Ifo Viewpoint No. 23: The Socialisation of Human Capital

A comment on the recent decision of the German Constitutional Court
Hans-Werner Sinn
Munich, 5 April 2001

The birth rate in Germany is below the replacement level, the ratio of old to young people will more than double by 2035, and Germany will then have the oldest population in the world. No less than 40 million younger immigrants would be needed to keep the present ratio of young to old constant up to 2035.

The ageing population is the result of changing lifestyles. The DINK family (dual income, no kids) is becoming increasingly popular. It's easier for two family members to live on two incomes than for five on one. Many young people don't even consider having children.

Demographic developments will weaken the growth forces in Germany. The largest age cohorts are still between 35 and 40. In the coming years, these people will advance the New Economy and boost growth. But in fifteen years the oven will cool down, and in thirty years the fire will have gone out. Today's 35 year olds will be retired, and after this generation not much will follow

Providing for the elderly will become more problematic. If pension benefits are adjusted in accordance with increases in gross wages, the pension contribution rate will have to increase from today's 20% to more than 40%. Only by cutting benefits in 1992, 1999 and 2000 and by shifting the pension costs to the general budget was it possible to cap the future contribution rate at 24% and to create the illusion of a problem solved. But who will pay the taxes, and how will society deal with increasing poverty among the elderly?

It is high time that Germany takes the problem of an ageing population seriously. The consequences and the causes of the high proportion of elderly are related. A generation that fails to build up human capital, by having children, or real capital, by accumulating savings, will go hungry when they are old, since you can't get out what you haven't put in. Germans now prefer to have fewer children than they once did, and they have also chosen to decrease their savings rate. This means that a crisis is looming in the provision for the elderly. Increasing savings is the least that can be done to avert the crisis. Opting for promoting savings instead of making savings obligatory was a mistake the German government made in the recent pension reform. Whoever saves money by not having children can certainly be expected to put the money away in a savings plan, especially when the suspicion arises that these people don't save because they expect to live off social welfare in old age.

It would be more important, of course, to change young people's attitudes toward children and family. This doesn't mean that the government should get involved in matters that are not its business, but it can put an end to the massive influence on family planning that it currently exerts via the pension insurance system. Pension insurance is insurance against childlessness since it gives an individual entitlements against the children of other people if that individual has no children of his own. This insurance is justified to the extent that the ability to have children is unpredictable. But the problem is that the number of children is largely planned and not accidental, and the pension insurance system has contributed to the declining number of children that people now have.

Before Bismarck introduced the statutory pension scheme, everyone knew that they would be poor in old age without children of their own and would have to rely on relatives to support them. For this reason, children were a planned part of people's lives, as is the case in most countries of the world. Pension insurance, however, has destroyed the connection between the living standard in old age and the number of own children. The example of the uncle or aunt who managed to survive in old age without having had children, has become the accepted thing. From generation to generation, life planning has gradually changed, and today the relationship between children and the standard of living of the elderly has vanished completely from the consciousness of young people. People no longer think about pensions when they think about having children. This proves how strong the fertility restraints of the statutory pension system are.

The false incentives provided by the pension system must be rescinded. Scaling the contributions to the pension and nursing-care insurance scheme according to the number of children, which the Constitutional Court has called for, is a reasonable solution. But it doesn't help relieve the pressure on future generations, who cannot be expected to bear the contribution burden in light of their few numbers. It would be much better to scale pension benefits to the number of children. All pensioners who helped create the foundation for pension benefits by having their own children should not be subject to benefit cuts. The rest must get by with less, but they already have the funds needed to offset benefit reductions with their own savings.

Such a system would impress upon young people in Germany that they are responsible for their own pensions, and it would at least restore a portion of the natural motivation for having children. Traditional family assistance attempts to offset the socialisation of human capital in the pension system by giving transfer payments to large families. It attempts to compensate one government intervention by another. The scaling of pension benefits according to the number of children achieves a similar goal by reducing the volume of intervention. In principle it is the correct means for meeting the demands of the Constitutional Court.

Hans-Werner Sinn
President of the Ifo Institute

German original published as "Rentenhöhe nach Kinderzahl" in Welt am Sonntag (08 April 2001, p.5).