Pay-as-you-go (PAYG) pension schemes are becoming increasingly unsustainable in the face of drastic population aging. Simultaneously, the contribution rates may aggravate an already serious unemployment problem. A regime switch to a funded system could help to alleviate the unemployment problem in addition to restoring sustainability of social security. This paper asks how the transition to a partially funded system is implemented such that all generations may share in the efficiency gains from lower unemployment. We propose a welfare based transition scheme that cuts contributions to the PAYG system and uses public debt to compensate old generations for their previously acquired pension claims. Relying on an overlapping generations framework with union wage setting, we show that this reform reduces unemployment, boosts capital accumulation and yields welfare gains to present and future generations.
