Ifo Viewpoint No. 42: Pensions and Children

Hans-Werner Sinn
Munich 15 January 2003

The pension crisis, which as we all know will lead to pension cuts, is basically attributable to the declining birth rate in Germany. Ten Germans now only have, on average, six children in the course of their lives. Also in terms of birth rates, Germany takes the bottom rank internationally. There are diverse reasons for the decline in the birth rate but one of the most important is the pension system itself.

Pension insurance is insurance against childlessness and the resulting old-age poverty. Even if people do not have children of their own, they will not become destitute when they are old because the children of other people will provide for them. Mutual insurance protection is a great advantage for all participants. The problem is that this insurance weakens the economic reasons for having children since it almost fully socialises the contributions of the children to the generation that preceded them. Before the introduction of the statutory pension scheme under Bismarck, it was common in Germany to have children to safeguard one’s standard of living in old age. This motive is lacking today. Old age provision no longer depends on having your own children. It suffices if other people have children who later pay the pension contributions. Pension insurance has suppressed one of the most important motives for having children from people's consciousness.

It is no coincidence that Germany, where statutory pension insurance was devised, is now a country with one of the lowest birth rates. Since 1889 generations of Germans have experienced that old age is manageable without one’s own children, and thus new life styles have developed from generation to generation that are adapted to the new institutional circumstances. Life as a single has become increasingly more attractive, and today DINKs are en vogue: double income, no kids. Two incomes without children is always better than one income and several children. It makes life much more pleasant.

But every generation becomes old at some point, and the elderly can only survive if they have taken precautions when they were young. Either they have added to society’s human capital by having raised children, or they must save and thereby accumulate real capital, directly or indirectly, so they can live from consuming this capital. A generation that adds neither human nor real capital must go hungry in old age.

Since Germans form less human capital today than former generations did, they must accumulate real capital as a substitute in order to replace the declining pension due to lack of progeny. This is the idea that led to the new German pension scheme and to pension cuts in the pay-as-you-go system. But the new scheme has not been completely thought through. It treats the symptoms of the German disease but not its causes. It does not reduce the negative incentives for family planning and leads to nearly intolerable burdens for those who by having raised children have already made the full contribution to the financing of pay-as-you-go system.

Instead of placing collective responsibility on a whole generation, the necessary pension cuts and the compensating new savings plan should be concentrated on the childless. Whoever has not raised children can be expected to take a pension cut of one half. The already built-up entitlements must not be infringed on, however. The reform should only affect today’s young people. They have time enough to save up for a sufficient pension with the new scheme if they choose not to have, or cannot have, children.

The adjustment of pay-as-you-go pension benefits to the number of children is justified because it follows the causation principle and the ability principle. Those who have no children and in this respect have not done enough to safeguard their own pensions in the pay-as-you-go system must bear the consequences and accumulate savings instead. And the childless are in a position to save because they do not incur any costs for child rearing. They are relatively liquid and can invest the money not spent on children in the capital markets to supplement their reduced pension benefits.

Some may argue that by paying their pension contributions, young, childless citizens have already provided for their own pensions, and for this reason it is unfair to force them to join the new scheme as a second savings plan. This argument fails to see that historically the normal duty of every generation was to provide two services: In the working years one’s parents and children had to be fed. Today, the first of these two services is provided in the form of pension contributions which fully go to today’s pensioners. But many now fail to provide the second service because they choose not to have children. Thus it is justified to require a second service from these people in the form of the new savings plan. In this way they safeguard their pensions whose full financing can no longer be borne by the few future contributors. To require people that raise several children to participate in the new plan would be imposing a triple burden on them. As contributors they now provide for the elderly, as parents they finance the pensions of all future pensioners via the costs of child rearing, and as savers they would also have to finance their own pensions.

The adjustment of the pay-as-you-go pension system to the number of children is not only just, it will also lead to a change in family planning. If the childless must put 8% of their gross income in a compensating savings plan, having children could take on greater importance in life planning. Under these circumstances an undecided young couple may just decide to have children.

Experience shows that family planning reacts strongly to economic incentives. When the GDR introduced economic incentives for boosting birth rates in the 1970s, the number of new-born children clearly increased. And in 1957 when Saarland shifted from the generous French system of family support to the more miserly west German system, birth rates clearly declined. The so-called social security hypothesis, which holds that the pension system influences the decision to have children, has been confirmed by empirical studies, for Germany, too.

This is not an argument for a state population policy that would interfere with the free decisions of its people and dictate the choice for children. Quite the contrary. Today the state intervenes massively in family planning by way of the pension system when it socialises the pension contributions of the children and thus suppresses the natural provision motive behind having children. To introduce a pension system based on the number of children is to reduce the degree of socialisation and to reduce the influence of the state in family planning. It doesn’t mean giving the state more influence.

Hans-Werner Sinn
Professor of Economics and Public Finance
President of the Ifo Institute

Published as "Rente nach Kinderzahl" in Frankfurter Allgemeine Zeitung, No. 11, January 14, 2003, p. 12 and as "Wer keinen Nachwuchs hat, muss zahlen" in Financial Times Deutschland, December 27, 2002, p. 30.