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Pension systems can influence capital flows by affecting saving and investment. At the same time, the growth of pension fund assets has implications for the depth of financial markets. This paper seeks to shed light on these effects, by highlighting three relevant aspects. First, the stage in the demographic transition. Since around the mid-1960s, lower EME fertility rates have meant lower dependency ratios, which has tended to boost saving, and also a rise in the working-age population, which has tended to boost investment. The transition has worked out as predicted in some countries but not in others. In particular, in the aftermath of crises (eg Asia in the late 1990s), saving and investment have tended to fall, and current account balances to rise. Nevertheless, current account surpluses are expected to fall or turn to deficits as populations age in coming decades. In some countries, this process has already begun. Second, pension system design. National saving could be affected by how pension benefits are financed. Recent reforms have favoured plans based on defined contribution and prefunding, moving away from defined benefit and pay-as-you-go plans. However, with a few exceptions, it is not clear that such pension system reforms have helped increase saving. This could be due to lower precautionary saving, transitional fiscal costs associated with pension reforms, problems with low or declining pension fund coverage, and high costs. Third, pension fund asset accumulation and financial deepening. Rapid growth in pension fund assets appears to be associated with deeper financial markets in a number of EMEs. This could also influence capital flows by affecting saving and current account balances, as well as the pattern of gross capital flows.

Pension Systems in EMES: Implications for Capital Flows and Financial Markets