2016 EEAG Report
Intergenerational Fairness
Torben M. Andersen, Giuseppe Bertola, John Driffill, Harold James, Hans-Werner Sinn, Jan-Egbert Sturm and Branko Uroševic
The idea of a contract between generations forms the bedrock of an equitable social order, stability and sustainability. In many countries the public sector is now expected to replace the family by funding education and pensions. The father of modern welfare economics, Arthur Pigou, envisaged the state as representing those who are "absent" from the discussion of the generational contract: "It is the clear duty of Government, which is the trustee for unborn generations as well as for its present citizens, to watch over, and, if need be, by legislative enactment, to defend, the exhaustible natural resources of the country from rash and reckless spoliation." (Pigou, 1932, pp. 29f.) But today social welfare models are facing major challenges produced by demographics and by funding challenges.
Modern Europe is ageing rapidly. The changing demographic pyramid gives politicians incentives to cater for the demands of the elderly, since they are becoming numerically ever more dominant, and to overlook the concerns of young people. Gerontocratic politics tend to focus more on the pay-out of past savings than on investment for the future. They result in policy choices that burden the younger generations and threaten the long-term sustainability of industrial and post-industrial societies.
The social or collectivised contract
The idea of a contract between generations is the basis for an equitable social order, stability and sustainability. The conservative theorist Edmund Burke famously put the generational contract in a larger perspective: "Society is a contract… a partnership not only between those who are living, but between those who are dead, those who are living, and those who are to be born." (Burke, 1790) Traditionally, the family has proven the most obvious way of expressing this idea of continuity among humans. Burke essentially saw a private contract that was violated by the dramatic political action of the French revolutionaries. But the character of the contract has changed remarkably since Burke's time.
In modern industrial societies, families no longer invest in children with the goal of securing their own position in old age, but have collectivised or socialised Burke's contract. The public sector is now expected to replace the family by funding education and pensions, but social welfare models are facing major challenges. We know now, after a century of experience, that the state is very likely to be captured by those who are present. In that sense, states fail to live up to the promise of yielding an equitable result. Collectivised intergenerational transfers lead to gaming of the system, and that helps to discredit the idea of the state, as well as that of the contract.
The labour market
Labour regulations offer employment security that fundamentally benefits older workers, and establish disincentives for employers to hire younger people. A dual or bifurcated labour market, particularly characteristic of Mediterranean Europe, protects the old and marginalises the young. As a result, young people who have received expensive training (perhaps not enough of it) are in no position to repay into the social contract. Relatively high rates of youth and younger generation unemployment have been a phenomenon of crisis economics in the Eurozone, and have led to political polarisation and radicalisation; but the phenomenon of high rates of exclusion in some parts of Europe preceded the crisis. The emigration of the young and talented makes the demographic pyramid even more lop-sided, and raises the question of how social security systems will be financed in the future.
Housing exclusion
Housing resources are inefficiently allocated, with dwellings that are too big for the old and unavailable to the young. Older people own real estate, and younger purchasers (especially in urban centers) are deterred by rising prices (and cannot even get a foot onto the lower rungs of the "property ladder"). The younger employed or unemployed are especially disadvantaged. As a result, many young people continue to live with their parents into their 30s: the so-called "Hotel Mama" phenomenon, which is especially prevalent in southern and eastern Europe.
Retirement pensions and health
Working-age adults accumulate either private assets or claims on public support in anticipation of their own old age. The socialisation of old age provision is seen as a backward-looking corollary to investment in the young. This calculation reflects a need to save for the future of the currently middle-aged generation that is now investing in education for the future. In the new socialised contract, that saving is the compensation for the incomes foregone as working people finance educational investment for the future. The socialised contract is of a Pay As YouGo nature: it implies an implicit return equal to wage sum growth – when fertility goes down, the return falls; when longevity goes up, individuals draw more on the contract.
Pension schemes, mostly originally designed as Pay As You Go systems, are proving increasingly precarious. The funding of the pension entitlements of younger people is threatened as demographic projections predict that there will be fewer new earners paying in ("as you go"). In addition, pensions have risen because of provisions that often both index and guarantee a certain increase, even when the increase in the cost of living is low. There is a strong case for raising the retirement age, but even stronger political pressure resisting such reforms.
In socialised medical insurance systems, increasingly expensive care for older people in the last years of their life dominates the cost structure. The health care explosion will disproportionately affect the most prosperous European countries, which are also likely to face the prospect of migratory outflows, especially by skilled younger people.
Expensive legacies
When productive and innovative (young) people abandon their country, they leave behind a highly indebted nation whose debts then have to be paid off by a smaller, less productive, ageing population. In a sense, individual citizens have an option to "walk away" from their government debt obligation by leaving their native country. Emigration can be seen as an individual's "private default option" on government debt. Government debt, frequently incurred to maintain the advantages of the elderly, is becoming unsustainable.
Finally, environmental damage threatens the future of the young, as present day output is obtained cheaply at the cost of future generations, who will have to bear the burden of the clean-up costs.
Europe is faced with a radical choice over where the responsibility lies for enforcing an effective and just social contract. In a world of high mobility, the old model of competing national examples is threatened by the possibility of exit from policy failures. There is a need to Europeanise some part of the intergenerational contract and, at the same time, to protect it from political interference – an interference characteristic not only of states with poor performance and failed policies, but also of apparently successful economic models.
References
Burke, E. (1790), Reflections on the Revolution in France, J. Dodsley, London.
Pigou, A. C. (1932), The Economics of Welfare, Macmillan, London.