit−1.

2
For a discussion about the relevance of international labor mobility see Sinn (2003). For the consequences of mobility
that is restricted to certain groups see Breyer and Kolmar (2002). For the foundation of the results derived in models of
unrestricted mobility in a model of local, overlapping mobility see Guggenberger et al. (2002).
 M. Kolmar / Regional Science and Urban Economics 37 (2007) 649–669 653

• The country-specific population-growth factor of skill types, k = h, l, is equal to mik

t t
= Nik t−1
/ Nik .
• The average population-growth factor of skill types, k = h, l, is equal to mk = Nk / Nk .
t t t−1

For simplicity we assume that group-specific wage and population growth and the interest
factor are constant over time, mkt = mk, gkt = gk, Rt = R, k = h, l, ∀t.

2.1. The pension systems

The pension system is of the defined-contribution type,3 which implies that individuals have to
pay a proportional factor, τi, of their wage income as contribution to the public-pension system.
For simplicity we assume that this fraction does not change over time. Hence, total contributions
of an individual, τiwik
t
, depend on qualification as well as on the working place (if τi ≠ τj). The
total contributions to pension system i in period t are then equal to ∑kNikt
τiwik
t
.
t
Benefits from a pension system in period t are denoted by bik. Because the place of work
t−1
determines contributions as well as benefits, there are Nik claimants to these benefits in every
period. Hence, total benefits paid are equal to ∑kNik bik. We consider completely PAYG-financed
t−1 t

public-pension systems, which leads to the following budget constraints of the pension funds:
X X X X
Nikt−1 btik ¼ Nikt si wtik ; Njkt−1 btjk ¼ Njkt sj wtjk : ð1Þ
k¼l;h k¼l;h k¼l;h k¼l;h

Pension systems can be classified according to the individual pension formula applied. We call
a system that pays the same pension benefit to every individual irrespective of the contributions
t
paid, bih = bilt, a Beveridge system. Accordingly, a pension system that pays higher benefits to
individuals with higher contributions, bih t
N bilt is called a general Bismarck system. The term
‘general’ refers to the property that there is only some link between contributions and benefits. It
therefore still allows for a high degree of redistribution between income groups.
We will focus on two special cases of the general Bismarck system. Given a proportional
relationship between contributions and benefits, a general Bismark system can be written in the
following form:

ik ¼ ai si wk ;
btþ1 ð2Þ
t

where αi denotes the proportionality factor. This allows it to derive a more specific relationship
between contributions and benefits using Eq. (1).

1. A Bismarck system without compensation for wage-group specific differences in population

growth (strong Bismarck system) treats both wage groups as being in different pension
systems. Eq. (1) can then be disaggregated to yield

Nikt−1 btik ¼ Nikt si wtk ; k ¼ h; l: ð3Þ

3
See Hindriks (1999) for further details. One advantage of this assumption is that we can analyze equilibria in any given
period t without specification of the pension system, market environment, and population distribution in period t − 1. It is
especially convenient that we do not have to specify a first period of market integration. However, the distribution of the
population in past periods would matter for a normative evaluation of equilibria because it is not guaranteed that pension
claims of a currently old generation are always respected.
654 M. Kolmar / Regional Science and Urban Economics 37 (2007) 649–669

It follows immediately that in this case

wtþ1
k Nik
tþ1
ik ¼
btþ1 si wtk ¼ mtþ1
ik si wk : ð4Þ
tþ1
wtk Nikt
|fflfflfflfflffl{zfflfflfflfflffl}
¼ai

2. A Bismarck system with compensation for wage-group specific differences in population

growth (weak Bismarck system) yields the following individual pension formula:

Niltþ1 wtþ1 þ Nihtþ1 wtþ1

btþ1 ¼ l h
si wtk : ð5Þ
i
Nilt wtl þ Niht wth
|fflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflffl{zfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflffl}
¼ai

t+1
3. Finally, in a Beveridge system, bih = bilt+1 = bit+1, Eq. (1) yields a pension benefit of

Niltþ1 wtþ1 þ Nihtþ1 wtþ1

btþ1 ¼ l h
si : ð6Þ
i
Nil þ Niht
t

Eqs. (4)–(6) reveal the fundamental differences in intra-generational redistribution between

the systems. In a strong Bismarck system every qualification group gets a pension benefit that
depends on the wage level and productivity growth as well as on the population growth of this
specific group. In a weak Bismarck system each wage group gets pension benefits according to its
wage level, but there is redistribution if group-specific differences in productivity-growth and
population-growth rates exist. This system most closely resembles the prevailing practice in most
countries using a Bismarck system, for example France and Germany. Finally, the Beveridge
system insures against differences in growth rates and wage levels.
Most empirical Bismarck systems have the character of a weak Bismarck system. Only a minority
of the population is covered by a different pension system that has more of the character of a strong
Bismarck system, in Germany for example the so called Berufsständische Rentenversicherung
(pension system for the ‘free’ professions) that covers high-skilled professions like architects,
physicians, pharmacists, or tax and legal consultants, and that consists of roughly half a million
members. Hence, systems competition between either Beveridge or weak Bismarck with strong
Bismarck systems is not that important from a quantitative point of view, but nevertheless establishes
a theoretical benchmark that allows it to better understand the decisive elements in systems
competition, as we will show throughout the paper.

2.2. The individual optimization problem

We assume that the individual utility-maximization problem has two different stages. First, at
the beginning of its active life, every individual chooses a place of work in either country i or j.
This decision determines its net income (gross income minus contributions plus discounted
benefits). Given this place of work, the household maximizes utility by choosing an inter-
temporal consumption plan. Every individual that is active in period t takes the sequence of wages
{wt, wt+1, …}, interest factors, {Rt, Rt+1, …}, the contribution rates of the pension systems, τi, τj,
and the decisions of all other individuals of its generation as given. We furthermore assume that
every individual is small in the sense that its first-stage decision does not change the profitability
of the pension systems.
 M. Kolmar / Regional Science and Urban Economics 37 (2007) 649–669 655

Given the contribution rates of the pension systems, τi, τj, the benefits of the pension systems,
bit+1, bjt+1, depend on the decisions of future generations about their membership in a pension
system. By E[bit+1] we denote the expectation of an individual of the generation active in t
regarding its future benefits. It is a complex function of all future policy variables as well as
population distributions. In order to make the problem analytically tractable we restrict attention
to equilibria with rational expectations in the sense that bit+1 = E[bit+1].
In order to have a simple notation we omit the country and wage-type index whenever
unambiguously possible. c1t , c2t+1, and st denote consumption during working life, consumption
during retirement, and private savings of a representative individual, respectively. The individuals
are egoistic in the sense that utility is a function of working-life and retirement consumption only,
u(c1t , c2t+1). We can then formulate the individual maximization problem for both types of
individuals in both countries at stage 2 as follows:

max uðct1 ; ctþ1

2 Þ ct1 þ st ¼ ð1−sÞwt
ct1 ;ctþ1
2 ð7Þ
∧ ctþ1
2 ¼ Rtþ1 st þ E½btþ1 :

The solution to this problem yields the consumption and savings functions c1t(w t , R t+1 , τ,
E[b t+1 ]), c2t+1 (w t , R t+1 , τ, E[b t+1 ]), s t (w t , R t+1 , τ, E[b t+1 ]).4
At stage 1 the individuals maximize utility by the choice of a place of work. The structure of
the stage-2 optimization problem shows that this problem boils down to the choice of the country
that maximizes expected lifetime income

i 
E½btþ1
Cit :¼ ð1−si Þwt þ : ð8Þ
Rtþ1

Hence, an individual of wage-type k will choose country i if and only if Cit ≥ Cjt.

2.3. Equilibrium

A solution to the above maximization problem yields a sequence of population distributions

T
{Nih , NilT , Njh
T
, NjlT}T=t,t+1,…. A migration equilibrium in period t is defined by the following
arbitrage condition:
8 8 9
< ¼ Nht tþ1 < N =
E½b  E½btþ1jh 
Niht a½0; Nht  () ð1−si Þwth þ tþ1 ih
¼ ð1−sj Þwth þ tþ1 ;
: R : ; R
¼0 b
8 8 9 ð9Þ
< ¼ Nlt tþ1 < N = tþ1

E½b  E½b jl
Nilt a½0; Nlt  () ð1−si Þwtl þ tþ1 il
¼ ð1−sj Þwtl þ tþ1 :
: R : ; R
¼0 b

A migration equilibrium in rational expectations is a sequence of migration equilibria such

t+1 t+1 t+1 t+1
that for all t, bik = E[bik ], bjk = E[bjk ], k = h, l.

4
In order to be able to restrict attention to interior solutions to the stage-2 optimization problem we have to either
assume that the individuals may be able to borrow against future pension benefits, or that the exogenous parameters of the
model guarantee that both wage types save a positive amount.
656 M. Kolmar / Regional Science and Urban Economics 37 (2007) 649–669

3. Characterization of migration equilibria

Intuitively, a pension system is sustainable if a migration equilibrium exists in every period t

such that both countries attract a strictly positive number of workers, Nit ∈ (0, Nt). In addition, a
Beveridge pension system can be said to be sustainable if a migration equilibrium in rational
expectations exists that has a strictly positive number of both high- and low-skilled individuals in
t
both countries, Nik ∈ (0, Nkt), because in the presence of only one skill group it would degenerate to
a de-facto Bismarck system. We therefore restrict attention to equilibria with a mixture of both skill
groups in every country when we refer to sustainable equilibria in the following. The following
lemma helps to simplify the characterization of sustainable migration equilibria.5
t
Lemma. A long-run migration equilibrium is sustainable if for Nik N 0, Njk
t
N 0, k = h, l, we have
t t
mik = mk , k = h, l.

The restriction to identical growth factors for each qualification group guarantees that both
countries remain populated even for t → ∞. The lemma implies that skill groups cannot grow with
different rates in different countries. However, the growth factors between skill groups can still differ.
Differences in, for example, population-growth factors between skill groups would imply that the
fraction of the slower-growing group converges to zero in the long run while at the same time the
absolute number of individuals remains positive if both growth factors are larger than or equal to 1.
In general, Eq. (9) implies that for a sustainable equilibrium to exist, the benefit levels of the
pension systems have to be coordinated in a specific way:

ih ¼ bjh þ R
btþ1 ðsi −sj Þwth ;
tþ1 tþ1

btþ1
il ¼ btþ1
jl þ R
tþ1
ðsi −sj Þwtl :

It is then the purpose of this section to see whether the above conditions can be fulfilled at all,
and if so, how, if different types of pension systems coexist.
In addition to a sustainable equilibrium there may exist other types of (corner) equilibria. There
are four potential candidates.

1. All individuals work in country i (Ai).

2. All individuals work in country j (Aj).
3. The high-skilled individuals work in i and the low-skilled individuals in j (HiLj).
4. The high-skilled individuals work in j and the low-skilled individuals in i (LiHj).

We therefore also characterize conditions for the existence of these types of corner equilibria.
A general remark on the structure and multiplicity of equilibria is in order here. As it has been
shown in von Hagen and Walz (1995) and Breyer and Kolmar (2002), two-country OLG models
with exogenous wage rates face the problem of multiple equilibra. Both sustainable and corner
equilibria may coexist, and there may exist additional types of equilibria as well. In this paper we
restrict attention to equilibria with permanently populated countries. In addition to these
equilibria, equilibria might exist where every member of a given generation chooses the same
country, but exactly the one not chosen by its predecessor generation (Breyer and Kolmar, 2002).

5
A proof of the lemma can be found in the Appendix.
 M. Kolmar / Regional Science and Urban Economics 37 (2007) 649–669 657

Such a time-path of alternating memberships leads to a de-facto abolition of pension systems.

Because the specific aspect of systems competition does not add anything substantial to this
intuition I make no attempt to give a complete characterization of the set of possible equilibria and
restrict my attention to the above-mentioned types of sustainable and corner equilibria in this
paper. The potential multiplicity of equilibria, however, points to a general problem of decen-
tralized public-pension systems in integrated (small) economies because the survival and struc-
ture of pension systems is not completely determined by technological and demographical factors
and can be influenced by political choices, but to a large extent also depends on the formation of
expectations about the future behavior of the system. I think that this multiplicity of equilibria is
not an artefact of the model used but captures an important aspect of reality.
In principle one could analyze six different institutional arrangements, three asymmetric cases
where both countries have different types of pension formulas, and three symmetric cases where
both countries have identical types of pension formulas. I restrict attention to the asymmetric
cases in this paper because only they capture the idea of systems competition. However, our
analysis can be easily extended to include the symmetric cases.

3.1. Beveridge versus strong Bismarck

3.1.1. Sustainable equilibria

Let us assume that country i runs a strong Bismarck system, whereas country j runs a Beveridge
system. In this case, the arbitrage conditions for a sustainable equilibrium are as follows:

1 Njl wl þ Njh wh
tþ1 tþ1 tþ1 tþ1
1 Nihtþ1
ð1−si Þwth þ s i w tþ1
¼ ð1−s j Þwt
þ sj ; ð10Þ
Rtþ1 Niht h h
Rtþ1 Njlt þ Njht

1 Njl wl þ Njh wh
tþ1 tþ1 tþ1 tþ1
1 Niltþ1
ð1−si Þwtl þ s i wtþ1
¼ ð1−s j Þw t
þ sj : ð11Þ
t
Rtþ1 Nil l l
Rtþ1 Njl þ Njh
t t

It is then straightforward to show that the above conditions imply that

h gh Njh wh þ ml gl Njl wl −ðNjh þ Njl ÞR

mtþ1 tþ1 t t tþ1 tþ1 t t t t tþ1 t
wh
si ¼ sj ; ð12Þ
ðNjht þ Njlt Þðmtþ1 h gh −R
tþ1 tþ1 Þwt
h
|fflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflffl{zfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflffl}
A1
and

h gh Njh wh þ ml gl Njl wl −ðNjh þ Njl ÞR

mtþ1 tþ1 t t tþ1 tþ1 t t t t tþ1 t
wl
si ¼ sj : ð13Þ
ðNjht þ Njlt Þðmtþ1 l gl −R
tþ1 tþ1 Þwt
l
|fflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflffl{zfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflfflffl}
A2

Eqs. (12) and (13) can only be simultaneously fulfilled if either τi = τj = 0, or A1 = A2. In the
former case no public-pension system exists. Whether the latter case can be fulfilled depends on
the parameter values of the economy.
The first result demonstrates the validity of conventional wisdom in an economy with equal
growth rates between skill groups.
658 M. Kolmar / Regional Science and Urban Economics 37 (2007) 649–669

Result 1. Assume that τi N 0 and τj N 0 and that high- and low skilled individuals and high- and
low skilled wages grow with the same factor, mht+1 = mlt+1 = mt+1, ght+1 = glt+1 = gt+1. Then, no
sustainable equilibrium between a strong Bismarck and a Beveridge pension system exists as
long as mt+1 N 0 and gt+1 N 0.
Proof. Eqs. (12) and (13) have to be equal for a sustainable equilibrium. Using mht+1 = mlt+1=mt+1
and ght+1=glt+1=gt+1, A1 and A2 can be simplified to

mtþ1 gtþ1 ðNjht wth þ Njlt wtl Þ−ðNjht þ Njlt ÞRtþ1 wtl 1
A1 ¼ ;
ðNjht þ Njlt Þðmtþ1 g tþ1 −Rtþ1 Þ wth

mtþ1 gtþ1 ðNjht wth þ Njlt wtl Þ−ðNjht þ Njlt ÞRtþ1 wtl 1
A2 ¼ :
ðNjht þ Njlt Þðmtþ1 g tþ1 −Rtþ1 Þ wtl

Both, (A1) and (A2), differ only with respect to the second term of the product. Hence,
(A1) ≠ (A2) if wlt b wht. □
Result 1 highlights that a sustainable equilibrium between a strong Bismarck and a Beveridge
pension system cannot exist in an economy without differences in the population-and wage-
growth rates of the qualification groups. The result holds, for example, for the case that both
qualification groups grow at the same rate and that there is no wage growth over time.
The intuition for Result 1 is as follows: both pension systems have to be coordinated such that
high-skilled and low-skilled individuals do not self-select. In order to guarantee that, e.g., high-
skilled individuals have an incentive to stay in the Beveridge system, there has to be a
compensation for its immanent intra-generational redistribution. If the virtual interest rate of a
PAYG system is below the capital-market interest rate, it induces an implicit tax. In this case the
compensation can be created by increasing the size of the pension system in the Bismarck
country, making it less attractive from the point of view of a high-skilled individual. However,
this compensation implies that the pension system is even less attractive for the low-skilled
individuals in the Bismarck country: they do not profit from intra-generational redistribution and
face the high burden of a large contribution rate. In summary, if the systems manage to make the
high-skilled individuals equally attracted to both countries, the low-skilled individuals have an
incentive to work in the Beveridge country.
Result 2 characterizes conditions under which conventional wisdom does not hold.
Result 2. Assume that τi N 0 and τi N 0. A necessary condition for a sustainable equilibrium
between a strong Bismarck and a Beveridge pension system is

h gh wh ¼ ml gl wl :
mtþ1 tþ1 t tþ1 tþ1 t

Proof. Setting (A1) = (A2) from Eqs. (12) and (13) and solving for bht+1 yields the result. □

Result 2 highlights that under certain conditions the coexistence of Beveridge and strong
Bismarck systems may be possible. For example, if g ht+1 = g lt+1 , w lt = 1 and w th = 2, we get
m ht+1 = 1 / 2m lt+1 as a condition for sustainability: in order to fulfill both arbitrage conditions, the
Beveridge system has to be sufficiently attractive for the high-skilled individuals and the
Bismarck system has to be sufficiently attractive for the low-skilled individuals. Both objectives
 M. Kolmar / Regional Science and Urban Economics 37 (2007) 649–669 659

are compatible if the growth rate of the high-skilled groups is sufficiently smaller than the growth
rate of the low-skilled group. In this case, the net redistribution of the Beveridge system is zero.
The tradeoff from the point of a low-skilled worker is between a high virtual rate of return but no
transfer in the Bismarck system and a low virtual rate of return but a positive transfer in the
Beveridge country. The tradeoff from the point of view of a high-skilled worker is exactly the
opposite. They have the choice between a low virtual rate of return but no redistribution in the
Bismarck system, and a high virtual rate of return and redistribution in the Beveridge country.
Result 2 only characterizes a necessary condition for the existence of a sustainable equilibrium.
The following corollary follows directly from Result 2 and gives more insights into the conditions
for its existence.
Corollary 1. Assume that the conditions of Result 2 are fulfilled. Then a sustainable equilibrium
exists if gh = gl and mhwh0 = mlwl0. Otherwise no sustainable equilibrium exists.
Proof. The necessary condition for a sustainable equilibrium, mht+1ght+1wht = mlt+1glt+1wlt , can we
rewritten for every period T and using constant growth factors over time to yield

mh m0h ðgh ÞT ¼ ml w0l ðgl ÞT ;

or
 T
gh ml w0l
¼ :
gl mh w0h

It follows that
8
 T < l; gh Ngl
gh
lim ¼ 1; gh ¼ gl :
T Y l gl :
0; gh bgl

It follows that both gh N gl and gh b gl cannot be sustainable equilibria. The remainder follows
immediately. □
Corollary 1 further strengthens the already strong conditions given in Result 2. Even if
m ht+1 g ht+1 w ht = m lt+1 g lt+1 w lt is fulfilled for g ht+1 ≠ g lt+1 in a given period t, a period of time exists
from which on this condition can no longer be fulfilled. As a consequence, the equilibrium
cannot be sustainable, and rational individuals will anticipate this fact. In summary, we can
hope for the sustainability of strong Bismarck and Beveridge systems only if wage growth
is identical between skill groups and the population-growth differential between low-skilled
and high-skilled individuals exactly balances differences in the initial wage level. Hence,
from a theoretical point of view, both systems are not incompatible in principle, but the
subset of parameter values for which a sustainable equilibrium may exist is very small, and
there is mixed empirical evidence about growth differentials. On the one hand it is a robust
empirical fact that the fertility rate of low-skilled individuals exceeds the one of high-
skilled individuals. On the other hand there seems to be a trend towards an increase in the
relative size of the high-skilled group.

3.1.2. Corner equilibria

The fact that sustainable equilibria exist only in exceptional cases, the existence and structure
of corner equilibria have to become the focus of the analysis.
660 M. Kolmar / Regional Science and Urban Economics 37 (2007) 649–669

(Ai) If all individuals work in Bismarckian country i, the arbitrage condition is

1
ð1−si Þwth þ h si wh Nð1−sj Þwh ;
mtþ1 tþ1 t
ð14Þ
Rtþ1

1
ð1−si Þwtl þ mtþ1 si wtþ1
l Nð1−sj Þwl ;
t
ð15Þ
Rtþ1 h

where we have used the convention that in a fixed-contribution system a single individual
working in j still has to pay contributions. This condition can be simplified to yield

mtþ1
h gh
tþ1
ðsi −sj Þ mtþ1
l gl
tþ1
ðsi −sj Þ
N ; N :
Rtþ1 si Rtþ1 si

The term on the left-hand side of the inequalities can be interpreted as a skill-group specific
Aaron factor (Aaron, 1966). The virtual interest factor of a PAYG exceeds the interest factor of a
capital-market investment if this factor exceeds 1. The term on the right-hand side measures the
relative contribution-rate differential. If both countries have the same contribution rates the
individuals work in country i if the Aaron factor exceeds 0.6 However, if the contribution-rate
differential is positive, the Aaron factor has to compensate for this relative loss of income.
(HiLj) If all high-skilled individuals work in country i and all low-skilled individuals work in
country j, the arbitrage condition is

ðmtþ1
l gl sj −mh gh si ÞbR
tþ1 tþ1 tþ1 tþ1
ðsi −sj Þbmtþ1
l gl s j ;
tþ1

where the left inequality refers to the high-skilled and the right to the low-skilled type.
Equilibrium types (Ai) and (HiLj) capture the essence of the conventional conjecture that high-
skilled individuals work in the Bismarck country to escape redistribution, and low-skilled
individuals either choose the Bismarck country or the Beveridge country (which is de-facto a
Bismarck country in this case), depending on the Aaron factor and the size of the system. Low-
skilled individuals will favor the country with the smaller contribution rate if the Aaron factor is
smaller than zero and vice versa.
(Aj) If all individuals work in country j, the arbitrage condition is

1 Nltþ1 wtþ1 þ Nhtþ1 wtþ1

ðsj −si Þwth b l h
sj ;
Rtþ1 Nlt þ Nht

1 Nltþ1 wtþ1 þ Nhtþ1 wtþ1

ðsj −si Þwtl b l h
sj :
Rtþ1 Nlt þ Nht

6
Efficiency of the funded system would require that the Aaron factor falls short of 1, cf. Spreemann (1984). The fact
that the arbitrage condition requires an Aaron factor larger than 0 results from the convention that individuals cannot
avoid paying contributions in the other country.
 M. Kolmar / Regional Science and Urban Economics 37 (2007) 649–669 661

Note that the right-hand sides of both inequalities are identical and that the left-hand side for
the high-skilled type is always larger than the one for the low-skilled type. Hence, only the
arbitrage condition for the high-skilled type matters. Thus, an Aj-equilibrium can exist if

ðsj −si Þ t 1 N tþ1 wtþ1 þ Nhtþ1 wtþ1

wh b tþ1 l l h
:
sj R Nlt þ Nht

high-skilled individuals might prefer to stay in a Beveridge system if on average it has an Aaron
factor that exceeds the normalized tax differential.
(LiHj) If all high-skilled individuals work in country j and all low-skilled individuals work in
country i, the arbitrage condition is
 t

tþ1 tþ1 wh
mh gh sj NR ðsj −si ÞN mh gh sj t −ml gl si :
tþ1 tþ1 tþ1 tþ1 tþ1
wl

In order to better understand the condition for the low-skilled individuals, assume that τi = τj.
In this case the condition simplifies to
 T
gl mh w0h
mtþ1
l g tþ1 t
l wl Nm tþ1 tþ1 t
h g h wh ; or N :
gh ml w0l

This condition can only be fulfilled if gl = gh, because otherwise either a period exists from
which on the wage of the low-skilled individuals exceeds the wage of the high-skilled individuals
(which contradicts the idea of high-and low skilled individuals), or it would have to be that mh b 0.
If gl = gh, we get mlwl0 N mhwh0: the relative difference in population-growth factors between low-
and high skilled individuals has to overcompensate the initial relative difference in wages.
The apparently counterintuitive case that all low-skilled individuals work in the Bismarck
country and all high-skilled individuals work in the Beveridge country can hence occur if two
conditions are met:

1. The high-skilled individuals face a sufficiently high Aaron factor and a higher contribution rate
or a sufficiently small Aaron factor and a smaller contribution rate in the Beveridge country.
2. The population of low-skilled individuals grows sufficiently faster than the population of high-
skilled individuals.

The baseline of the argument why low-skilled individuals might prefer to work in a strong
Bismarck country despite the fact that all high-skilled individuals work in the Beveridge country
is that income redistribution might be a bad deal for low-skilled individuals because a Beveridge
system not only redistributes from rich to poor but also from fast-growing to slow-growing
groups.
I summarize the findings with the following result:
Result 3. (1) All types of corner equilibria might occur if strong Bismarck and Beveridge
systems compete. The existence of these equilibria depends on the political, demographic, as
well as on the technological parameters of the economy. (2) If the growth differential between
low-skilled and high-skilled workers is sufficiently large a corner equilibrium exists where all
low-skilled individuals work in the Bismarck country and all high-skilled individuals work in the
Beveridge country.
662 M. Kolmar / Regional Science and Urban Economics 37 (2007) 649–669

3.2. Beveridge versus weak Bismarck

3.2.1. Sustainable equilibria

Result 2 has shown that differences in the wage-and population-growth rates of the skill groups
may be sufficient to make Beveridge and Bismarck systems sustainable. In order to make this kind
of result possible it has been important that the strong Bismarck system treats both wage groups as
if they were in different systems. This is no longer the case in a weak Bismarck system because it
compensates for differences in wage and population growth. Hence, despite the fact that the weak
Bismarck system is more redistributive than the strong Bismarck system, it might very well be
possible that because of exactly this type of redistribution it is more difficult to reach a sustainable
equilibrium when confronted with a Beveridge system. I will clarify this intuition in this section.
As in the last section, it is assumed that country i runs a weak Bismarck system, whereas
country j runs a Beveridge system. In this case, the arbitrage conditions for a sustainable
equilibrium are as follows:

1 Njl wl þ Njh wh
tþ1 tþ1 tþ1 tþ1
1 Niltþ1 wtþ1 þ Nihtþ1 wtþ1
ð1−si Þwth þ l h
s i wt
¼ ð1−s j Þw t
þ sj ;
Rtþ1 Nil wl þ Nih wh
t t t t h h
Rtþ1 Njl þ Njh
t t

ð16Þ

1 Njl wl þ Njh wh
tþ1 tþ1 tþ1 tþ1
1 Niltþ1 wtþ1 þ Nihtþ1 wtþ1
ð1−si Þwtl þ l h
s i w t
¼ ð1−s j Þw t
þ sj :
Rtþ1 Nilt wtl þ Niht wth l l
Rtþ1 Njlt þ Njht
ð17Þ

If both equations have to be fulfilled, si has to be the solution to the following two equations:

ðNiht wth þ Nilt wtl Þðmtþ1

h gh Njh wh þ ml gl Njl wl −ðNjh þ Njl ÞR
tþ1 t t tþ1 tþ1 t t t t
wh Þ
tþ1 t
sti ¼ sj ;
ðNjht þ Njlt Þðmtþ1
h gh Nih wh þ ml gl Nil wl −ðNih wh þ Nil wl ÞR
tþ1 t t tþ1 tþ1 t t t t t t tþ1 Þwt
h

ðNiht wth þ Nilt wtl Þðmtþ1

h gh Njh wh þ ml gl Njl wl −ðNjh þ Njl ÞR
tþ1 t t tþ1 tþ1 t t t t
wl Þ
tþ1 t
∧ sti ¼ sj :
ðNjht þ Njlt Þðmtþ1
h gh Nih wh þ ml gl Nil wl −ðNih wh þ Nil wl ÞR
tþ1 t t tþ1 tþ1 t t t t t t tþ1 Þwt
l

Both conditions can only be simultaneously fulfilled if either τi = τj = 0, or

l gl Njl wl ¼ −mh gh Njh wh

mtþ1 tþ1 t t tþ1 tþ1 t t

Because all terms in the above equation are positive (remember that g and m are growth
factors), the equality can never be fulfilled if mlt+1 N 0, mht+1 N 0. We summarize with the
following result.
Result 4. No sustainable equilibrium with positive contributions to the pension systems between
a weak Bismarck and a Beveridge country exists as long as glt+1 N 0, ght+1 N 0, mlt+1 N 0, mht+1 N 0.

A comparison of Results 2 and 4) demonstrates that the coexistence of different pension

systems in integrated labor markets may in fact be easier if the competing systems are relatively
more unequal (apply very different pension formulas). Hence, the ‘insurance’ against different
growth rates of the qualification groups implied by a weak Bismarck system makes it impossible
 M. Kolmar / Regional Science and Urban Economics 37 (2007) 649–669 663

to reach a sustainable equilibrium. The ability to reach a sustainable equilibrium between strong
Bismarck and Beveridge countries under specific circumstances relies on the fact that the virtual
rates of return of the PAYG systems depend on group-specific and population-growth factors.
Exactly these differences are eliminated in a weak Bismarck system.
As we have argued before, the weak Bismarck system most closely resembles pension
principles applied to a majority of the population in countries like, e.g. France and Germany. As a
consequence, conventional wisdom is correct in stressing that increasing labor mobility will
challenge the coexistence of different pension systems in the European Union.

3.2.2. Corner equilibria

The analysis of corner equilibria closely resembles the one in the last section. We are therefore
brief in the presentation.
(Ai) If all individuals work in country i, both arbitrage conditions turn out to be identical for
both skill groups and are equal to
 tþ1 tþ1 
1 Nh wh þ Nltþ1 wtþ1 ðsi −sj Þ
l
N :
Rtþ1 Nh wh þ Nl wl
t t t t
si

The identity of both arbitrage conditions results from the redistribution of growth differentials
in a weak Bismarck system. As a consequence, the absolute advantage of working in country i
may differ between skill groups, but not the relative advantage.
(HiLj) If all high-skilled individuals work in country i and all low-skilled individuals work in
country j, the arbitrage conditions are
 t

tþ1 tþ1 wl
mh gh si −ml gl sj t NRtþ1 ðsi −sj ÞNðmtþ1
tþ1 tþ1
h gh si −ml gl sj Þ;
tþ1 tþ1 tþ1
wh
where the left inequality refers to the high-skilled and the right inequality to the low-skilled
individuals.
(Aj) If all individuals work in country j, we get (as for the case of a strong Bismarck country)

1 Nltþ1 wtþ1 þ Nhtþ1 wtþ1

ðsj −si Þwth b l h
sj ;
Rtþ1 Nlt þ Nht

1 Nltþ1 wtþ1 þ Nhtþ1 wtþ1

ðsj −si Þwtl b l h
sj ;
Rtþ1 Nlt þ Nht

and only the inequality for the high-skilled individual may be binding.
(LiHj) If all high-skilled individuals work in country j and all low-skilled individuals work in
country i, the arbitrage condition is
 t

tþ1 tþ1 wh
ðmtþ1
h g tþ1
h s j −m tþ1 tþ1
l g l s i ÞNR ðs
tþ1 t
j −s t
i ÞN mh g h s j t −m tþ1 tþ1
l g l s i :
wl
However, this would imply that

wth
h gh Nmh gh
mtþ1 ;
tþ1 tþ1 tþ1
wtl
664 M. Kolmar / Regional Science and Urban Economics 37 (2007) 649–669

which would contradict wht N wlt. As for the case of sustainable equilibria, it is the inherent
correction for growth differences between qualification groups that makes a (LiHj) equilibrium
impossible. In all cases where the low-skilled individuals do not profit from the redistribution of
the Beveridge system because of a large growth differential, the high-skilled workers can profit
from exactly this growth differential by also joining the Bismarck system.
We summarize our findings with the following result:
Result 5. High-qualified individuals working in the Beveridge country whereas low-qualified
individuals working in the Bismarck country can never be an equilibrium between weak
Bismarck and Beveridge systems. All other types of corner solutions can be equilibria.

To summarize, the coexistence of weak Bismarck and Beveridge systems in a sense intensifies
system competition compared to a situation with coexisting strong Bismarck and Beveridge
systems. It does not only completely eliminate the possibility of a sustainable equilibrium, it also
makes the kind of self-selection that critiques fear more likely to occur, namely that low-skilled
individuals can no longer profit from redistribution in a Beveridge system, either because they do
not join the system or because they are the only ones joining it. The only case that a Beveridge
system can effectively survive is if it is attractive for the high skilled individuals to accept
redistribution. This case occurs if either the average growth rate exceeds the high-skilled growth
rate or if it is at least sufficiently strong to exceed the opportunity costs and all high-skilled
individuals have the expectations that the other high-skilled individuals work in j.7

3.3. Strong Bismarck versus weak Bismarck

The analysis of equilibria for competing strong and weak Bismarck systems is more of
theoretical interest because, at least in the European Union, there is no member state that applies a
pension system to a substantial part of its population that resembles a strong Bismarck system.
However, for systematic reasons, and because the exceptions to the rule cover important profes-
sions,8 it is important to analyze how both systems would compete in an integrated labor market.

3.3.1. Sustainable equilibria

We assume that country i has a strong and country j has a weak Bismarck system. The
arbitrage condition (9) becomes

1 Njl wl þ Njh wh
tþ1 tþ1 tþ1 tþ1
1 Nihtþ1
ð1−si Þwth þ s w
i h
tþ1
¼ ð1−s j Þwt
þ wth sj ; ð18Þ
Rtþ1 Niht h
Rtþ1 Njlt wtl þ Njht wth

1 Njl wl þ Njh wh
tþ1 tþ1 tþ1 tþ1
1 Niltþ1
ð1−si Þwtl þ s wtþ1
i l ¼ ð1−s j Þw t
þ wtl sj : ð19Þ
Rtþ1 Nilt l
Rtþ1 Njlt wtl þ Njht wth

As before, both conditions can be reformulated to yield

h gh Njh wh þ ml gl Njl wl −ðNjh þ Njl ÞR

mtþ1 tþ1 t t tþ1 tþ1 t t t t tþ1
si ¼ sj ; ð20Þ
ðNjht wth þ Njlt wtl Þðmtþ1
h gh −R
tþ1 tþ1 Þ

7
A comparison with (HiLj) shows that if the high-skilled growth rate is sufficiently high all high-skilled individuals
would profit from a coordinated move to country i.
8
See the remark about the berufsständische Versorgung at the beginning of the section.
 M. Kolmar / Regional Science and Urban Economics 37 (2007) 649–669 665

and

h gh Njh wh þ ml gl Njl wl −ðNjh þ Njl ÞR

mtþ1 tþ1 t t tþ1 tþ1 t t t t tþ1
si ¼ sj : ð21Þ
ðNjht wth þ Njlt wtl Þðmtþ1
l gl −R
tþ1 tþ1 Þ

Both conditions differ only with respect to the growth factor (mkt+1gkt+1), k = l, h in the
denominators. It follows immediately that

mtþ1
l gl
tþ1
¼ mtþ1
h ¼ mtþ1
h gh
tþ1
ð22Þ
is a sufficient condition for the existence of a sustainable equilibrium.
Result 6. Assume that τi N 0 and τj N 0. Then there is a sustainable equilibrium between a strong
and a weak Bismarck pension system if high-and low-skilled individuals have the same growth
factor of total wages, mlt+1glt+1 = mht+1ght+1.

Result 6 is intuitive: a weak Bismarck system compensates for differences in growth factors. If
there is no difference in growth factors, weak and strong Bismarck systems are equivalent because
neither system does in fact redistribute between skill groups.

3.3.2. Corner equilibria

The analysis of corner equilibria can again be brief because the relevant equilibrium conditions
are more or less permutations of the conditions we have already derived.
(Ai) If all individuals work in country i, the arbitrage conditions are equal to

mtþ1
h gh
tþ1
ðsi −sj Þ mtþ1
l gl
tþ1
ðsi −sj Þ
N ; N :
Rtþ1 si Rtþ1 si

(HiLj) If all high-skilled individuals work in country i and all low-skilled individuals work in
country j, the arbitrage conditions are

ðmtþ1
h gh si −ml gl gh sj ÞNR
tþ1 tþ1 tþ1 tþ1 tþ1
ðsi −sj ÞN−mtþ1
l gl s j ;
tþ1

with the left inequality referring to the high-skilled and the right inequality referring to the low-
skilled individuals.
(Aj) If all individuals work in country j, we get identical arbitrage conditions for both types of
individuals:

1 Nltþ1 wtþ1 þ Nhtþ1 wtþ1

ðsj −si Þb l h
sj :
Rtþ1 Nlt wtl þ Nht wth

Both conditions are identical because every skill type gets the same proportionalityfactor αhj =
αlj = αj,
k = h, l. The differences in wage levels are irrelevant for the decision to work because they
proportionally influence both, the opportunity costs of working in country i, and the absolute
advantage of the pension system in country j.
(LiHj) If all high-skilled individuals work in country j and all low-skilled individuals work in
country i, the arbitrage condition is

h gh sj NR
mtþ1 ðsj −sti ÞNðmtþ1
h gh sj −ml gl si Þ:
tþ1 tþ1 t tþ1 tþ1 tþ1
666 M. Kolmar / Regional Science and Urban Economics 37 (2007) 649–669

An inspection of all four possibilities shows that all types of corner solutions are possible,
depending on the parameter values of the model.

Result 7. All types of corner solutions can be equilibria if weak and strong Bismarck systems
compete. The type of equilibrium depends on the demographic, technological, and political
variables of the model.

4. Conclusions

The analysis of migration incentives in integrated economies with different types of PAYG-
pension system has revealed a complex incentive structure that is determined by demographic,
technological, as well as political variables. The findings further stress Cremer and Pestieau's
insight that the conventional wisdom according to which the self-selection of income groups
between Bismarck and Beveridge systems would make Beveridge systems non-sustainable is a
much too crude conjecture.
Different to the findings by Cremer and Pestieau (2003) that is based on immobile high-skilled
individuals and a migration decision before the realization of an income risk, however, the
sustainability of systems is a consequence of a more complex redistributive pattern present in
different pension systems in our model. Beveridge and Bismarck systems can then be sustainable
if they do not differ with respect to their net redistribution, even though all individuals are mobile
and there is no remaining uncertainty. The existence of a sustainable equilibrium depends on very
specific parameter values of the demographic and technological variables that are difficult to
influence by the design of the pension systems or the surrounding institutional background.
Hence, summing up the analysis supports the general scepticism with respect to systems com-
petition expressed by the ‘conventional wisdom’.
Nevertheless, the analysis of corner equilibria has shown that market integration does not
create a one-way street towards a Bismarck system. Even more, there are equilibria where the
low-skilled individuals choose to work in the Bismarck country, whereas the high-skilled
individuals prefer to work in the Beveridge country. The reason is that a Beveridge system does
not only redistribute between high-income and low-income individuals, but also between groups
with high and low growth rates. Hence, if the low-skilled sector has a larger growth rate than the
high-skilled sector, the redistribution of a Beveridge system might be a bad deal for the low-
skilled individuals.
The approach in this paper starts from a number of assumptions that should be discussed in order
to better understand the empirical relevance of the paper as well as directions of further research.
An apparent shortcoming of the analysis is that I have not endogenized the political choice of
contribution rates. I have decided to concentrate on the characterization of migration equilibria for
given contribution rates for two reasons. First, every political choice model relies on the structure
of the underlying migration equilibria. Hence, the analysis can be seen as a necessary first step for
the analysis of endogenously determined pension policies. Second, we know from the literature
that the optimal policy of a national (for example utilitarian) social planner is either to extend the
PAYG system as much as possible, if the Aaron factor is larger than 1 for both skill groups, or that
his optimal policy depends on the normative weights attached to each skill group and every
generation. Hence, the optimal policy being largely undetermined without knowledge of the actual
weights, one could rationalize every contribution rate by an adequate choice of welfare weights.
The analysis starts from the assumption that differences in the effective rates of return of
pension systems can motivate individuals to choose their country of employment. Empirically,
 M. Kolmar / Regional Science and Urban Economics 37 (2007) 649–669 667

this assumption raises at least two questions. Do individuals in fact react to changes in their
expected net benefits from the pension systems by migrating to other countries and if so, how can
this isolated incentive be incorporated into the overall picture of migration incentives induced by
fiscal policies of competing states or regions?
Historically, migration between member states of the European Union (EU) has been relatively
low. According to Gyourko and Tracy (1989) and Inman and Rubinfeld (1996), labor in the
United States is very mobile and responsive to tax differentials. On the other hand, Wildasin
(2000) shows that labor mobility in the European Union is substantial but too low to be compatible
with the assumption of unrestricted labor mobility. However, whereas legal barriers for the
migration of workers have been abolished in the past, it can be expected that also informal barriers
will decline in the future, which increases the fraction of potentially mobile individuals among the
working population. For an overall assessment of the future relevance of intra-EU migration that
might be expected in the future one has to include other aspects of the different national tax-
transfer systems as well as cultural and geographical considerations into the consideration.
Mobility alone, however, is not sufficient, it also has to be shown that migration can have a
substantial impact on lifetime income. Wildasin (2000) has been the first who has analyzed
quantitative importance of differences in pension systems between member states of the European
Union. He found that differences in pension systems and demographic trends sum up to 15% of
lifetime income of a representative worker. For an assessment of whether financial incentives of
this size in fact create sufficient incentives for migration must, of course, also take into
consideration expectations about the political sustainability of the pension systems (which is
exogenously guaranteed in this paper) as well as aspects of bounded rationality and insufficient
foresight might also be important explanatory factors.
In this paper, it has been assumed that individuals make a once-and-for-all decision about the
country in which they are employed. This assumption has two dimensions. First, it implies that
retirees cannot change their pension benefits by post-retirement migration. This assumption takes
into account that, in the European Union for example, pension payments for mobile workers are
calculated according to the principles valid in the countries of employment (Art. 27, 28 Treaty of the
European Union, Regulation 1408/71), which implies that pension benefits cannot be changed by
post-retirement migration. Second, the assumption excludes the possibility to change the country of
employment several times during one's working life. By and large, the overall willingness to migrate
is most probably maximal at the beginning of a working life because most people have to change
their social and geographical environment anyway, and given the rules concerning the cumulation of
pension claims defined in Regulation 1408/71 it is impossible to generate excessive pension claims
by a ‘smart’ choice of countries of employment. However, given that part of the income risk is not
completely determined at the beginning but only revealed during working life, the different
insurance packages offered by Beveridge and Bismarck systems might create an additional bias
against Beveridge systems. The effects can only be adequately analyzed in a model that allows both
risk aversion and multiple options to change the country of employment. The development of such a
model therefore constitutes an important direction of future research.
Another simplifying assumption underlying the analysis is that of the independence of both
groups' wage levels. In reality one might expect that even in a small country the systematic
emigration of certain professions will have an impact on the productivity of the remaining groups.
Two cases can be considered. If both groups' qualifications are complementary, a downward
pressure on the remaining group's wage rate exists, which might create an additional incentive to
emigrate for this group. If both groups' qualifications are substitutes, an upward pressure on the
remaining group's wage rate exists results, with the associated incentives for migration.
668 M. Kolmar / Regional Science and Urban Economics 37 (2007) 649–669

Appendix A

Proof of the lemma. Denote the initial period by 0. By definition we get

Niktþ1 þ Njktþ1
mtþ1 ¼
k
Nikt þ Njkt

for the average growth factor of skill group k. This definition can be decomposed to get

Nkt mtþ1
k ¼ Nikt mtþ1
ik þ Njk mjk :
t tþ1

Backwards induction yields

T T T
Nk0 j mtk ¼ Nik0 j mtik þ Njk0 j mtjk
t¼1 t¼1 t¼1

for a given last period T. By definition we know that mkt = mh (constant average population growth
of every skill group). In order to replicate identical optimization problems for every generation of
households, the implicit interest factor of the pension system has to be time-invariant, which
implies that mikt t
= mik, mjk = mjk. In addition, we can define σk = Nik0
/ Nk0, (1 − σk) = Njk
0
/ Nk0. The
above condition can then be simplified to yield

ðmk ÞT ¼ rk ðmik ÞT þ ð1−rk Þðmjk ÞT ;

or
 T1
1 1−rk :
mik ðmk ÞT − ðmjk ÞT
rk rk
Assume without loss of generality that j is the faster growing region, mjk N mk N mik. A
necessary condition for this to be a long-run equilibrium is that mik N 0, which implies that
1 1−rk 1
ðmk ÞT − ðmjk ÞT N0 () ðmk ÞT Nð1−rk Þðmjk ÞT () mk Nð1−rk ÞT mjk :
rk rk
1
However, we get limT Yl ð1−rk ÞT ¼ 1, which contradicts mjk N mk. □

References

Aaron, H.J, 1966. The social insurance paradox. Canadian Journal of Economics and Political Science 32, 371–374.
Borras, S., Jacobsson, K., 2004. The open coordination method and the new governance patterns in the EU. Journal of
European Public Policy 11, 185–208.
Breyer, F., Kolmar, M., 2002. Are national pension systems efficient if labor is (im)perfectly mobile? Journal of Public
Economics 83, 347–374.
Casarico, A., Devillanova, C., 2003. Social security and migration with endogenous skill upgrading. Journal of Public
Economics 87, 773–797.
Cremer, H., Fourgeaud, V., Leite Monteiro, M., Marchand, M., Pestieau, P., 1996. Mobility and redistribution: a survey of
the literature. Public Finance 51, 325–352.
Cremer, H., Pestieau, P., 2003. Social insurance competition between Beveridge and Bismarck. Journal of Urban
Economics 54 (1), 181–196.
Goerke, L., 2001. Bismarck versus Beveridge: flat rate and earnings related unemployment insurance in an efficiency wage
framework. Finanzarchiv 57, 243–260.
 M. Kolmar / Regional Science and Urban Economics 37 (2007) 649–669 669

Guggenberger, P., Kaul, A., Kolmar, M., 2002. Efficiency properties of labor taxation in a spatial model of restricted labor
mobility. Regional Science and Urban Economics 32, 447–473.
Gyourko, J., Tracy, J., 1989. The importance of local fiscal conditions in analyzing local labor markets. Journal of Political
Economy 97, 1200–1231.
Hartwig, I., Meyer, C.O., 2002. Towards deliberative network governance? Theorizing socio-economic policy
coordination in the European Union. GOVECOR Discussion Paper.
Hindriks, J., 1999. The consequences of labor mobility for redistribution: tax vs. transfer competition. Journal of Public
Economics 74, 215–234.
Homburg, S., Richter, W., 1993. Harmonizing public debt and pension schemes in the European community. Journal of
Economics, Supplementum 7, 51–63.
Inman, R.P., Rubinfeld, D.L., 1996. Designing tax policy in federalist economies: an overview. Journal of Public
Economics 60, 307–334.
Kolmar, M., 2001. Optimal intergenerational redistribution in a two-country model with endogenous fertility. Public
Choice 106, 23–51.
Oates, W., 1999. An essay on fiscal federalism. Journal of Economic Literature 37, 1120–1149.
Razin, A., Sadka, E., 1999. Migration and pension with international capital mobility. Journal of Public Economics 74,
141–150.
Sinn, H.W., 2003. The New Systems Competition. Blackwell Publishing, Malden, MA.
Spremann, K., 1984. Intergenerational Contracts and Their Decomposition. Journal of Economics 44, 237–253.
von Hagen, J., Walz, U., 1995. Social Security and Migration in an Ageing Europe. In: Eichengreen, B., Frieden, J., Hagen,
J.v. (Eds.), Politics and Institutions in an Integrated Europe, Berlin, pp. 177–192.
Wildasin, D.E., 2000. Factor Mobility and Fiscal Policy in the EU: Policy Issues and Analytical Approaches. Economic
Policy.
Wilson, D., 1999. Theories of tax competition. National Tax Journal 52, 269–304.