Complete German Version
Intergenerational Equity in Times of Demographic Change
The aging society challenges the intergenerational contract like never before. In its newly published discussion paper, the Berlin Institute analyses how the costs of this development can be distributed more equally between generations.
In spite of manifold social problems, Germany offers a relative balance of material prosperity across all age-groups. This is not self-evident, as it is largely the labour force which creates this prosperity. At the same time, people in paid work are also responsible for children, who are not yet part of the labour force, and for senior citizens, who have left it. The redistribution of wealth between the generations is the purpose of the intergenerational contract. Actual redistribution is carried out through the welfare system, primarily through statutory pension insurance. Pay-as-you-go financing, which does not save an insured person’s contributions but forwards them directly to the pensioner, continues to work well. But while the proportion between the contributors to the pension insurance and pension recipients has been well-balanced for quite a long time, it will soon be uneven. Over the past decades, declining birth rates and growing life expectancy have severely changed the age structure of German society. The proportion of people over 65 years is growing, while the proportion of people between 15 and 64 years diminishes.
As a consequence of this trend, the number of potential earners also shrinks. This group of people, which is the most active economically and which is the main source of material prosperity in our society, will soon have to provide for a growing number of pensioners. From the beginning of the next decade onwards, retirements will increase substantially, with the so called ‘baby boomers’ reaching pension age.
It’s all about participation in the labour force
Funding gaps in the foreseeable future
Despite of a series of reforms, such as the introduction of a “sustainability factor” in 2004 and the stepwise increase of the retirement age from 65 to 67 years between 2012 and 2029, there will probably be an increase of pension contribution rates and, at the same time, a decrease of the benefit level. It is difficult to predict how high the contribution rate will be in the coming decades and it is also difficult to predict which benefit level pensioners can count on in future. There’s too much uncertainty about the development of labour participation and unemployment, about the evolution of qualification levels among employees and about the number of immigrants. However, numerous scenarios point to the same direction: the more recent the year of birth of an insured person, the less benefit this person will draw out of his or her pension insurance.
This presents a threat to the carrying capacity of the welfare system. When people in the labour force lose their trust in receiving an adequate and sufficient pension on retirement, they will be less willing to contribute for the sake of intergenerational solidarity.
Funding the past or investing in the future?
From a political perspective, it may be alluring to transfer financial burdens to future generations. This can occur through the state taking on debt or making long-term commitments, the consequences of which will only be felt in the future. Policy makers tend to pay more attention to the short-term rather than the long-term consequences of their decision-making, focusing more on the current interests of their electorate. With regard to intergenerational equity in the long run, this is a fatal attitude. The longer necessary policy changes are adjourned, the greater the future burden.
Provisions allowing for more justice within and between generations should rather aim at limiting costs for future earners. They should also provide for sufficient capital in order to help overcome the increasing challenges in the welfare system. The key considerations for coping with the problems of injustice are:
Older workers staying in their jobs a little longer will have two positive effects on the pension insurance system: they contribute more money to the pension fund and draw less money out of it. This as they are retired for a shorter time period. During the last decades, growing life expectancy has increased the length of time people draw a pension but has not affected the amount of time an individual spends in the labour force. This development may be pleasing an individual level but it is deleterious to the pension fund.
A dynamic adjustment of the statutory retirement age to life expectancy would split people’s increased lifespans between labour and retirement using a well-determined formula. As an example, if a person is expected to live one year longer than her ancestors, she would have to work for eight more months until she reaches retirement age. This regulation would balance the costs of a longer life time between different generations, and it would limit further discussion about the statutory retirement age.
More children, less income per capita
One of the requirements for the continuity of the intergenerational contract is that people have children and invest in the next generation. Both parents and non-parents benefit from children being future contributors to the welfare system. Parents, however, have to pay the direct and indirect costs for raising their children largely on their own. It is in everybody’s interest therefore to relieve the burden of people with children and to lower the costs of bringing up children. The expansion of an affordable and high quality childcare infrastructure, from nursing homes to all-day schools, will be an important part of this. Additionally, a comprehensive childcare system has two positive side effects: As labour participation and family work go together more easily, more mothers may opt for going back to their jobs. They will then pay more taxes and thus largely refinance the additional expenses for the extended childcare system. High quality nursing homes and after school care also assist in children’s later educational performance.
A high educational level is a key requirement for a sustainable welfare system. In a pay-as-you-go system, annuity claims resulting from the intergenerational contract are not covered by any capital stock, but are continuously financed by the current labour force. The more those people in the labour force are able to earn, the more money can be paid to the financially dependent. Most of all, in an aging society with a shrinking labour force, education plays a crucial role. The aging and shrinking of the population presents our society with great challenges and it is hard to imagine, that “keep going” would be the right track for our social security systems. The growing number of pensioners and the increasing demand for ambulant and hospital care as well as for medical treatment will lead to increasing demands upon the social security system.
Whether or not this situation results in conflicts between or within different generations will largely depend on how fair people conceive the distribution of financial loads to be. The more people contribute to the welfare system, the more productive they are and the more they appreciate raising children as an indispensable part of the intergenerational contract, the less conflicts will arise as a consequence. Furthermore, future generations will be more willing and more capable of carrying financial burdens they already accept and expect.
Click here to view the full German version of the discussion paper “The future of the intergenerational contract”.
The Berlin Institute is grateful to its group of sponsors who made this discussion paper possible.