Population aging is just beginning to hit the industrialized countries in full force, and it will have a tremendous impact on capital markets. In this paper, we argue that the capital market effects of population aging are particularly strong in continental European economies such as Germany, France, and Italy, with their large and ailing pay-as-you-go public pension systems, relatively thin capital markets, and poor capital performance. The younger generations in these countries are quite aware of the need to provide for more retirement income through own private saving, and these effects will be accentuated by fundamental pension reforms that aim at more pre-funding. Population aging changes households' savings behavior and portfolio composition, and much more assets will be invested on the stock market. Capital markets will grow in size, and active institutional investors such as pension funds will become more important in continental European countries. These changes are likely to have beneficial side effects in terms of improved capital efficiency, total factor productivity, and growth. Looking at the effects of population aging on savings behavior and capital markets therefore adds a new dimension to the continuing debate about advantages and disadvantages of pay-as-you-go and fully funded pension systems.
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