Pensions are intergenerational contracts. In recent decades, many European countries have witnessed low fertility rates, which has put pressure on that contract. Although many assume that they have paid their own pension, this is not the case.
When we pay pension contributions, we mostly pay the pensions of the previous generation. Only on a minor scale do we contribute towards our own future pension (if prefunding is involved). In a pay-as-you-go (PAYG) system, those who are active in the labour market share part of their income from labour with the current pensioners and mandate the succeeding generation to do the same for them in due course. The pension system is an intertemporal contract also with people who have not even been born yet.
In a public pension system, there are three ways a generation can secure the financing of its own pensions. It can either prefund part of its pensions, provide-in-kind by child-rearing, or take in working-age immigrants to pay for its pensions.
Two of these financing methods are collective, that is, the costs are carried by the whole generation and not by specific individuals. The potential costs of prefunding and immigration are paid by everyone, and there can be no free riding. As a result, the equal treatment of individuals is not an issue in the collective methods.
However, the situation changes when we look at the third option: starting a family. It is an individual choice that is often associated with positive emotions, but it involves costs (both in terms of money and time) for the individuals who make that decision. Parents keep up the intergenerational contract by raising the succeeding generation that will pay the pensions of the preceding one. Even though parents do not contribute more (in cash) to the pension system than other members of society do, it could be argued that, through child-rearing, they contribute more financially. That is why we might need to consider a ‘pro-parent pension policy’ that acknowledges the contribution that parents make.
Do parents contribute more?
Gal et al. (2018) have shown in their recent research that parents invest a great deal of private resources (cash and time) to raise their children. These private transfers are almost exclusively intra-household, but they generate large social returns since the children will become net contributors in working age. According to Gal et al.’s results (when time transfers are valued at market price), the cumulative transfer burden over the active section of the lifecycle (net of public transfers in old age) is more than twice as large for parents than for non-parents. Their research supports the argument for levelling out this transfer burden of parents.
Gal et al.’s research is in line with the stance that Germany has taken. In a landmark decision in 1992, Germany’s Federal Constitutional Court stated that parents of large families contribute more to the sustainability of the pension system than others do. The court ruled that child-rearing periods should be credited to eliminate the existing discrimination within the pension system against families with children. According to the German court, PAYG pension systems should take child-rearing periods into account. Since that decision, Germany’s statutory pension insurance system has credited one of the parents in a family for child-rearing periods.
Is there a parenthood penalty?
The Nordic countries are champions in Europe in terms of the employment rate of women. There are many reasons for this, but one of them is the high share of institutionalized childcare. Both parents can work since affordable childcare is available. However, according to research, and in practice, women suffer from an earnings reduction due to motherhood.
Kleven et al. (2019) have shown that women’s earnings drop considerably when they become mothers compared to their pre-motherhood situation. The researchers label this drop a ‘child penalty in earnings’. In a recent paper, they show that mothers’ long-term penalty in earnings ranges from 21 to 61 per cent in the countries they studied. As pension systems have been reformed and the earned pension is based on the earnings throughout one’s working life, this decrease in earnings will later materialize as lower pensions.
What can pension systems do?
Sweden abolished its lifelong survivor’s pension in an extensive pension reform in 1999. Instead, it created a childcare credit for couples with small children (pensionsrätt för småbarnsår). The idea of this credit is to compensate the potential drop in earnings due to child rearing. Life with small children often means that the parents have to reduce their working hours to accommodate to their new situation in life. This, in turn, leads to a drop in earnings, which impacts their pension level. To mitigate this impact on pensions, childcare credits are offered to the parent with lower earnings.
As pension systems are based increasingly on individual rights, countries have reformed their lifelong survivors’ pension systems to reflect this idea better. However, it would be even more important to address the issue of parenthood and pensions since it is so significant for the sustainability of the pension system. Instead of addressing the issue of whom people have married and whether they have succeeded in staying together, maybe we should address the issue of whether they have contributed to the future sustainability of the pension system through child-rearing. In that case, we could transfer the money from survivors’ pensions to parents who experience an earnings reduction because they raise children. After all, in due course, the very same children will pay the pensions of the generation before them.
Gal, R. I. & Vanhuysse, P. & Vargha, L. (2018) Pro-Elderly Welfare States within Child-Oriented Societies, Journal of European Public Policy, vol 25(6), pp. 944-958
Gosseries, Axel (2005) Justice entre les générations et financement des retraites. Sécurité Sociale CHSS 5/2005, pp. 300-305
Kleven, H. & Landais, C. & Posch, J. & Steinhauer, A. & Zweimüller, J. (2019) Child Penalties Across Countries: Evidence and Explanations, NBER Working Paper No. 25524