Closing Europe’s Risk Capital Gap: The Role of Funded Pensions

Europe faces a shortage of risk capital, i.e., capital invested in risky asset classes such as public and private equities and infrastructure, relative to economies with more developed funded pension systems. We examine how pension system design is associated with long-term risk capital accumulation and household risk-taking. Countries that transitioned in the 1990s from pay-as-you-go (PAYGO) to partially funded pension systems such as Australia, Canada, and Sweden have accumulated two to three times more risk capital per worker than PAYGO systems such as France and Germany. Higher funding levels in state and occupational pension funds are associated with greater risk-taking in both pension funds and household portfolios. Successful reforms share common institutional features, including scale, cost efficiency, strong governance, broad coverage, portability, and effective financial incentives. These findings provide practical guidance for pension design and have implications for strategic asset allocation and long-term investing. A broad shift toward funded pension systems could increase demand for risky assets and compress equity risk premia.