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Just Pension
by Hilde Wisløff Nagell
Institute of Political Science
University of Oslo, October 2002
i
Preface Public pension systems are, to use Karl Hinrichs' characteristic, “elephants on the
move”(Hinrichs 2000). They are huge: they comprise a large share of public budgets,
and as pension systems mature and the baby boom generation grows old, the size of
the total budget that goes to finance pension increases. They are also evolving:
pension systems established after the Second World War are now increasingly subject
both to inside and outside pressure: international capitalism requires flexible working
conditions and open labour markets. Changes in life expectancy, lifestyle and working
conditions radically change the concept of retirement and old age. In the face of new
circumstances, there is a need to rethink the rationale behind public pension systems.
In doing this, it is important to ask the question of what a just or equitable pension
scheme is.
The title of this dissertation, however, hides a second meaning. Disagreements about
the size and funding of pension schemes increasingly dominate political debates and
have even contributed to cause changes in governments. The large share of funds
needed to cover pension expenditures implies an increasingly pre-determined public
budget, with very little flexibility. One could ask why pensions should have such a
privileged position in public budgets and political debates.
The focus on the question of justice between generations in a national insurance
scheme has placed me at an interdisiplinary crossroad. My own point of departure is
Normative Political Theory. This is a somewhat unusual approach to the study of
pension systems, and one that has required the intervention of strands of research from
the fields of economics, philosophy, law, sociology, and empirical political science.
My supervisor Raino Malnes has played a crucial role throughout the entire process of
this research. I am grateful for the fact that he was always available and had a speedy
rate of "turnover" when it came to reading my newest ideas. His sense of logic proved
invaluable and his comments were always to the point. Furthermore, he provided
courage when I was lacking and encouragement when that was needed.
A host of other persons have provided useful insight along the process. Alexander
Cappelen and Halvor Mælum guided me through the economics literature and made
valuable contributions to Chapters Three and Four. I have also been fortunate enough
to be able to draw on the expertise of a number of philosophers. Among these, I would
in particular like to mention Dagfinn Føllesdal, Andreas Føllesdal, Thomas Pogge,
Henrik Syse, Onora O'Neill, Samuel Scheffler, and Tore Lindholm. Special thanks to
Helge Høybråten for a frank and rewarding discussion of Chapter Six. Årstein Risan,
Einar Øverbye, Kåre Hagen, Axel West Pedersen, and Aksel Hatland made sure my
theoretical discussion were in sync with political reality.
The Ethics Programme provided a challenging and rewarding research environment. I
would in particular like to thank coordinators Tom Eide and Ulla Schmidt, and fellow
participants Eli Feiring and Anne-Julie Semb. On a more personal level, Mona Fixdal
has been an important source of help and support. The Institute of Political Science
provided me with office space and other facilities needed throughout these years,
while "The Lunch Club" consisting of Kaja Kjerschow, Synne Hedlo, Evalill Bølstad
Karevold, and Hanne Hjelbak made it easier to get through long days of work.
As with most other lengthy processes, it has at times been tempting to quit. However,
like Ulysses tied himself to the mast to avoid being tempted by the Sirens, I have had
two very effective pre-commitment strategies: In May 2001, I accepted an offer to
work at the Research Ethical Committees. The position was to be full-time once I had
finished my dissertation, and has served as a "carrot" throughout the last year. Another
incentive to finish came in the form of a much-desired pregnancy and the
determination to give birth to my intellectual baby first. Last but not least, I would like
to thank Tor, without whom these words would not have been written, and Jonas for
reminding me what truly is important in life. I intend to soon make up for all the lost
time when I have not been around.
Hilde Wisløff Nagell Oslo, October 2002
iii
Contents
1. Introduction ..................................................................................................1 1.1. Introduction................................................................................................................1 1.2. More than a Financial Problem..................................................................................1 1.3. Pension from the Individual’s Perspective ................................................................4
1.3.1. Public Pension and Basic Income ......................................................................5 1.3.2. Public Pension and Insurance ............................................................................7 1.3.3. Public Pension and Entitlement .......................................................................10 1.3.4. Public Pension and Political Guarantees..........................................................12 1.3.5. Public Pension as Legal Guarantees ................................................................14
1.4. Distribution of Costs ................................................................................................15 1.5. Distribution of Risks ................................................................................................16 1.6. Remedies for Time-inconsistency............................................................................17 1.7. Protection of Rights .................................................................................................17 1.8. Common Ground .....................................................................................................18 1.9. The Case of Norway ................................................................................................19
2. Common ground.........................................................................................21 2.1. Introduction..............................................................................................................21 2.2. Rawls and a Duty of Civility ...................................................................................22 2.3. Nagel and Impartial Partiality..................................................................................28 2.4. Common Ground .....................................................................................................33 2.5. References................................................................................................................35
3. Redistribution.............................................................................................36 3.1. Introduction..............................................................................................................36 3.2. Generational Accounting and the Principle of Horizontal Equity ...........................37 3.3. Rawls' Account of Justice Between Generations.....................................................41
The Motivation Assumption ........................................................................................43 The Previous Generations Assumption........................................................................45 The Argument of Previous Generations and the Strict Compliance Condition...........46 The Previous Generations Assumption as an Additional Condition in the Original Position ........................................................................................................................49
3.4. The Original Position and the Account of Intergenerational Justice Revisited .......52 Vertical Equity: the Two-Way Saving Principle .........................................................55
3.5. Concluding Remarks................................................................................................57 4. Risk Sharing ...............................................................................................60
4.1. Introduction..............................................................................................................60 4.2. Generational Risks ...................................................................................................62
4.2.1. Financial Market Risks ....................................................................................63 4.2.2. Macroeconomic Shocks ...................................................................................66 4.2.3. Demographic Shocks .......................................................................................67 4.2.4. Political Risks ..................................................................................................69
4.3. Intergenerational Risk Sharing ................................................................................71 4.3.1. Two Variants of Consumption Smoothing ......................................................72 4.3.2. Insurance Behind a Veil of Ignorance .............................................................73
4.3.3. Model 1: The Rationale for Risk Sharing in Defined Benefit Plans................74 4.3.4. Model 2: the Rationale for Risk Sharing in DC Plans .....................................75
A Formalisation of the Rationale for Risk Sharing .....................................................76 4.3.5. In Summary:.....................................................................................................78
4.4. DB + Buffer Fund ....................................................................................................78 4.5. DC + Guaranteed Real Return .................................................................................84 4.6. Concluding Remarks................................................................................................87
5. Pre-commitment.........................................................................................88 5.1. Introduction..............................................................................................................88 5.2. The Pre-commitment Model ....................................................................................89 5.3. Pre-commitment at the Level of Society .................................................................94 5.4. Saving ....................................................................................................................104 5.5. Credibility ..............................................................................................................112 5.6. Concluding remarks ...............................................................................................116 References............................................................................Error! Bookmark not defined.
6. Democracy ................................................................................................118 6.1 Introduction............................................................................................................118 6.1. The Enabling Character of Constitutional Democracy: Holmes’ Argument.........119 6.2. Democracy and Rights: Habermas’ Argument ......................................................121 6.3. Reasonable Disagreement: Waldrons’ Argument..................................................125 6.4. Constitutional Essentials: Rawls’ Argument .........................................................127 6.5. Constitutional Protection of the Right to Public Pension ......................................135
7. The Case of Norway.................................................................................138 7.1. Introduction............................................................................................................138 7.2. Four Issues of Discussion ......................................................................................139
7.2.1. The Problem of Financing .............................................................................140 7.2.2. The Introduction of Defined Contribution Plans ...........................................143 7.2.3. The Question of Funding and Oil ..................................................................147 7.2.4. The Question of Constitutional Pension Rights.............................................152
7.3. Four Proposals for a Pension Reform ....................................................................161 8. References:................................................................................................164
v
vii
Introduction
1. Introduction
1.1. Introduction
Public pension systems have enjoyed high popularity as long as their promises seemed
credible and generous. There is growing fear in many countries, however, that the
national pension plans will not be sustainable. In response, the debate concerning the
nature and scope of pension systems has increased in both size and intensity over the
last years, and much has been done to re-examine the principles of current systems
and assess principles of reform.
This thesis contributes to the debate in two ways. First, it includes time as a variable
in the discussion of pension systems. National pension plans are collective enterprises
involving many generations. Different generations are linked together through a
distribution of rights and obligations. The financial burden of a pension system is
likewise spread over the generations. Thus, even if intergenerational justice is
considered an especially difficult topic in political theory,1 no debate about public
pension systems is complete without it. The second aim of this thesis is to draw
theoretical implications to the case of Norway. Norway is currently in the process of
reforming its national insurance system. Although not the main focus of this thesis,
the last chapter will discuss policy implications and propose elements of a reform.
1.2. More than a Financial Problem
In most OECD countries, pensions are financed primarily by taxes that the working
population pays each year, a system of intergenerational transfer. In such pay-as-you-
go (payg) systems, the working part of the population pays directly to support those
who have retired. They must, in turn, rely on the next generation to pay for them when
they retire.
1 Questions of intergenerational justice are considered to be “hard cases” (Goodin 1999:194)
1
As long as workers greatly outnumber pensioners, the system works reasonably well.
However, birth rates have fallen sharply over the last 50 years. The occupationally
active population will increase only to a minor degree, while the number of pensioners
will increase considerably and reach a peak between years 2010 and 2050. The “baby-
boomers” who were born around 1945 will then have reached retirement age. They
will have earned the right to a maximum pension and, due to increased early
retirement and longevity, may look forward to a longer period of retirement than any
generation before them. Most OECD countries will, therefore, have problems
financing their existing pension systems even if they gradually increase retirement age
to 70. The cost of the state pension scheme will by 2040 increase to 14 percent of
gross domestic product (GDP) in France, 18 percent in Germany, and 21 percent in
Italy (OECD 1998), (Feldstein and Samwick 2001: 1).
It is generally recognised that the question of how to finance pensions will, in the near
future, be one of the major economic challenges facing modern welfare states. These
anticipated financial problems, often referred to as “the pension time bomb”(Sterling
and Waite 1998) or “the old age crisis”(WorldBank 1994), have resulted in quests for
reforms in current payg pension systems.
Some of these reforms are “parametric”, in the sense that they aim to alter the details
of existing schemes by, for instance increasing retirement age, raising contribution
rates or altering the generosity of pension benefits. Other reforms involve more
fundamental restructuring of existing schemes, such as a shift from pay-as-you-go to
funded schemes, or a move toward private market solutions.
It is evident that the ageing of the population imposes an increasing strain on public
finance. It is equally clear, however, that in order to provide a remedy for these
financial problems, reforms must lead to higher government saving in aggregate.
Pension expenditures, today and in the future, must always be provided for out of
current production in the same time period. What matters for the financial situation is
the size of the gross domestic product, since GDP expresses the availability of real
Introduction
resources that may be used to finance the consumption of goods and services by
people in their old age. Thus, the true pension burden is measured by the spending on
retirement relative to GDP.
Changing the way pensions are financed is unlikely to change the magnitude of the
costs associated with an ageing society. Both payg and funded pension schemes rely
on future consumption, and are therefore equally exposed to a decline in the ratio of
workers to retirees (Barr 1997:213-215). However, changing the way pensions are
organised may change the distribution of these costs. What a pure economic analysis
tends to overlook is that workers and pensioners are groups with opposing interests.
Pensioners need a firm and solid claim on the national product to be able to consume
the goods and services currently being produced. Similarly, the support of the pension
scheme depends on whether it is conceived of as reasonably just and believed to be
sustainable in the long run. The major choice when reforming national pension
schemes is, therefore, not so much a question of how to solve the current financial
problem, but rather of how to solve the potential conflict of distribution between
different generations of workers and pensioners. The latter question can be divided
into four main issues:
1) Which principles should guide the distribution of pension income between
generations in an ageing society?
2) How should risk be distributed between workers, retirees, employers and the
state, and how may risk be distributed between generations?
3) How can the government pre-commit itself to a long-term pension plan?
4) How can the vulnerability of pension entitlements be reduced?
These four questions will form the basis of the discussion in this thesis, and I will
expand on them later in this introduction. First, however, characteristic features of
public pension rights will be investigated.
3
1.3. Pension from the Individual’s Perspective
To save for retirement, from an individual’s perspective, is to transfer resources from
one's working years to one's later days and thereby create a claim on future national
income. Income smoothing is accomplished by exchanging current production for a
claim on future production. There are basically two ways in which individuals might
do this:
They can save money that could later be exchanged for goods from future production;
or they could obtain a promise from their children or the government. In return for
giving up a part of present consumption, they will be promised a share of future
consumption (Barr 2001:90). The terms of this promise are given in a country's social
security legislation and constitutional law.
Both ways of consumption smoothing create a private claim on the value-generated
process of productive capital. In national pension schemes, this creates a right to
retirement income where the society as a whole has a liability toward the holder of the
claim.
One cannot help but notice the increased focus on “rights” in Western societies. The
number of different contexts in which the notion of a right appears is also striking. We
talk about the right to free speech and freedom of association, but also about the right
to hospital treatment, the right to certain social services, the right to vacation, and the
right to go shopping on Sundays. One reason for the increased appeal to rights is that
they serve to draw attention to obligations. To have a right usually implies to have a
valid claim against someone.2 Someone is to be held responsible: a particular person
or organisation, the state, or “all of us”. The reference to rights, then, gives extra
2 W.N Hohfeld, in his classic analysis, identifies four different categories of rights. When we talk about someone having a right, we are likely to have in mind one of the following four concepts: a claim-right, a power, a liberty, or an immunity. However, only claim-rights can, according to Hohfeld, properly be called rights. Claim rights is the most important category of rights, and can be expressed in Alan Gewirths definition: “A has a right against B by virtue of Y, where A is the right-holder, X the object of the right, B the person who has the corresponding duty, and Y the justificatory basis, ground or rule of the right (Gewirth cited in Syse 1996:14, Waldron 1984:93)
Introduction
strength to arguments in cases of political controversy. To have a right to x may
involve a legal claim or a moral claim or both.3
Rights to public pension for old age are legal welfare rights. They are rights that can
be traced back to the development of a welfare state, and they reflect what a given
society defines as the best overall conception of welfare. It is worth remembering that
an overwhelming majority of the world’s population lacks a well-developed income
security in old age. However, in a number of both developing and advanced countries
throughout the world, the reform, development, or adjustment of the national pension
scheme is on the political agenda.
Most state pension systems consists of two basic elements: a basic pension that aims
to provide basic security for all, and a supplementary pension that aims to prevent a
large decline in the standard of living after retirement through a system where each
pay according to his or her income. Different welfare regimes combine these elements
in a number of different ways. Given that public pension rights consists of these two
components, a basic pension and a supplementary pension, what more could be said
about them? The next five sections show that public pension rights have different
normative elements. Pension rights can be understood as basic income protection, as
personal saving insurance, as entitlements, and as political and legal guarantees. A
national pension scheme normally contains all five elements.
1.3.1. Public Pension and Basic Income
The right to basic pension is a right to a basic minimum. The claim-right involved
here is a right to money, (which may or may not be mean-tested, but usually is not). It
is a right to receive money from the state after having retired from ordinary work as
the result of age. The right to basic pension is a safety net: it provides income security
to aged persons with the aim of reducing social risk. A social risk can be defined as
3 Legal rights are rights people have according to positive law. Moral rights are rights people should have according to some moral principle.
5
one of those life situations or conditions that increases the likelihood that an
individual’s livelihood may be in jeopardy (Øverbye 1998:39).
It is important to keep in mind, however, that the social risk of old age in advanced
countries has changed dramatically over the last years. As Anthony Giddens puts it:
“[o]ld age is a new-style risk masquerading as an old-style one” (Giddens 1998:119).
Ageing is no longer synonymous with reduced working capacity, poor health, or a
more passive life. On the contrary, people in general are healthier, live longer, and
have a more active life after retirement, than ever before. In addition, average life
expectancy is higher and, over the last two decades, the average retirement age has
fallen substantially in almost every OECD country (James 2000:273). This results in a
much longer period of retirement. Otto von Bismarck once set the optimal age for
retirement at sixty-five. Life expectancy was then just forty-five. Average life
expectancy in OECD is now 76, whereas average age of retirement is 62 (OECD
2001). This implies a much longer period of retirement. It also means that retirement,
to a larger extent, is something one chooses willingly. Early-retirement schemes and a
lower more flexible age of retirement in public pension systems underscore this
development. Many still retire as the result of pressure at the workplace, or because
they are worn out, but this is no longer the general tendency.
When patterns of social risks are changing, so should the strategies for risk-reduction.
In the classic life-cycle model of saving, individuals do not have smooth patterns of
consumption over their lifetimes. They will, therefore, be inclined to save for periods
when their income is below average. Economists usually stipulate the normal
consumption-income pattern to be something like the following: young people
consume more than they earn in a period when they are students, buy their first
houses, etc. They then have a period of steady income, when they can repay their
loans and save for retirement. The life cycle is developed into three phases: education,
employment, and retirement. Today it is much less evident that people should save for
retirement only It may be equally compelling to use saved resources to finance
additional education, reduce working hours when raising young children, etc.
Introduction
(Giddens 1998 374). At the same time, the need to compensate for temporary and
permanent loss of income from work is growing. The introduction of new technology
and rapidly changing labour markets result in uncertainty and exclusion. Low-skilled,
part-time or temporary workers are particularly vulnerable, but full-time high-skilled
workers also risk that their skills become outdated or less in demand. Some have
argued that new risks like these are best addressed by introducing a minimum income
guarantee.4 A minimum income would substitute the basic pension, but also make it
possible, for instance, for one to take a sabbatical year in the middle of a working
career. It would also benefit the active elderly who wish to work less, take a few
months off from work, or concentrate on unpaid work without having to fully retire. I
will leave the question of a minimum income guarantee aside. It is worth noting,
however, that public pensions aim to provide basic income protection.
1.3.2. Public Pension and Insurance
There are important differences but also considerable similarities between pensions
provided by the state and private pension plans. However, all pension schemes include
an element of insurance.
A relevant difference between mandatory publicly managed schemes, financed by
payroll taxes on a pay-as-you-go basis, and private insurance, based on fully funded
individual accounts, is that with private insurance the money, virtually “is there”.
Each member has the right to his or her more or less predefined share of that money.
Needless to say, a funded system may also have problems fulfilling its obligations.
The difference between the two systems is basically that in an un-funded payg system,
the pension entitlements are not automatically made visible on the deficit side of the
budget. In these schemes, the financing of pension obligations depends on the
willingness of the next generation to give their contribution. In a fully funded
individual account, the future pension has more the character of an economic property
or entitlement to be paid out. However, the two models are by no means restricted to
the public and the private sector respectively. Many private occupational pension
4 For a discussion of the idea of a minimum income, see for instance (van Parijs 1996/2000)
7
plans are payg, and partial funding in individual accounts has increasingly been
introduced also in the public sector.
The difference between defined-benefit and defined-contribution is another important
distinction in the qualification of pension systems. Defined benefit specifies a certain
given level of pension, for instance 2/3 of prior earnings. In a defined benefit pension
system, one has a relatively clear idea of the level of future annual pension benefits,
but the amount one must pay to receive that pension may vary. The opposite is true in
a defined contribution system. Defined contribution specifies the amount of premiums
paid into the scheme, rather than defining the amount of future benefits to
policyholders. No commitment is made with respect to the benefits; the contributions
are invested in the financial markets, and the benefits are paid according to how well
these investments fare.
Many public pension systems are defined benefit pension schemes. Exactly how
“defined” these benefits really are, however, is an open question that will require
empirical investigation. A number of small adjustments and changes can be made that
together affect the size of future pension entitlements. The government may also
change other important income parameters that will influence the real value of pension
benefits, such as the level of taxation. A central question with regard to pension rights
in a defined benefit system is, therefore, to what extent may the benefits be adjusted
before the rights in question are violated.
Until recently, defined contribution plans have been used primarily in the private
sector. However, many public pension reforms have included some form of
individually owned, privately invested, retirement accounts based on financial market
return. One problem with these schemes is that they expose individuals to financial
market risks. Insurance against these risks may be provided through guaranteed
minimum benefits or rate of return guarantees. A main argument in this thesis, and
one I will return to later in this introduction, is that the government is in a privileged
position to facilitate the trading of risk across the generations.
Introduction
In contrast to private pension plans, public pension systems often combine different
policy goals; in addition to being a mandatory saving plan, there is often a
redistributive component. Those with the highest income contribute more and benefit
less than those in the lower income strata. Other policy goals may also be
implemented through the public pension system. In Norway, for instance, pension
contributions from employers have a geographic distribution profile: firms situated in
remote areas pay less. This thesis argues that the pension system may also be a tool
for redistribution of income between generations.
While there are important differences between private and public pension, they also
share important traits. An important similarity between the two is that they both have
insurance as their basic objective. In two Norwegian social security cases, public
pension was directly compared to private insurance. 5 In one of the cases it was argued
that some public pension rights resemble rights in private insurance schemes.6 One
Supreme Court justice pointed to the fact that the supplementary pension had been
paid for and so resembles more of an ordinary insurance than the pension in the other
case. The other case concerned the supplement for a spouse, a pension benefit that
does not require prior payment. This was emphasised as an important distinction
between the two cases. The acknowledgement of this distinction led this particular
justice to claim stronger constitutional protection for rights to supplementary pension.
A majority of the Supreme Court justices, however, concluded that all pension rights
are financed by taxes and accordingly pension entitlements should be regarded as an
ordinary part of public expenditure. I will return to these cases in Chapter Seven.
The comparison between private and public pension alludes to the element of
individual saving insurance in pension schemes. Even though there are important
differences in institutional design between private and public pensions from an
individual's perspective, these differences may not seem so relevant. Supplementary
5 Supreme Court case 76 b 1996 nr 160 and 77 B 1996 nr.224 6 Supreme Court case 77 B 1996 nr,224, p.5
9
pension involves a connection between contributions and benefits. Each individual
pays during her working period in order to receive a pension when she retires.
Furthermore, if the public pension system had not existed, people would have saved
for their retirement in other ways. People rely on the public pension system to provide
them with a pension when they retire and therefore they do not buy private insurance
to the same extent as they would have. Mandatory payment to public pension also
places restrictions on money that could have been used to pay for private insurance.
1.3.3. Public Pension and Entitlement
The idea of pension has traditionally been closely tied to paid work. Pension plans are
part of the regulations between employer and employee. 7 Pension is a benefit that the
employee receives after life-long contribution in the labour market. In most countries,
national retirement benefits are financed through contributions from both workers and
employers. Contribution is an important feature in the normative foundation of
pension systems, even when there is no immediate or direct connection between what
one pays and what one receives.
Pension is not just something that is given to anybody. The recipient of the pension
must stand in a special relationship to those providing the pension and must have, in
some manner, made a contribution, either through paid or unpaid work or both. The
pension is something one is entitled to. A clear expression of this principle is the
supplementary element of public pension where, at least in the case of Norway,
pension points are accumulated every year, and the total benefits depend on earlier
contribution. Perceptions that benefits have been earned through a lifetime of
contributions greatly strengthen the general sense that a pension constitutes something
of an untouchable entitlement. Contributions imply a right to benefit. The basic
pension has also internalised this logic. Basic pension is usually only given to people
with a minimum number of years of residency in the country in question. Only those
who have taken part in the major enterprise of developing country X can claim a right
to a public pension in that country.
7 In many countries, the government also provides partial financing out of general revenues.
Introduction
This logic is reflected in angry notes written by elderly people that appear in the
newspaper whenever cuts in the public pension system are under discussion. “It was
we who built the country”, they argue. “We therefore have a legitimate claim against
the younger generations. We have a right to a rate of return on the investment we have
made in developing the wealth of the country. Now it is our turn to be helped and
cared for and be rewarded with a decent income in retirement. We have done our
share, now it is the duty of the next generation to take care of us.” 8
This relationship between contribution and entitlement seems to presuppose
membership in a community over time. It is easy to see how internationalisation, in
the sense of greater cross-national labour mobility, may challenge this relationship
because people become members of a number of different communities over their
lifetime. This problem is dealt with today, for instance, by the European Union (EU).
The new labour mobility within the EU provides new challenges for national social
security laws, and raises questions such as what happens to the pension rights of a
worker who was employed for several years in another country, and where should
social security contributions be paid. Many workers may be insured twice or not at all,
acquired rights to social security benefits may be lost, and other rights would be built
up.
In the European Union, these questions are regulated through community provisions
on social security (contained in Regulations No 1408/71 and 574/72). It is interesting
to note that the relationship between contribution and entitlement is taken seriously
and promoted through the new regulations. In every country where a person has been
insured, his insurance record is preserved until he reaches pensionable age; in other
words, contributions paid are neither transferred to another country nor paid to the
person if the person is no longer insured in that country. Every country where a person
has been insured for at least a year will have to pay an old-age pension when the
8 For an example, see Aftenposten Morgen Mandag 21.des.1998: “Pensjonen er betalt” av Erling Wasland, YS pensjonistforum
11
person concerned reaches retirement. For example, if you have worked in three
countries, you will receive three separate old-age pensions once you retire. These
pensions will be calculated according to your insurance record in each country. No
contribution will be lost, acquired rights are protected, and every country will pay a
pension according to the insurance periods completed there.
1.3.4. Public Pension and Political Guarantees
Politicians often use the term “right” in political slogans such as “all citizens in
category A should have the right to X”. Political promises of this kind are often vested
in law, but are particularly vulnerable to political changes. Many welfare rights are of
this kind. 9
In some welfare states, there has been a gradual shift in how political parties use the
term “right”. In Norway, Anne Lise Fimreite has documented this development
(Fimreite 2000). By examining the programs of three political parties, the Liberal
Party, the Labour Party and the Conservative Party, she has identified a change in
their use of the terms “right” and “right to”. From the late 1970s and early 1980s, all
of the parties have become more specific with regard to what, in terms of goods and
services, citizens are entitled to from the state. These welfare entitlements have
increasingly been termed “rights”. In the 1990s, all three parties have further increased
their focus on individual rights, and also emphasised the ability of individuals to
choose between alternative public services. During the 1990s the increased focus on
rights has led to the implementation of a number of new laws concerning the welfare
state.
Simultaneously, the public sector has adopted increasingly more contractual language,
especially as the result of the influence of “new public management”. The focus is on
each individual and how the public sector manages to “produce” the best, most
efficient product to satisfy the needs and expectations of particular individuals. Users
9 As Asbjørn Kjønstad and Aslak Syse put it in their book on Welfare Law :”Welfare law is to a large degree the realisation of political promises” (my translation) (Kjønstad, 1997:71).
Introduction
of the public sector (health-care, schools, etc.) view themselves more as “consumers”
than as mere “users” of the welfare state. When we buy something new, we rightfully
expect and demand that the product is that which the informative label declares.
Similarly, if a public service does not satisfy our expectations, we may complain and
be inclined to “go shopping” elsewhere. Rights in this respect may simply mean the
rights we have as consumers of goods and services, and they are often given in the
form of political guarantees. An illustration of political guarantees on a large scale is
the UK Citizen’s Charter. The Charter was launched by the Major-government in
1991, and sets out the quality and standards of service that people are entitled to
receive when dealing with public bodies. Although The Charter uses the word citizen,
it views the citizen as a consumer. Its emphasis is on the individual user, and the user
is entitled to as many or as few rights as the consumer in the market.
In an international perspective, political guarantees of this kind may come to play an
important role in attracting particular categories of workers. An effect of greater cross-
national labour mobility is the increased possibility of opting out. Public pension
systems are no longer absolutely mandatory since people may opt out simply by
moving to another country. This may affect the extent- and form of solidarity and the
pooling of risks in each country.
However, public pension guarantees are not quite like other political guarantees. The
special nature of pension systems will, in general, tend to make promises of public
pension more binding than other political promises. As we have seen, a pension
insurance scheme can be interpreted as a strategy of long-term saving where the aim is
to secure against a future loss of income. Such a saving strategy is highly dependent
upon stable rules. On the other hand, the nature of the intergenerational contract
inherent in a national payg pension system presupposes some degree of choice or
flexibility on behalf of the younger generations. They may feel that they should not be
forced to contribute to a pension system without any possibility of affecting its rules,
and they increasingly have a real possibility of opting out.
13
1.3.5. Public Pension as Legal Guarantees
A national insurance scheme normally includes rights to pension in cases of sickness,
disability, unemployment, and old age. This work focuses on rights to pension in old
age. Public pension rights are the implementation of a certain welfare policy. In
liberal Western societies, they are also the outcome of a democratic decision
procedure. As legal rights they should therefore be regarded as both legitimate and
binding. A more open question, however, is whether these rights are also morally
binding for future generations.
Constitutional rights are often discussed with reference to political and civil rights
(right to a fair trial, right to equality of treatment, right to life, right to vote, right to be
free from discrimination, etc.). These rights were central to the constitutional
innovations of the American and French revolutions. But there are also new
“generations” of rights that have derived from the development of social and
economic institutions in modern welfare states, such as the right to a minimum
standard of living, the right to work, or to hospital treatment.10 Among these rights is
also the right to social security.
The protection of individual rights is a central function of a constitution. 11
Constitutional rights take a variety of forms. They can be procedural (i.e., “due
process of law”) or substantive (i.e., right to property), negative (rights against
interference) or positive (rights to something). Regardless of the form, it is inherent in
the very definition of constitutional rights that they represent limits on majority
decisions.
10 There is often a distinction made between “first”, “second” and “third” generation’ rights. First generation rights are the traditional liberties and privileges of citizenship: religious toleration, freedom from arbitrary arrest, free speech, the right to vote, and so on. Second-generation rights are socio-economic claims: the right to education, housing, health care, employment and an adequate standard of living. Third-generation rights have concern communities or peoples, rather than individuals. They include minority rights, national rights to self-determination , etc. 11 There are basically two ways in which a constitution serves to protect individual rights. First, the Constitution is higher law- or Lex Superior: other laws must be in accordance with the constitution. Second, it can form a certain obstacle against regular majority vote because of its special rules and built-in delays.
Introduction
In a democracy, the legislative assembly has considerable freedom of action in its
duties and prerogatives. The role of the legislative power is to give laws. Thus, it
should have the freedom to do so without too many built-in constraints. Democratic
values are assured when elected members of the legislative assembly have control
over public expenditure. A constitution imposes certain limits on democratic decision-
making, and may therefore be regarded as “un-democratic”. In much the same vein,
public pension entitlements (even when they are not constitutionally entrenched)
impose restrictions on what the legislature can do. In effect, strong public pension
rights mean that public expenditure will be earmarked for the purpose of paying
public pension entitlement. With reference to the American system, Mattew Price
calls this “entitlement spending”, which he claims has unfortunate side-effects; as
mandatory expenditures drive out the discretion of government (and, thus, politics),
responsiveness to social and economic challenges will be diminished; the political
system’s hands will be tied (Price 1997:47).
In the next sections I will introduce the four themes that dominate the four substantial
chapters in this thesis. The first is the question of the distribution of costs between
generations.
1.4. Distribution of Costs
Even with moderate economic policy and long-term financial planning, payg national
insurance schemes may be difficult to sustain without significant increases of taxes
and contributions on the part of the occupationally active population. This will most
likely lead to disproportional burdens of payment on the generation of workers.
A state pension system is a vehicle for redistribution of income within a society at a
given time. Most public pension systems have inherent in them a strong element of
redistribution. However, national pension systems may also be used as instruments for
redistribution of income across generations.
15
Chapter Three argues that redistribution between generations may be justified as a
means of sharing the benefits of economic growth. Statistics present strong evidence
that future generations will, most likely, be better off than the current one. The claim
is that this may justify redistribution from “rich generations” of tomorrow to today’s
“poorer" generations. In the economic literature, questions of intergenerational justice
in a pension scheme are often addressed using the method of generational accounting.
However, generational accounting does not take into consideration the fact that
generations ahead in time are likely to be better off. This, I will argue, is a serious
weakness of this type of analysis.
1.5. Distribution of Risks
A pension system’s lack of robustness to external shocks or inherent instability may
expose individuals to what we may term generational risks. Generational risks are
risks that affect all members of a generation, but have a smaller effect on other
generations. Examples of such risks are an unforeseen economic depression, a
financial market crash or unexpectedly large demographic fluctuations.
Chapter Four focuses on a largely neglected point, namely that all generations can
gain by forming insurance against such risks together with other generations. The
government is the only conceivable provider of this type of insurance. Even if
resources were redistributed to a point where no unfair inequalities existed, the
welfare state would still be needed. This is because people would still need to insure
themselves and to redistribute wealth over the course of their lives.
Whereas in Chapter Three, part of the pension premium is viewed as a tax with the
purpose of redistribution, in Chapter Four, part of the pension contribution is viewed
as an insurance premium that aims at compensating for the loss of income later in life.
Introduction
1.6. Remedies for Time-inconsistency
A common rationale for making the provision of an old age pension mandatory is that
workers may be myopic or lack forward-looking behaviour. Providing for old age and
allocating savings requires forward-looking rational choices. These problems are not,
however, only confined to individual actors. Chapter Five address the question of how
the problems of myopia or inconsistency, caused by the behaviour of society’s
governing institutions, can be dealt with.
There are at least two long-term concerns regarding public pension where time-
inconsistency may represent a problem, and it may be preferable for a society to bind
itself. First, there is the problem of national saving. Saving is necessary in order to
fulfil public pension entitlements already accumulated in the system. At the same
time, it is often assumed that politicians are biased toward the kind of state spending
that produces immediate effects, and thus have incentives to under-save. Second, there
is the problem of making credible political promises to enhance stability.
Predictability and stability are general long-term goals, and particularly important
with regard to pension for old age. Because people must rely on the system when
planning for their retirement, rules must be stable and entitlements predictable. At the
same time, politicians may be inclined to try to free themselves of parts of the
financial burden the public pension entitlements represent.
Chapter Five asks whether strategies of self-binding could reduce problems of time-
inconsistency in a pension scheme. The more general question is whether the idea of a
society binding itself is a viable one.
1.7. Protection of Rights
A national pension scheme involves considerable transfer of rights and obligations
across generations. This implies restriction of the political freedom of future
generations and their governments. One may ask why future tax payers should be
bound to pay for a pension system that they themselves have not voted for, and that
17
does not even guarantee that they will receive a similar pension in the future. The
expected increases in the tax burden due to the development of costly, extensive
systems of public pension for old age combined with the rapid ageing of the
population makes this question ever more pressing.
This question bares a striking resemblance to the classic question in constitutional
theory: how are we to justify binding obligations to which subsequent generations are
given no opportunity to consent? A constitution imposes certain limits on democratic
decision making. Similarly, as we have seen, public pension rights represent
restrictions on the economic priorities politicians can do.
Chapter Six argues that constitutional rights are legitimised as long as they are
necessary preconditions for democracy. A constitution represents certain limits on
democratic decision making. But constitutional rights might also be interpreted as
forms without which democratic self-rule could not exist. Instead of limiting
democracy, a constitution serves to establish ground-rules for the practising of basic
democratic rights. Chapter Five explores the question of the degree to which the
argument from democracy can justify binding present and future generations through
strong legal and political public pension guarantees.
This thesis includes two other chapters in addition to the four just mentioned. Chapter
Two develops a normative foundation for a discussion of pension rights. Chapter
Seven uses the case of Norway to illuminate the theoretical points discussed in earlier
chapters.
1.8. Common Ground
Chapter Two argues for the possibility of discussing ethical or normative questions
from a more neutral or “objective” position that enables us to evaluate our practices
and principles partly detached from our particular position within society. This is
important, the argument goes, in order to ensure that the domain of political theory is
not reduced to an entirely internal self-reflective process. The chapter argues that we
Introduction
should ask what people like ourselves could agree on as members of a political
community. Finding solutions to public issues requires a willingness to search for
common ground and a willingness to regard one’s own position as only one among
other equally important positions.
1.9. The Case of Norway
Chapter Seven relates the theoretical discussion to the Norwegian public pension
system. Government reports and the general debate concerning the future of the
National Insurance Scheme are used in order to confront and highlight the theoretical
points made earlier. In part of this chapter, two social security cases are being used as
the point of departure. Both of these cases involved a conflict between the right to
receive a pension according to certain rules and the government’s right to a
considerable freedom of action with regard to changing these rules.12 Norway is
currently in the process of rethinking and reforming its pension system. A government
commission has been set up in order to evaluate the existing system, and develop
proposals for reforms. In conclusion, this dissertation proposes four elements that
should be considered:
1. Allow for increased taxation of future generations of workers
2. Government provision of intergenerational risk-insurance
3. No general earmarking of the Petroleum Fund for pensions
4. Constitutional entrenchment of a right to basic pension
12 Høyesterettssak 76 B 1996 nr.160, Høyesterettssak 77 B 1996 nr.224
19
References:
Common ground
2. Common ground
2.1. Introduction
Pluralism is a common point of departure for a discussion of ethical reasoning, and
will also form the basis for my discussion. Acknowledging pluralism means accepting
that there is a plurality of different, and sometimes even fundamentally
incommensurable, ethical, philosophical, religious and cultural beliefs. This chapter,
however, points to a particular challenge with regard to pluralism. Pluralism poses the
threat of “privatising” moral and ethical questions. Pluralism means that what is the
good life for me does not necessarily comprise the good life for someone else. This
implies that there is no longer an obvious link between what is the good life for a
particular person and what is a good society. In his book In Search of Politics,
Zygmunt Baumann calls for the restoration of a political agenda that relates the
question of what is the good life for me personally to the question of what is a good
society; a political agenda that manages to convert private troubles into public issues
(Bauman 1999:7). Public solutions are still needed, even if they need to take into
account the problem of diverging values, opinions and world-views. Now, how will
such solutions be possible?
The argument in this chapter is that finding such solutions will require a special
“mode of thinking” – a moral state of mind, so to speak – that goes beyond the
question of what is good or bad, right or wrong for me to do personally. It requires the
willingness and ability to search for common ground. Furthermore, if my convictions
are to have any position apart from being my subjective opinions, they must be placed
on another level of generality. I must be able to ground my opinions in some other
way than by reference to my taste, or my personal beliefs. This necessitates some kind
of objectivity. In the words of Jeremy Waldron, it requires “a particular well-worked
out opinion or position, which in outline might be held by any citizen” (Waldron
2001: 228).
21
If all there was to ethics was a collection of subjective, personal opinions, we would
have no reason whatsoever to engage in questions of what constitutes the good
society, the public good and so on. One could defeat any moral argument simply by
saying that one took another view, and there would be nothing more to be said, for or
against the matter. In this chapter, my claim is that it is possible to take account of
pluralism– of the fact that values and world-views differ, and at the same time
embrace the idea of a more neutral or objective “mode of thinking.” My argument
goes as follows: In dealing with moral questions in a political society, citizens should
search for common ground. First, this means to be guided by a duty of civility, and
second, it implies regarding one’s own position as one among other, equally important
positions as “input” in the political process.
Section 2.2 develops the concept of a duty of civility, a term borrowed from John
Rawls. Section 2.3 elaborates the idea of a position-dependent “objectivity.” The
discussion in this section is inspired by Thomas Nagel. Section 2.4 concludes by
presenting the argument for common ground as a combination of these two elements.
2.2. Rawls and a Duty of Civility
For John Rawls, the criterion for legitimising political principles is that they can be
subject to agreement between people who otherwise have different religious or
philosophical world-views (what Rawls calls “comprehensive doctrines”). However, it
is not just any form of agreement that will do – unanimity is not enough. What is
needed is not merely agreement, but reasonable agreement. Rawls defines
“reasonable” as a virtue of persons engaged in social co-operation. There are two
aspects to such reasonableness (Rawls 1993:94). The first is the willingness to
propose and abide by fair terms of social co-operation between equals. The second is
the recognition of and willingness to accept the consequences of what Rawls calls “the
burden of judgment,” that is, to acknowledge that people naturally disagree and that
Common ground
this makes it difficult, if not impossible, to find one and only one answer to all moral
questions.13
The first aspect of Rawls’ definition of reasonableness is to seek and abide by fair
principles of co-operation. However, this definition is not very informative, since
“reasonable” is explained by an equally general term, namely “fair.” What we can
extract from this definition is that being reasonable means being willing to search for
common ground. Charles Larmore suggests such an interpretation in his discussion of
Rawls. More fundamental than the political principles on which the citizens will agree
is their commitment to organise political life along these lines, to seek principles that
can be the object of agreement (Larmore 1999:601, 609). Rawls, therefore, puts
something more into the concept “reasonable” than mere compliance, or the
willingness to abide by fair principles; it also involves a readiness to co-operate.
The second aspect of Rawls’ definition of the reasonable is this: As reasonable, we
should be willing to see ourselves as one among other equally important members of
society (Rawls 1993:94). This implies that we must accept that our own world-view,
religion or basic beliefs must be viewed on an equal footing with other world-views,
religions or basic beliefs when it comes to the question of establishing equitable
political institutions. In addition to the willingness to co-operate, then, reasonableness
also encompasses the willingness or ability to be impartial.
Rawls uses a hypothetical contract argument (the original position) to model this idea
of reasonableness. The model is one of hypothetical choice: all interests and views
should be taken into account. The identities and positions of the parties is concealed
under a veil of ignorance, which ensures that all interests are given equal
consideration (impartiality). The question for Rawls is: what could we all have agreed
on, given that we were all reasonable and rational? According to Rawls, basic political
principles should be subject to agreement. But these principles cannot be determined
13 For a definition of the burden of judgment, see (Rawls 1993:54-58)
23
by simple majority decisions. People in general fail to be reasonable and tend to
follow their immediate self-interests. Furthermore, even in a well-functioning
democracy, minority interests may regularly be repressed. Thus, the outcome of a
democratic decision-making process is not impartial in the sense that it gives equal
weight to the interests of all participants. The alternative then, according to Rawls, is
that political institutions should be guided by principles that could have been subject
to agreement in an ideal world without these defects. Instead of demanding the
impossible of each and every one of us, a hypothetical contract argument illustrates
which principles people would have chosen to regulate their basic political
institutions, given such ideal circumstances. The hypothetical contract argument
models reasonableness. For political institutions to be legitimate and just, they should
therefore be regulated by principles that could be the outcome of such a hypothetical
thought experiment.
This argument is challenged by Ronald Dworkin’s critique of hypothetical contract
arguments. According to Dworkin, a hypothetical contract is not just a paleform of
contract, it is no contract at all (Dworkin 1977:151). To say that I would have agreed
to something does not count as a reason, independent of other reasons, for enforcing
the rule on me later. Everything depends on your reasons for supposing that I would
have agreed.
There are basically two interpretations of Rawls’ theory that could meet Dworkin’s
objection. One solution is to anticipate that the contract argument in itself has little
force. Instead, what drives the argument, one could say, are the basic premises that the
contract models, such as choice, autonomy, and respect for persons (Kymlicka 1990
:70). This interpretation of Rawls would clearly be a substantive account, and would
therefore be difficult to combine with pluralism. However, instead of seeing the
hypothetical contract argument as possessing independent justificatory force, it can be
understood as a “device of representation.” The force of the contract argument does
not lie in its telling us what people would have agreed on had they been asked. The
real strength of the argument lies in its function as a device of representation: It
Common ground
appeals to the reasonableness in us. Whenever we are inclined to act on behalf of our
immediate self-interests we would do well to ask: is this something that all the
involved parties could agree would be a good thing to do under a veil of ignorance?
Rawls’ approach is even less ambitious because it is restricted to the political domain.
The force of the hypothetical contract is that it is designed to guide our choices and
thinking with regard to the creation and maintenance of basic political principles.
As a device of representation, the idea of the original position serves as a means of public
reflection and self-clarification. It helps us work out what we now think, once we are able to
take a clear and uncluttered view of what justice requires (…) (Rawls 1993:26)
Rawls is alluding to a certain duty of civility (Rawls 1993:217). Since no one can be
said to have a monopoly on truth when it comes to political issues, justice in the
political domain cannot be a pre-established entity. We must all be willing to
participate in the project of searching for equitable political institutions, and we must
be willing to ask: what can we agree on under the condition that we give equal weight
to what everybody else can agree on? As a citizen, you should be willing to take into
account more than that which satisfies your individual self-interests, or what is
defined as right and wrong according to your particular position. Appreciating this
duty of civility also implies that “we should sincerely think that our view of the matter
is based in political values everyone can reasonably be expected to endorse“(Rawls
1993:241).14 Rawls introduces the veil of ignorance and the hypothetical thought
experiment to help us to grasp what this duty of civility demands of us.
However, Rawls acknowledges that there may be a problem of motivation. It is too
much to ask of people that they recognise such a duty of civility in their ordinary lives
as citizens. Very few are actually willing and able to live with such a strong moral
predicament. The solution Rawls seems to be suggesting is a two-level model of
political decision-making. Actual consent by all citizens based on a “duty of civility”
14 Rawls links the discussion of what it is that everyone can reasonably endorse to an idea of public reason (Rawls 1997:573). This concept is complex and in my view utterly problematic. It would be going too far, however, to discuss the idea of public reason here.
25
is too demanding – it is “ideal theory.” But in their role as participants in constitution
making, citizens are both more able and more willing to acknowledge their duty of
civility. The unique nature of constitutional principles (they are particularly long-
lasting and constitutive of the political organisation of society) is likely to evoke a
more reflective response.
The time horizon for constitutional principles in itself is also likely to motivate the
duty of civility. Constitutions are long-term projects. Constitutional principles are
designed to last for generations and centuries, during which political, social and
economic conditions may shift dramatically. Similarly, the life situation of a particular
person is likely to change in unpredictable ways given a long enough time perspective.
The mere fact of uncertainty about the future may therefore force people to take into
consideration a greater variety of situations and personal destinies before determining
which principles are to guide our political institutions. Robert Goodin particularly
emphasises this point:
When asked to choose fundamental laws and basic structures for their society, people are
perforce contemplating schemes designed to persist into the indefinite future; when doing so,
they are forced to extend their time horizons, thinking in terms of further futures that they
would ordinarily have any reason to contemplate; and the further into the future they project
their deliberations, the greater will be the uncertainties surrounding their own fate. (..)[T]he
greater the consequent impartiality with which even the most purely prudential actor will be
forced to reflect upon the possible plights of all people in general. (Goodin 1992:104)
This does not imply that the duty of civility applies only when constitutional questions
are at stake. The discussion thus far shows that there is a problem of motivation
attached to the duty of civility, and that motivation is likely to be less of a problem
with regard to constitutional deliberation. Focusing as Rawls does on the basic
structure of society may reduce the problem of motivation, but will never eliminate it.
If I am to choose principles that I know will last for a very long time, I know that I
cannot expect to remain in my current position forever. There is therefore every
reason to suppose that I shall someday be in a position to do unto you what you do
Common ground
unto me today (Goodin 1992:106). Rawls suggests that citizens should imagine
themselves as judges with the duty to decide in cases when such fundamental
questions are brought up (Rawls 1997/1999:605). Just as judges are expected to
adjudicate between different positions without exhibiting partiality, so are citizens
expected to reason in accordance with the duty of civility.
Civility is often associated with law-abidingness and civil obedience. For Rawls, the
duty of civility is something far more. Civility, one could say, fits citizens into
pluralist society and is closely connected to virtues such as respect, considerateness
and tolerance. A fundamental aspect of showing respect, considerateness and
tolerance is to seek compromise through reasoned dialogue. This is how I interpret
Rawls’ definition of the duty of civility.
The duty of civility demands of us that we search for common ground. I take this to
mean that we are to seek points of moral agreement, offer rationales that minimise the
risk of rejection of our own position, and refrain from presenting our own view as an
unalterable conviction. It means acknowledging the opponent’s view as one about
which people may reasonably disagree.
In his discussion of the duty of civility, Rawls refers to an article by Amy Gutmann
and Dennis Thomsen. Gutmann and Thomsen develop an idea of mutual respect very
similar to Rawls’ definition of a duty of civility (Gutmann and Thomson 1990).
Essential to their definition of mutual respect is that citizens should try to reach
agreement on a morally disputed policy by reason rather than force, and more
specifically through moral reasoning rather than self-interested bargaining (Gutmann
and Thomson 1990).
Inherent in the definition of pluralism provided here is the possibility that values and
arguments may clash to the extent that reaching agreement on the subject matter
seems next to impossible. The fact remains, however, that we must nonetheless deal
with these issues. Moral conflicts inevitably arise, and we do not wish to solve them
27
with the use of violence. The underlying purpose of moral discussion is therefore the
possibility it creates for us to come to terms with the issues by way of argument.
Consensus is not always possible, and is sometimes not even desirable. What is
important is finding solutions with which we all can live despite our disagreement.
Important to note, moreover, is that even when agreement is not possible, one may
learn and profit from debate and argument. Therefore, encouraging different positions,
communicating and seeking to understand each other, are important in their own right.
Such debates are essential to any well-functioning society. Baumann asks us to
remember the Greek formula edexe te boule kai to demo – “it is deemed good by the
council of the people.” In deciding on public issues, the citizens had to ask themselves
questions such as:
Look, these are laws which most of us think are good – but are they indeed as good as we
think they are? Is there something we may and need do to make them better? (Baumann 1999:
137)
This formula, Baumann says,
… reminds us of the choice which has been laid at the foundation of whatever has been
authorized to rule our conduct. And it reminds us of the responsibility for making that choice
good– a responsibility we cannot shake off and lay at the doorstep of another, external and
unreachable, power.” (ibid.)
It is obviously a very important aspect of a duty of civility to engage in public debates
on these conditions, and this captures the essence of what it means to search for
common ground.
2.3. Nagel and Impartial Partiality
The second aspect of a search for common ground is a willingness to see ourselves as
one among other equally important members of society. Rawls’ hypothetical thought
experiment might be helpful in this respect. According to Rawls, the thought
experiment helps us to “take a clear and uncluttered view of what justice
requires”(Rawls 1993:26). This section discusses what it means to take a clear and
Common ground
uncluttered view, and argues that such a view can never be completely “objective” or
neutral in the sense that it is independent of personal positions.
In philosophy, the idea of “objectivity” is often understood as a neutral, independent
position from which to discuss and weigh arguments, and view the matter from
“above” or the “outside,” in the sense that equal consideration is given to the interests
of all parties involved. This is what Thomas Nagel calls the impersonal standpoint
(Nagel 1986:152) .15 But Nagel also finds strong reasons to attach importance to the
desires, projects, commitments, and personal ties of the individual agent. This is what
he calls the personal standpoint. His model of moral reasoning combines the two
standpoints. As individuals we should be “partial to our selves, impartial among
everyone, and respectful of everyone else’s partiality” (Nagel 1991:38). In other
words, he asks us to step back from our initial position, but not all the way back. The
step should still allow us to attach some importance to some of our personal projects
or desires. On the other hand, it does not mean that the decision only revolves about
what I should do, but rather what this person should do (Nagel 1997:110). Objectivity,
therefore, is not “a view from nowhere” but a view from a particular “here.”
Let us immediately refute another common misinterpretation of the term “objectivity”
in ethical reasoning. A reason is not closer to truth if it is not subjective, but it is no
longer merely a matter of my taste. To use Ronald Dworkin’s illustration: If someone
claims that soccer is a “bad” or “worthless” game he may well concede, on reflection,
that his distaste for soccer is entirely “subjective”, that he doesn’t in any way regard
the game in any “objective” sense as less worthwhile than games he prefers to watch
(Dworkin 1996:98). I am trying to be objective if I recognise that there is a world of
reasons of which my own point of view is only a part.
We may now return to Nagel’s position. The impersonal standpoint, according to
Nagel, refers to the ability of each of us to abstract from our specific positions. We
29
can remove ourselves in thought from our particular position in the world and think
simply of all those people, without singling out as I the one we happen to be. (Nagel
1991 10)
What we learn from the impersonal standpoint is that everyone’s life matters, and no
one is more important than anyone else: everyone counts the same. We may identify
two general requirements as implicit in the idea of an impersonal standpoint. These
are often referred to as the criterions of Universalisability and Other-regardingness,
and they are interpreted as general requirements of any ethical theory (Beauchamp
1991:16).
The criterion of universalisability states that moral considerations should apply to all
people situated in relevant similar circumstances. What is right for one person must be
right for all persons similarly situated. The criterion of universalisability does not
imply that moral principles should apply equally to all people everywhere, regardless
of cultural tradition or social context. What it does say is simply that two acts should
be judged the same of there are no ethically relevant differences between them.
Different theories give different answers to the question of what may be considered as
ethically relevant differences. But in the process of formulating what these ethically
relevant differences are, morality does not recognise a relevant difference between my
judgement and your judgement per se. Individual differences should not count unless
they can be given a general justification.
The criterion of other-regardingness requires that we take into consideration the
interests of other people: everyone counts and everyone counts the same. We should
therefore consider the welfare and interests of others, or at least be concerned with
harm and benefit to other persons. This criterion is relevant to most moral theories,
even though there are widely divergent opinions as to its implications.
15 Nagel seems to have changed his position with regard to the question of objectivity in ethics. Although I will refer to the definitions presented in his books The View from Nowhere (1986), the position I will discuss is the
Common ground
However, what is specifically worth noting in Nagel’s account is that he also
emphasises the personal standpoint. Some reasons are strictly personal reasons, like
for instance the reasons for wanting to climb Mount Kilimanjaro or learn the
Beethoven sonatas. There is little or no reason for others to care about whether I
manage to do these things or not. Such reasons, Nagel argues, do not have any value
in themselves. They are only valuable in so far as they are someone’s reasons. What
we should acknowledge, from an impersonal standpoint, is that everybody wants to be
able to pursue his or her own plans and projects. Each person has reasons stemming
from the perspective of his or her own life. From an impartial standpoint we should
recognise that this also holds true for everybody else. There is nothing universal about
the reason for wanting to climb Mount Kilimanjaro. What we have in common is the
desire to follow our own projects and plans. This desire to follow one’s plan is general
and valid, and should be taken into consideration. Some reasons, Nagel believes,
apply to everyone. They are impartial reasons. I have an impartial reason to help you
if you are in pain. Other reasons are personal or agent-relative, and a theory of moral
reasoning must take into account that we also have reasons that are agent-relative.
This is not to say that all subjective reasons have objective correlates. Sometimes the
agent-relative element should be allowed to count when we are considering things
from an impartial standpoint, but not all agent-relative reasons are valid, and they are
valid in all situations. Nagel tries to define some kind of rule for when and how agent-
relative reasons should be considered valid: “An individual is permitted to favour
himself with respect to an interest to the degree to which the agent-relative reason
generated by that interest exceeds the corresponding agent-neutral reason” (Nagel
1986 175). The problem, which is not easily resolved, is how to combine the two
standpoints in such a way that an answer can be given which is generally valid, and
which can be acknowledged by everyone to be so (Nagel 1991:12). The method Nagel
recommends is dialectical:
one presented in his later work Equality and Partiality (1991), and The Last Word (1997).
31
First, from the impersonal standpoint, the basic insight is that everyone’s life matters,
and no one is more important than anyone else. This is the judgement one would make
if one valued the world from outside. The success of this approach depends on the
capacity of individuals to detach themselves from their particular position, even when
they are strongly emotionally or personally involved in the matter under consideration.
Nagel admits that this is difficult. A theory that does not take into consideration
people’s actual motivation will not have any practical force. Consequently, moral
justification must be capable of motivating. The impersonal standpoint requires that
each of us possess the ability to abstract from our specific position. This ability to
remove ourselves in thought from our particular position depends on the nature of our
motivation. Nagel recognises that we might not always be able to switch off the
effects of a personal motive in favour of an impartial procedure (Nagel 1991:25).
Thus, the role of the impersonal standpoint is limited by the ability of individuals to
be motivated by it. Nagel claims that a theory should not require more than it is
possible to motivate reasonable persons to accept.
Second, from the personal point of view, it is clear that each person, from his or her
particular point of view within the world, has particular projects, concerns and
attachments that are extremely important to that individual.
The two standpoints meet in a third: from a personal standpoint, my life is extremely
important, but from an impersonal standpoint, I realise that so are the lives of
everybody else (Nagel 1991:15). When the two standpoints merge, we should ask:
“what, if anything, can we all agree that we should do, given that our motives are not
merely impersonal” (Nagel 1991:15).
It is obviously difficult to combine the two standpoints, and conflicts that are not
easily solved will arise. However, this approach, I believe, helps us to evaluate
alternatives that affect different people differently in ways that matter to them. The
strength of Nagel’s approach is that it seeks to combine two basic intuitions: one, that
everyone’s life is equally important, and two, that everyone has his or her own life to
Common ground
lead. Both the impersonal and the personal standpoint must be taken into account in
the justification of any ethical or political system.
Political institutions may have an important role to play in easing some of the tension
between the impersonal and the personal standpoint. What we need, according to
Nagel, is a set of institutions within which people can lead a communal life that meets
the impartial requirements of the impersonal standpoint while at the same time having
to conduct themselves only in ways that may reasonably be required of individuals
with strong personal motives.
What is particularly worth noting, however, is that what is regarded as reasonable
grounds for objecting to a principle comes from the point of view of distinct
individuals rather than any collective or impersonal point of view. At best, this
approach may help to close the gap between an individual-centred pluralism and a
collective search for practical solutions to common political problems.
2.4. Common Ground
The position I have tried to develop in this chapter is that political decision- making in
the light of pluralism needs to start with argumentation. However, not all arguments
contribute in an essential way to our moral thinking. The arguments must be subject to
certain constraints. These are constraints on the messages we send about other
people’s moral status in the conversation, and about our willingness to reach a
common understanding. Searching for common ground implies an active willingness
to listen to others, to try to see things from the point of view of their conception of the
good and not to be either contentious about or indifferent to the life plans of others,
but to make fair-minded accommodations to their views. It means respecting that
other people have views, tastes and interests of their own, and that these are valid to
them in ways that are relevant to a moral discussion. The aim may be to convince
others, but never to overrule them by force or present one’s argument as the only one
of import.
33
I have argued that being able to abstract from– or move beyond – our particular
viewpoints is something we should strive for. Our ability to do so may be encouraged
by narratives or thought experiments that enable us to render vivid the lives of others.
Rawls’ hypothetical thought experiment, we have seen, is one such tool of
imagination. If we can find good examples in ethical reasoning, these examples may
play a similar role by applying to our intuitions in a special way: we are faced with the
question of what we would have done or how we would have felt in that particular
situation.
A main objective in moral deliberation, of course, is to be able to convince others
through argumentation. We try to develop good arguments and counter-arguments.
But arguments should also be open to revision– we must not give our opinions
immunity from any critical review. Nevertheless, it lends extra strength to an
argument if it is based on commonly accepted, uncontroversial premises. My
argument is stronger, for example, if it is built on statements that everyone can agree
upon than if it is done with reference to the Bible or the Torah or some other divine or
external authority. If you are a Christian and I am a Muslim, I would try as hard as I
could not to mix religion into the picture if my aim was to convince you, say, of the
superiority of public schools. I would use the information I have about you and try to
imagine what reasonable grounds you may or may not have for rejecting that idea.
Nagel’s model of ethical reasoning implies a similar procedure.
The argument in this chapter is that we need certain ground rules to enable us to
engage in public conversation where the aim is to reach common solutions with
people who think differently. What is needed first of all is a willingness to enter into
and continue in a co-operative venture– the political society. Next, it requires
willingness to respect and take into consideration other people’s life plans and
projects.
This may sound both trivial and uncontroversial. The importance of a search for
common ground is nonetheless both neglected and underrated. It is of the utmost
Common ground
importance to have a clear stance on how to deal with the question of pluralism,
particularly in modern, multicultural and heterogeneous societies. The recent trend in
these countries has been toward a declining interest in politics, most clearly expressed
in lower voting participation. This phenomenon is often explained as a result of the
peoples’ indifference. Political analysts suggest that people no longer care about
politics, but are only interested in their own life plans and projects. I think this
analysis is wrong. What may have happened is that people have lost faith– both in the
possibility of finding common solutions to problems where there is great conflict of
value, and the ability of basic political institutions to adjudicate between these
different views. They may simply think it is waste of time to bring their own personal
convictions into a public debate. Finding answers in a context of pluralism is not easy,
but the process of trying to find answers is equally important. Only when this process
is encouraged and guided by something like a search for common ground can private
troubles have some chance of being converted into public solutions.
2.5. References
35
3. Redistribution
3.1. Introduction
Should public pension systems redistribute income across generations? During the
last fifty years, there has been a marked increase in the standard of living in most
OECD countries. If this trend continues, a backward redistribution from the current
working generation to the current retirees may be justifiable, if the first group will
over the course of their lifetime, be better off than the second group.
This conclusion is contrary to how a fair distribution between generations in a pension
system is usually viewed. Generational accounting is a common method for measuring
the distribution of costs and benefits between generations in national insurance
schemes (Auerbach, Gokhale et al. 1994). Generational accounting has, as its point of
departure, a principle of horizontal equity. In its basic form, horizontal equity means
that equal cases should be treated equally. Applied to public pension systems, the
principle of horizontal equity implies that the ratio of benefits to burdens should be the
same for individuals in the same income-brackets, regardless of the generation to
which they belong .
This chapter argues that the principle of horizontal equity should be supplemented by
a principle of vertical equity. Vertical equity means that two cases should be treated
differently if there is a morally relevant difference between them. The principle of
vertical equity developed in this chapter justifies redistribution from wealthy to less
wealthy generations. It is a two-way saving principle that allows for both “positive”
saving (from present to future generations), but also “negative saving” (from future to
present generations).
One of the most influential theories of redistribution is that presented by John Rawls.
He has also discussed the question of justice between generations. This chapter points
out important weaknesses in Rawls’ account of intergenerational justice, and proposes
36
Redistribution
an alternative model. Section 3.3 critically assesses Rawls’ attempt to adjust his idea
of an original position to apply to the question of intergenerational justice. Section 3.4
proposes a revised and alternative version of his thought experiment, and deduces the
principle of vertical equity as a two-way saving principle.
I will begin, however, with a presentation of the principle of horizontal equity, and
how this principle is embedded in the method of generational accounting used by
economists to measure distribution between generations. This will motivate the need
for a principle of vertical equity.
3.2. Generational Accounting and the Principle of
Horizontal Equity
Public pension systems are frequently used as vehicles for redistribution of income
within a generation. Most public pension systems inherently have a strong element of
redistribution from rich to poor individuals, and are designed to favour those with
lower lifetime earnings. They are progressive in the sense that the payback ratios of
people in the lower income brackets are higher than for people in the higher income
brackets.
Most public pension systems also redistribute between generations. These systems
were not explicitly designed as a means of transfer from the young to the old, or from
future generations to present generations. It is evident, however, that due to special
circumstances such as demography, life expectancy, rate of contribution to rate of
benefits etc., pay-as-you-go public pension systems all over the world today have
these types of redistributive effects. In many countries, there has been a substantial
redistribution from young to old over the post-war period (Barr 1998 :219). There is
also a growing awareness in social policy of the impact of pension systems on
intergenerational equity.
37
An often discussed attempt at calculating the distributive effects of these pension
systems is the method of generational accounting developed by Alan Auerbach,
Jagadeesh Gokhale, and Laurence Kotlikoff (Auerbach, Gokhale et al. 1994). This
method is now frequently used in most OECD countries. Politicians facing increasing
debt burdens, caused by rapidly ageing populations, and maturing pension systems
have been forced to rethink traditional fiscal indicators based on cash flow accounts.
These indicators fail to take these costs seriously because future liabilities of pay-as-
you-go systems are absent from current fiscal flows (Raffelhüschen 2001).
Generational accounting has been specifically developed as an analytical method for
handling the distributional effects across the generations in states with formal welfare
regimes and entitlements.
Generational accounting is a method for incorporating the future demographic
environment and its consequences into public budgets. Generational accounting is
needed because traditional accounting focuses only on current revenues and
expensesof the government. Generational accounting reports the remaining net
payments to the budget for every generation alive and distributes the resulting burden
(or surplus) equally to all future generations. The generational account can be
expressed by a simple equation (Auerbach, Gokhale et al. 1994:75):
Present value of remaining net tax payments of existing generations
+ Present value of net payments of future generations
= Present value of all future government consumption
- Government net wealth
The great advantage of generational accounting is its long-term perspective. The
intertemporal budget constraint measures all expenditures and revenues in present
values. The intertemporal budget constraint also states that expenditures must be paid
for either by present or by future generations. The intention of governmental
accounting is to give a more realistic assessment of the burden of government tax and
spending policies and, in particular, of how such policies affect each generation or
cohort. Generational accounting has been accused of being based on uncertain and
38
Redistribution
debatable assumptions (Haveman 1994), (CBO) 1995).The focus here, however, is on
the notion of intergenerational equity embedded in the method of generational
accounting.
Generational accounting employs a principle of horizontal equity. It measures how
much tax current and future generations must pay over time in relation to what they
receive in benefits. The logic is that the generations born in the future should not pay a
higher share of their lifetime income to the government than today's new-borns
(Auerbach, Gokhale et al. 1994:84). In generational accounting the redistribution
between different generations is thought to be a zero-sum game (Kotlikoff 2001:10).
The government's bills must be paid. If current generations do not pay as much tax as
they receive in benefits, future generations will be forced to cover the difference.
The account is in balance when future generations face the same lifetime net tax
burden as current generations. The lifetime net tax burden is defined as taxes paid
minus transfer payment received (Kotlikoff and Gokhale 1994:73). Generational
accounting does not take into consideration the fact that it is most likely that later
generations will be better off than the present generation. There is no room, therefore,
in the framework of generational accounting for taking into account the relative
welfare of different generations. If future generations experience a steady increase in
growth rates, they are still expected to pay the same proportion of tax in relation to
income.
An application of the principle of horizontal equity means that all individuals in the
same income class should pay the same amount in tax (Goodin 1999:190). Goodin
compares the logic of horizontal equity to that of non-price discrimination. Just as it is
unfair to charge different consumers different prices for the same good (other things
equal), so it is inequitable that individuals should pay different tax rates for the same
amount of public benefits. The example he gives is that of Albert and Bernard who
belong to different communities (equal in almost all respects: same number of people,
age-distribution, number of swimmers to non-swimmers etc.). In both communities, a
39
swimming pool is to be built (by the same builder, for the same price). The only
difference between the two communities is the tax base. Because the tax base in the
two communities differs, Albert is required to pay twice as much as Bernard toward
the cost of an identical pool in his community. This, Goodin argues, is unfair and in
conflict with a principle of horizontal equity because the community to which they
belong should not be viewed as a morally relevant difference between Albert and
Bernard.
The principle of horizontal equity can, according to Goodin, be transferred to cases of
intergenerational justice. The particular case he refers to is that of public pensions.
Horizontal equity across time would mean merely that people at different times should
enjoy the same benefits for the same taxes (Goodin 1999: 195). In accordance with the
principle of horizontal equity, what we are trying to equalise is “ the ratio of benefits
to burdens as a proportion of people’s real, inflation-adjusted income” (Goodin 1999:
196). The goal is to equalise the premium/payout ratio across members of all
generations by setting it at the mean premium/payout ratio for all of them.
The remedy for horizontal inequity is some variant of "fiscal equalization", a term
Goodin borrows from fiscal federalism literature. Fiscal equalisation can be practised
radically, by equalising the tax base of all jurisdictions, or by equalising post-tax
revenues (for instance by "topping up" revenues raised in low tax base jurisdictions).
With regard to public pension schemes, this can be done, for example, by borrowing
or by building up trust funds. The idea is that "high tax base" generations pay more
than is strictly necessary for the system to break even, and "low tax base" generations
pay less than what is needed to cover the whole pension bill in their period. High tax
base generations build up revenues; low tax base generations acquire debt.
A problem with the principle of horizontal equity is the "all things equal" clause that it
presupposes.16 Horizontal equity justifies equal treatment of two persons if they are
equal in all morally relevant respects. However, other things are never literally equal
40
Redistribution
and often may be unequal in ways that matter to our notions of equity and justice.
First, the result of a decision to treat people equally always depends on which
dimension one chooses to equalise. In Goodin’s account of the principle of horizontal
equity, pre-tax income is the criterion used to measure which persons are equal. It is
not obvious that this is the morally relevant criterion for equalisation. This is
particularly evident when we apply the principle of horizontal equity to the
distribution between individuals who belong to different generations. Two persons
may have the same pre-tax income but live in societies with radically different
income-opportunities and labour market conditions. Thus, the effort needed to acquire
the same amount of income is not the same for these individuals, although they may
otherwise be equal.17 Second, Goodin’s account of the notion of horizontal equity
cannot adequately cope with the situation in which all proceeding generations
experience a higher level of economic growth than the present generation. The
principle of horizontal equity, therefore, should be supplemented with a principle of
vertical equity.
3.3. Rawls' Account of Justice Between Generations
As an extension of his general theory, John Rawls has developed a principle of
vertical equity, or more precisely a principle for just saving between generations.
Rawls’ theory of justice is based on a thought experiment: free and rational self-
interested persons come together in an original position in order to choose principles
that can guide the basic institutions in society. They are behind a veil of ignorance and
know nothing about their own position in society, their preferences and so on.
Rational individuals will find it in their self-interest to take proper account of the
interests of all, including the worst-off in society, because from behind the veil of
ignorance, they have no knowledge about their own position. The idea of the original
position is to set up a fair procedure so that any principle agreed upon will be just
(Rawls 1971 136). The question is, then, which principle of redistribution between
generations would rational parties choose under a veil of ignorance?
16 In footnote 14, Goodin acknowledges this problem as important but, nevertheless, he chooses to disregard it. 17 I owe this point to Alexander Cappelen.
41
Rawls’ theory is meant to apply primarily to liberal closed societies. Rawls,
nevertheless, indicates that it is possible to extend the contract to include the interests
of future generations in order to find principles of fair distribution between them.
Rawls claims that his theory “yields reasonable answers” to the problem of future
generations (Rawls 1993: 21). However, extending a theory of redistribution to cover
future generations gives rise to an important problem: how can it be in the self-interest
of rational individuals to choose a principle of saving that will benefit other
generations? Why should we be willing to sacrifice anything for posterity when
posterity can do nothing to harm or benefit us?
In response to this problem, Rawls has proposed different solutions. In A Theory of
Justicehe introduces a motivation assumption (Rawls 1971:140). The parties in the
original position are thought to be heads of families who care about their family
members. In his book, Political Liberalism, this assumption is abandoned. The
assumption he puts forward instead is this: the parties are asked to choose a principle
of saving on the condition that they must want all previous generations to have
followed it (Rawls 1993: 274). I will call this the previous generations assumption.
Rawls reason for changing his account is that by doing so he then “leaves the [initial]
motivation assumption unchanged” (Rawls 1993: 20), footnote 22). He is referring to
the initial assumption that the parties are thought to be rational and mutually
disinterested. I will question whether he actually succeeds in his intention to keep this
assumption unchanged. Furthermore, I will argue that the previous generations
assumption fails to explain why rational individuals in the original position should be
willing to save for the sake of future generations. First, I will present the arguments
behind the motivation assumption and the previous generations assumption. Second, I
will examine implications of the latter for the account of a principle of just saving.
42
Redistribution
The Motivation Assumption
In A Theory of Justice, Rawls discusses the possibility of extending the original
position to cover the interests of future generations (Rawls 1971: 284-293).
The parties in the original position do not know to which generation they belong. The
veil of ignorance is complete in this respect (Rawls 1971: 287). The veil is, however,
not absolutely complete. The parties do know that they are contemporaries. This is
called the present time of entry assumption. Rawls does not say much about why he
makes this assumption. The reason he gives seems to be that to open up the original
position for actual and potential people would “stretch fantasy too far...” so that “the
conception would cease to be a natural guide to intuition”(Rawls 1971:139). In other
words, the original position must be modelled in such a way that one can adopt its
perspectives at any time.
The parties are asked to decide how much they would be willing to save at each stage
based on the assumption that all other generations are to save at the same rates (Rawls
1971: 287). “Since no one knows to which generation he belongs, the question is
viewed from the standpoint of each and a fair accommodation is expressed by the
principle adopted” (Rawls 1971: 288).
This begs the question: why should they, rational individuals as they are, choose a
saving principle? The first generation will obviously not benefit from such a principle.
Because the first generation begin the saving without there having been an earlier
generation who had saved for them, they must pay the costs of saving without
receiving anything in return (Rawls 1971: 288). So the first generation has no
incentive to choose such a principle.
Moreover, the present time of entry assumption implies that each generation will, in
effect, be in the situation of the first generation. Because they know that they are
contemporaries, rational profit-maximising agents have no motivation to choose a
saving principle for future generations. There is nothing they can do to change the
43
past, and so there is nothing they can do to affect the size of the savings they receive.
In Rawls’ words, “Either earlier generations have saved or they have not; there is
nothing the parties can do to affect it”(Rawls 1971: 292). Furthermore, the next
generation cannot punish them for not saving. There is absolutely no way that people
in the distant future can affect presently existing ones. This asymmetry of power
makes it irrational for rational profit-maximising contemporaries to save for future
generations.
In response to this problem, Rawls introduces a motivation assumption. The parties
are thought to be heads of families. They are regarded as representing family lines
with ties of sentiments between successive generations (Rawls 1971: 292). Since it is
assumed that the parties care for their descendants, they should now have an incentive
to acknowledge a just savings principle (Rawls 1971: 288).
Serious problems arise with the introduction of a motivation assumption. The most
important objection to the motivation assumption is that it causes the original position
to lose some of its force. The motivation assumption implies that the parties are no
longer mutually disinterested since they are thought to be heads of families who care
about their offspring. The original position cannot, then, be used to justify principles
as the result of rational self-interested agents’ choices under a fair procedure.
Jane English has given a good example of how the introduction of a motivation
assumption may affect the outcome of the original position. She asks us to consider
the familiar case of generating a fair division of a pie by asking one person to slice it
under the constraint that the others will choose their pieces first. This technique can be
expected to yield a fair distribution only if it is assumed that all the parties try to
maximise the amount of pie they are to receive. If the divider behaves altruistically by
intentionally cutting a smaller piece for him- or herself, the division would not be a
fair one. Independent of whether the others choose the smaller or larger slices, the
result will not be one that takes equal account of the interests of all. English’s point is
that the method is a better model of fairness if the parties are purely self-interested
44
Redistribution
(English 1977: 92). This is the type of objection that can be held toward the original
position if the parties are no longer thought to be mutually disinterested.
While one might object to the motivation assumption for other reasons, it does not
seem necessary for the purpose of this chapter to go through all the possible objections
here. Rawls must surely have noticed some of them since he decided to change his
account.
The Previous Generations Assumption
In a footnote to Political Liberalism, Rawls explains that he has changed his account
from “A Theory of Justice”(§44). The idea was given to him by Thomas Nagel and
Derek Parfit, and independently presented by Jane English in an article in
Philosophical Studies (English 1977). He admits that he “…simply missed this better
solution”((Rawls 1993: 22),footnote 20). The better solution is as follows:
The parties can be required to agree to a savings principle subject to the further condition that
they must want all previous generations to have followed it. Thus the correct principle is that
which the members of any generation (and so all generations) would want preceding
generations to have followed (and later generations to follow), no matter how far back or
forward in time. (Rawls 1993: 274)
The reason he gives for the substitution of the motivation assumption is that:
“(…) it removes the difficulty without changing the motivation assumption. It also preserves
the present time of entry assumption and coheres with the strict compliance condition in Ideal
theory generally.”((Rawls 1993: 274), footnote 12)
The difficulty he refers to is the problem stated in the beginning of this paper: how can
rational, mutually disinterested individuals be motivated to save at all? According to
Rawls, the advantage of the previous generations assumption is that it solves this
problem without changing the initial assumption that the parties are thought to be
rational and mutually disinterested. It is not clear how Rawls grounds the previous
45
generations assumption and what this assumption actually implies. In the next two
sections, I will discuss possible interpretations.
The Argument of Previous Generations and the Strict Compliance Condition
In order to give the parties incentives to choose a saving principle, it is assumed that
they must want the previous generations to have followed the principle they
themselves adopt as contemporaries. Rawls claims that this is a reasonable assumption
because it “coheres with the strict compliance condition and ideal theory generally”
((Rawls 1993: 274), footnote 12).
The strict compliance condition is part of Ideal theory, and implies that everyone act
justly and do his part in upholding just institutions (Rawls 1971 8). The principles of
justice are chosen on the supposition that they will be generally complied with (Rawls
1971: 245).
I assume that an attempt to draw a connection between the previous generations
assumption and the strict compliance condition must proceed something like this:
Because in ideal theory, people are thought to comply with just principles, the parties
in the original position can expect that previous generations have followed just
principles, and thus have saved. As contemporaries, they are asked which principles
they would have wanted these generations to have followed.
Can the strict compliance condition motivate the parties to select a saving principle?
Rawls does not elaborate on this point, but refers to a passage in Jane English’s article
where she draws the connection to ideal theory (Rawls 1993:274),footnote 12).
Since Rawls’ account of saving is part of ideal theory, the choosers in the original position
should assume that other generations save according to just principles, too. Then selecting a
saving principle would not be contrary to their self-interest. (English 1977:98)
This passage is not uncontroversial. First, the strict compliance condition is moved
into the original position. This makes the saving principle a precondition in the
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original position. Second, it is no longer only the individuals in society who are
thought to comply. It is also assumed that the parties in the original position have this
capacity. This represents a change in the initial motivation assumption because it
implies that the parties are thought to be both rational and reasonable. Third, from the
premise that the parties can expect other generations to save, English seems to draw
the conclusion that they will have a motivation to select a saving principle. This
conclusion, however, cannot be reached by reference to Ideal theory. I will discuss
these objections in due course.
In my reading, strict compliance means that the parties can expect that principles be
followed once they are chosen (and therefore legitimised) in the original position.
Thus, strict compliance is a condition in society. To be more precise, it is a condition
that characterises an ideal society, i.e. a well-ordered society under favourable
conditions. In an ideal society, people comply with the principles that have been
chosen in the original position. From this, it does not follow, however, that strict
compliance should also be a condition that characterises the original position. It is a
contradiction to say that the parties in the original position already comply with the
very same principles they are asked to choose. In this interpretation of the previous
generations assumption, the savings principle is modelled into the original position
before the parties have had a chance to choose it, since it is assumed that the previous
generations have already saved according to just principles. As Dasgupta puts it,
“(t)his in particular would mean that they have read their Rawls” (Dasgupta 1994:
107).
The present time of entry assumption makes the parties contemporaries, and thus,
introduces a temporal dimension. This represents a new element in the parties’
decision procedure. The present time of entry assumption combined with the strict
compliance condition confronts them with the following question: what should I do,
given that others have already followed fair principles? If this question is to have an
effect on their choice of a saving principle, they must be willing to recognise that they
47
should comply given that others comply. To be willing to comply with the rules and
principles requires, what Rawls defines as, a capacity to be reasonable.
The distinction Rawls makes between the reasonable and the rational has already been
discussed in chapter two. As citizens, we have the capacity to be both reasonable and
rational, in contrast to the parties in the original position who are merely rational
(Rawls 1993 104). The rational is, according to Rawls, a distinct idea from the
reasonable. That the parties are rational means that they are “single, unified agents
(…) with the powers of judgement and deliberation in seeking ends and interests
particularly [their]own” (Rawls 1993:50). One aspect of being reasonable (as opposed
to being only rational) is that
persons (…) are ready to propose principles and standards as fair terms of cooperation and to
abide by them willingly, given the assurance that others will likewise do so (Rawls 1993:49).
If the strict compliance condition is to have any effect on the parties’ incentives to
choose a saving principle, the parties must be both rational and reasonable. The
willingness to acknowledge fair terms of co-operation and comply with principles and
standards is part of what it means to be reasonable. Contrary to Rawls’ claims, the
previous generations assumption therefore represents a change in the initial motivation
of the parties.
There is an even more serious objection to this interpretation of the previous
generations assumption. Given that all previous generations have saved according to a
just savings principle, it is assumed that the contemporary rational agent will choose
to save. But why should we assume that rational, self-interested agents necessarily
behave in such an ideal way? The fact that I can expect that previous generations have
saved according to a just principle does not imply that it is in my self-interest to save
for the future according to a just principle. It could very well be in my self-interest to
be a “free rider” and benefit from previous generations’ savings without paying the
price of saving for the next generation. The introduction of a strict compliance
condition cannot alone motivate rational parties to comply.
48
Redistribution
As I have argued earlier, one effect of a change in the motivation of the parties would
be that the original position looses some of its justifying force. It does not function as
a hypothetical device that can guide our considered judgements, if it can not explain
why rational individuals would choose a just saving principle in the original position.
The point I believe Rawls wants to make, by reference to the strict compliance
condition, is that it is reasonable to assume that the previous generations have saved.
Ideal theory tells us to assume the best, namely that previous generations reasoned
much as we do today and saved for us according to a just saving principle. This,
however, does not explain why the parties as contemporaries should be willing to
select a just savings principle. Strict compliance and ideal theory do not provide
much guidance with regard to this question.
The Previous Generations Assumption as an Additional Condition in the Original
Position
The previous generations assumption can be understood as an additional condition in
the original position. The parties are not only behind a veil of ignorance, they are also
asked to decide which principle they would want previous generations to have
followed. The additional condition is that they must want the previous generations to
have followed the principle they themselves adopt as contemporaries.
This seems to imply that the parties in the original position must themselves be willing
to engage in a thought experiment. The hypothetical situation they are asked to
consider is something like the following: although you know that you are
contemporary, and thus have no influence on the rate of savings you receive from
earlier generations, pretend that you have. Imagine now that you are to decide the
saving principle the previous generations should follow.
To be contemporary means knowing that what is behind you in time is past and
inalterable, and what is ahead of you is the future on which your actions have an
49
effect. If you do not know this, the whole idea of being contemporary disappears.
When the parties know, however, that they have no influence on the past, choosing a
principle for previous generations saving can only be hypothetical.
It is not obvious why rational self-interested agents should be willing to engage in
such a thought experiment. The compliance condition indicates that the previous
generations have already saved. Anyway, there is nothing the parties, being
contemporaries, can do to affect the level of past saving. So they must pretend that
they are to decide the previous generation's rate of saving. Because the parties know
they are contemporaries, they should also know perfectly well that the principle they
are asked to choose is, in effect, the principle they must follow in order to save for the
sake of future generations.
This raises the question of why rational profit-maximising agents should agree to this
procedure. If they know that they will only lose by applying a saving principle, why
should they choose to do so? I can see no obvious reasons why.
The previous generations assumption will, however, set a limit on the type of principle
the parties can actually end up choosing. The condition restricts the number of
solutions available to them, and the principle they choose under this condition, will, if
we accept Rawls’ premises, be a fair one. Each generation is asked to choose the
saving principle that will affect the rate of saving it receives. Because the parties do
not know to which generation they belong, the interests of all generations are given
equal weight.
The original position together with the previous generations assumption fails,
however, to show why rational individuals would engage in such a thought
experiment. The aim of the original position is to justify the principles by reference to
a fair procedure. Rawls’ fundamental insight is that, from behind a veil of ignorance,
self-interested, rational agents would choose just principles to govern the basic
50
Redistribution
structure of society (English 1977:91). It is therefore a serious objection to his account
of just saving that it fails to show why it is rational for them to do so.
The previous generations assumption is a new component in the construction of the
original position. What is the logic behind this new thought experiment within the
thought experiment? It seems to me that the previous generations assumption
resembles a golden rule of the form: do unto others, as you would want them to do
unto you. You shall choose the principle of saving (which will, in effect, only benefit
the future generations) that you would want previous generations to have followed in
order to save for you. The parties in OP are to choose a principle they would be
willing to find themselves on the receiving end of.
To sum up:
To be willing to participate in this thought experiment, the parties must have a
capacity to be reasonable. As I have noted earlier, one aspect of being reasonable is
the willingness to propose principles and standards as fair terms of co-operation. In
Rawls’ words, “What rational agents lack is the particular form of moral sensibility
that underlies the desire to engage in fair cooperation as such (…)”(Rawls 1993 51).
This implies that the parties in the original position must be more than rational. In
order to accept the previous generations assumption they must also have a capacity to
be reasonable. The initial motivation assumption, that the parties are thought to be
rational and self-interested only, can therefore not remain unchanged.
The previous generations assumption functions as a thought experiment within the
thought experiment. It is not, however, evident why rational, self-interested agents
should be willing to engage in such a thought experiment. To be willing to do so, they
must have a capacity to be reasonable. This again would imply a change in the initial
motivation assumption of the parties.
Rawls’ account of just saving does not show why it is in the self-interest of rational
utility-maximising persons to choose a principle of just savings from under a veil of
51
ignorance, under the further condition that they must want all previous generations to
have followed it.
The strength of the hypothetical thought experiment is that, given a fair procedure,
rational self-interested individuals will end up choosing just principles. When it
cannot be shown that rational individuals have incentives to do so, the advice of the
original position can no longer work as a justification for the principle.
3.4. The Original Position and the Account of
Intergenerational Justice Revisited
Rawls is struggling with the problem of how the first generation can be motivated to
choose a principle of just saving since it begins the entire process and thus does not
share in the fruits of its own provision. This problem becomes more intense with the
introduction of the present time of entry assumption, since all generations are, in
effect, in the position of the first.
I will now present what I believe to be a better solution. The answer to the problem of
the first generation is found in the definition of the saving principle. In Rawls account,
just saving is strictly defined as a one-way transfer. Income is saved from one
generation to the next. Saving may, however, occur in the other direction as well:
children may save to pay for their parents in their old age or parents may live
extravagantly and leave heavy debts to be paid by their offspring (English 1977:97).
Government deficit spending in times of war and economic recession are other
examples of a negative saving rate. The inclusion of a two-way saving principle
eliminates the problem of the first generation since there is now reciprocity between
the generations that overlap in time. When saving can be both positive, from present
to future generations, and negative, from future to present generations, even members
of the first generation knows that there always exists a possibility that they may find
themselves on the receiving end.
52
Redistribution
When the first-generation-problem is resolved, we may then start again from the
beginning with a more straightforward interpretation of the original position with
regard to the question of intergenerational justice. In this new and revised version of
the thought experiment, the parties to the contract are rational and mutually self-
interested. They are representatives of all the generations and behind a veil of
ignorance they do not know to which generation they belong. The present time of
entry assumption tells them that they are contemporaries. The parties are rational and
mutually self-interested. However, several other problems still remain to be solved.
First, because the parties do not know to which generation they belong, the so-called
social discount rate is zero. A social discount rate discounts the present value of
future benefits and losses. The present moral importance of future events declines at a
rate of n percent per year (Parfit 1984:480). A social discount rate is often presumed
since people are thought to care more, in general, about the present than the future,
and more about their contemporaries than about people who will exist only sometime
in the distant future. The problem of how to motivate real-life people to consider a
thought experiment with a zero social discount rate seems to be huge.
Second, the thought experiment includes all future generations. This assumption is
problematic for two reasons. First, we have very little information about the distant
future. Projections of economic growth, demography, etc. are less reliable the longer
the time-span. Second, in order to make sense of redistribution, we need to have at
least a vague approximation of the limits for the redistribution. For mathematical
reasons, the time-space in which we are to redistribute cannot be indefinite.18
Third, any definition of a generation is bound to be arbitrary. The term can denote a
particular group defined by age, or a special family relation (i.e. mother and father in
one generation, children in the next, then grandchildren, and so on). Generations can
also be thought of as cohorts, meaning all those people born between two specified
dates. The choice of birth dates to determine a cohort’s membership is entirely
53
arbitrary; a cohort can be of any size and be recruited at any time and over any period
of time. The generations as they are perceived by a particular ego are manifestly
different from cohorts. Furthermore, the assemblage of all contemporary persons can
be, and usually is, regarded as the current generation by its members. The examples
above illustrate that the word “generation” can have very different interpretations.
How then are we to define representatives of these generations?
The answer I propose for dealing with these three problems is to construct a window
for analytical purposes. The idea of a "window" is to analyse a defined time span. The
conclusions from this analysis can be used to indicate a distribution for a larger whole.
This is possible because each window overlaps with another window in which some
of the same individuals are still alive. This allows us to generalise the results from one
window to the next, simply because the chain of generations is continuous.
A window can be defined and delineated in a number of ways. A convenient
definition would be that which allows a window to stretch for a limited number of
years, say, the average life-expectancy of a person in that society. It is important to
note that the individuals who will belong to the community in this period do not need
to be divided into generations. They are represented in the original position as
individuals, not as representatives of generations. In this way, we steer clear of the
problem of arbitrary generational groups. The distinction between generations that
overlap and generations that do not, is also less important when we use the window-
approach since the results from one window (containing people who overlap in time)
can be generalised to future “windows” containing distant future generations.19
18 For a further elaboration of this point, see (Nagell 1996) 19 One problem is left unsolved, however, and that is related to what Brian Barry calls “sleepers”. These are effects of our present choices that materialise only far into the future(Barry 1977: 268). One example of a sleeper is environmental waste contained in a tank that is constructed to be safe for two hundred years, but will then erodes and the poison leaks out. (Malnes 1996: 293). The effects will not be felt by the present generation or by their immediate successors, and the harm is therefore not likely to be calculated by the contracting parties. I will disregard this problem here on the presumption that it is not very likely to arise with regard to intergenerational distribution in a pension system.
54
Redistribution
The idea of a window will also reduce the problem of how to motivate ordinary
people to consider the thought experiment. Many of the individuals in a given window
will be contemporaries and overlap in time. They will, therefore, have an opportunity
to reciprocate. The idea of reciprocity, as Rawls defines it, is that all who are engaged
in the social co-operation of society are to benefit in an appropriate way (Rawls 1993:
26). People may give something now, under the further condition that they may later
receive something in return. Furthermore, one would assume that, at least with regard
to young people, it would be quite easy to motive them to engage in a thought
experiment in which they are asked to imagine that they do not know how old they
are, and then to consider a question of redistribution in a pension system, since they
do know that they themselves will one day be workers and retirees.
Which principles will be chosen in this “window-version” of the original position is
the next question. I will argue that the parties of the contract will choose a principle of
vertical equity, a two-way saving principle based on the maximin criterion.
Vertical Equity: the Two-Way Saving Principle
Rawls’ account of a saving principle states that earlier generations should save for
later ones. He also argues that they should do so, even if earlier generations are worse-
off than the later ones. The saving principle asks the worst-off to sacrifice for the
benefit of subsequent persons who may be better off (Rawls 1971:292). This is
contrary to other applications of Rawls’ difference principle, which calls for
maximising the well-being of the least advantaged. In his account of justice between
generations, the difference principle, surprisingly, is not thought to apply. In an early
article, Rawls claims that the criterion is unsuitable for determining the just rate of
saving and that it is intended to hold only within generations (Rawls 1974:142). 20
Rawls applies different principles of justice to the question of distribution within a
generation and the question of distribution between different generations. In the
window-definition of the original position, this seems to be both unnecessary and
20 In another article, Rawls argues that the saving principle may be reconciled with the difference principle if “the representative man required to save belongs to the lowest income class” (Rawls 1967:147). The idea seems
55
unjust. Because saving is thought to be a two-way process between a chain of
generations that overlap in time, there is no obvious reason why the difference
principle should not apply to the question of just saving. The difference principle
reads:
Social and economic inequalities are (…) to be to the greatest benefit of the least advantaged
members of society (Rawls 1993:6).
If later generations are at a lower level of income than previous generations, the
application of the difference principle is straightforward: a positive saving principle is
chosen in which present generations save in order to increase the position of the
worst-off in future generations. If society is progressing, however, saving will not
result from the difference principle in its simple form. If the minimum level of welfare
is higher in the later generations, no positive saving for future generations is required.
However, from the "lexical form" of the difference principle, the result is different.
The difference principle in its lexical form states that an inequality that benefits one
representative individual, X, is just only if it does not lower the prospects of any
individuals who are worse off than X (English 1977:100). The lexical version of the
difference principle is an advanced form of the simple difference principle: once the
position of the worst-off is improved as far as possible, we are then to choose the
principle that improves the position of the second worst-off group, etc. After the
bottom has been raised (the worst-off group is now in a better position) we are to
continue redistributing to the second worst-off group, and so on. The lexical form of
the difference principle, therefore, calls for additional saving from the better-off in
earlier generations for the benefit of those who are worse-off in later ones (English
1977:100).
In the case where society is progressing, however, the difference principle also calls
for backward redistribution, from future wealthy generations to present poorer ones.
to be that the parties to the intergenerational contract are all representatives of the least advantaged group in their society. In this way, the saving rate chosen is acceptable even by this group.
56
Redistribution
A two-way saving principle, based on the logic of the difference principle, will allow
for both positive and negative saving. The direction of the saving depends on the
relative wealth of different generations and, in particular, on the situation of the worst-
off.
The principle of saving defined in this manner is a species of vertical equity. An
application of the principle of vertical equity means that individuals in different
income brackets pay appropriately different amounts in tax. However, for an account
of justice to be complete, we also need a principle of horizontal equity. It seems
plausible to suppose that, when situated in an original position where the interests of
all are taken equally into account, the parties would agree to a principle of distribution
that treats people in the same situation equally. A principle of horizontal equity
coheres with the basic intuition behind Rawls’ difference principle: inequality is only
justified if it is to the greatest benefit of the least advantaged. The contracting parties
will not permit inequalities that do not result in a better position for the worst-off.
They will, however, permit redistribution as long as it will benefits the least
advantaged.
3.5. Concluding Remarks
This chapter has developed a two-way saving principle based on a notion of vertical
equity. John Rawls’ account of justice between generations was used as the point of
departure. I have shown that problems exist in both the manner in which Rawls
tackles just saving in A Theory of Justice and his revised account in Political
Liberalism. The solution Rawls proposes in Political Liberalism, that which I have
called the previous generations assumption, is introduced in order to avoid changing
the initial assumption that the parties in the original position are rational and
disinterested. It is therefore a serious criticism when this chapter shows that the
motivation of the parties does in fact change with the introduction of the previous
generations assumption. One of the consequences is that the thought experiment fails
to show why rational parties under a veil of ignorance would choose a principle of just
saving.
57
In this chapter an alternative definition of the thought experiment has been proposed.
A window covering a certain period of time has been defined. Within this window, a
veil of ignorance covers the parties (all individuals alive in this period) They do not
know their age or to which generation they belong. From behind the veil of ignorance
they are to choose the appropriate principle of saving, under the further condition that
saving can be both positive and negative, i.e. that a principle of saving can redistribute
resources both from young to old and from old to young. The parties in this
“window” approach will chose a principle of vertical equity that states that just saving
is to be for the greatest benefit of the least advantaged in each generation.
The method of generational accounting is a much-used tool for measuring equity
between generations. Generational accounting is in accordance with a principle of
horizontal equity that states that the ratio of benefits to burdens should be the same for
individuals in the same income-brackets, regardless of to which generation one
belongs. There is, however, no room within this method for a consideration of the
principle of vertical equity. According to a principle of vertical equity, a method of
generational accounting should also attempt to harmonise the after-tax income of
current and future generations.
What does the principle of vertical equity imply in practice? 21 In pension systems that
are still maturing, there is a transfer from young to old (Barr 1998 219). When pay-
as-you-go public pension systems began, many workers were paying for very few
retirees and the ratio of beneficiaries to workers was low. This ratio increases as the
systems mature, as longevity increases and more workers retire (Ghilarducci 1998 2).
One unit of investment does not yield the same return and therefore violates the
principle of horizontal equity and is regarded as inequitable by generational
accounting. However, in the period when these schemes were introduced, levels of
21 There is some discussion in the economic literature about the effect of intergenerational redistributive policy: The so-called Ricardian Equivalence states that it is impossible for a policy of redistribution between generations to be effective. The reason is that parents and children are altruistic toward one another and will use
58
Redistribution
economic growth have been high. From a principle of vertical equity, the differences
in contributions to returns can therefore be justified as long as the redistribution was to
the advantage of the worst-off in each generation.
private transfers to offset any government attempt to redistribute among them (For a discussion and attempt to refute the Ricardian equivalence see (Kotlikoff 2001: 72-79)
59
4. Risk Sharing
4.1. Introduction
Large fluctuations in productivity growth, unexpected declines in longevity and birth
rates, and the risk of a bear financial market represent different possible burdens on
generations in a pension system. This chapter argues that only the government can
adequately provide generations with insurance against such risks.
A basic aim of any pension-system is consumption smoothing, the redistribution of
income over the individual lifecycle. In a world of certainty, there is no need for
government intervention in consumption smoothing.22 People provide for their old age
through well informed saving decisions, and those voluntary decisions are efficient. 23
However, the real world is different. In saving for retirement, people are faced with
various kinds of risks and uncertainties. This chapter focuses on what we may call
“generational risks”. Generational risks are external shocks, such as an unexpected
breakdown of financial markets or a severe economic downturn. These largely
unpredictable incidences are risks that affect more or less all members of a generation.
Because the loss is incurred by all, the private market has difficulty insuring against
these risks. This chapter suggests how the government can provide protection against
these risks, which the private market largely fails to insure.
In most public pension systems, redistribution of income between individuals is a
substantial component. Chapter three (“Redistribution”) investigates the case where
the expected level of welfare varies between generations, and asks whether this is also
a reason to redistribute between them. Different generations have experienced
different levels of economic growth. Chapter Three questioned whether this could be
a reason for backward redistribution, from younger to older generations.
22 This is, if we presuppose that individuals are non-myopic.Governments may intervene in consumption smoothing for paternalistic reasons; individuals are not always capable of long term saving because they have the tendency to save less then their long-term overall plan (myopia).
60
Risk Sharing
The topic in this chapter is not the spreading of income (redistribution), but the
spreading of risks (risk sharing). Even when generations are faced with equal expected
productivity, longevity etc., there may still be a need for government intervention
because generations would want to insure themselves against “shocks” of the kind
mentioned above. Note that the subject of Chapter Three was redistribution between
generations with different risk profiles. The point made in this chapter is that even
generations faced with the same risk profile, have reasons to form a common
insurance. This is because general trends (for example, in productivity, longevity,
inflation etc.) are likely to show high fluctuations.
Paul Samuelson, in his classic article, argues that only the government can provide
intergenerational risk sharing (Samuelson 1958). Agents alive at one point in time
cannot enter into a contract with those who will be born well after they themselves are
deceased. Were they able to contract, agents alive today and those born in the future
could form risk-sharing arrangements by buying and selling state-contingent contracts
and various bonds. All generations could therefore gain from introducing an
intergenerational risk-sharing arrangement. Nevertheless, intergenerational risk
sharing is seldom referred to as an argument for government provision of pension for
old age. As Joseph Stiglitz interestingly notes, "[A]s important as intergenerational
risk sharing be in practice, it has provided little of the official rationale for social
insurance programs" (Stiglitz 1988:332). This chapter’s main contribution is the
investigation of the potential for government provision of intergenerational risk
sharing.
Section 4.2 presents the concept of generational risks, explains why private insurance
companies cannot handle this type of risk, and identifies generational risks associated
with pension saving. In section 4.3, two models for intergenerational risk sharing are
proposed. The next two sections (4.4 and 4.5) discuss interpretations of these models:
23 Such a world is modelled in the classical life-cycle model (Modigliani 1986).
61
a defined benefit plan with a buffer fund and a defined contribution plan with a
guaranteed real return. Section five concludes.
4.2. Generational Risks
Generational risks can be defined as risks that affect all the members of a generation,
but have a smaller effect on other generations. 24 Generational risks take the form of
"shocks", particularly severe incidences such as “(…) the risk of having a bear market
during the years one saves for retirement, being the cohort that goes off to an extended
war, or having ones prime employment years during a recession” (Rangel and
Zeckhauser 1999:3). A general definition of risk is the chancing of a negative
outcome. In the language of risk assessment, such negative outcomes are referred to as
“negativities” (Rescher 1983:18). A risk is a product of the negativity and the chance
of its realisation.
Given perfect information, private insurance markets could provide insurance against
risk only if (Barr 2001:19):25
(1) the risks are individual and not common shocks
(2) it is possible to assess probabilities to outcomes
The basic idea behind insurance is that a group of people is insured against a loss that
its members know with statistical certainty will happen to some of them. The
members’ probabilities are independent. The insurance premiums paid in by those
who are lucky, pay for the costs of those who are misfortunate. Thus, it is obvious that
insurance companies cannot insure against common shocks. Environmental
catastrophes like floods or earthquakes are telling examples. When shocks like these
occur, the state is often called in to bail out private insurance companies. By
24 The concept “generation” is difficult to define in a non-arbitrary way. For a discussion of different definitions of the concept of a generation, see Laslett and Fiskin (1992): “Justice between generations” Introduction (Laslett and Fishkin 1992)For the purpose of this paper, it is sufficient to use a general definition, where the words “generation” and “cohort” are used interchangeably. 25 The discussion here presupposes perfect information. Imperfect information may lead to market failures such as “adverse selection” and “moral hazard”. These problems of imperfect information may call for government
62
Risk Sharing
definition, generational risks fail the first requirement. These risks are common
shocks and are therefore uninsurable.
It is either difficult or impossible to assign probabilities to intergenerational risks.
Note that the term “risk” is normally used when the probability distribution of the
outcomes is known, and “uncertainty” when it is not. In the standard approach, risk is
measured in terms of probabilities. These probabilities can be defined by three
different sources: statistical data, theoretical considerations, and personal estimates
(Rescher 1983). It is generally the case that, the longer the planning horizon, the
greater the element of uncertainty. Most of the generational risks discussed in this
chapter are more uncertainties than risks according to the definition above. This
implies that the private insurance market cannot insure against them. Insurance
addresses risk, not uncertainty. The insurance premium is determined by the size of
the loss and the probability of the risk. If the latter cannot be assessed, the price of
insurance is indeterminate.
In the following, generational risks associated with pension systems will be identified.
These risks will be discussed under the headings: financial market risks, demographic
risks, macroeconomic shocks, and political risks.
4.2.1. Financial Market Risks
When people invest their accumulated savings in capital markets, they face the risk of
a low return on their assets. Financial risks can be divided in two categories:
1) portfolio risks
2) volatility risks
The portfolio risks relate to the choice between different compositions of stocks and
bonds. A common argument against individual investment-based pension plans is that
they result in growing inequalities between the disposable income of individual
pensioners. Although this may prove to be an important argument against such
intervention in the insurance market. This chapter focuses, however, on a category of risks that occurs even in the case of perfectly informed insurance markets.
63
schemes, the risk of choosing the wrong portfolio composition is first and foremost an
individual risk, and therefore falls short of the definition of a generational risk.
Individual choices between different portfolios result in increased inequality between
different individuals in the same generation, but not systematic inequality between
different generations. Thus, these risks are not “common shocks” and could (at least in
theory) be covered by ordinary insurance in the private market.
Portfolio risks, however, can be shared between the generations. Just like income, risk
can also be redistributed over an individual’s lifetime; it is possible to accept a higher
risk when young and to be more risk averse when old. For instance, one can have a
higher composition of stocks to bonds early in life, and shift to a composition of fewer
stocks and more bonds when closer to retirement. One can also imagine that
individuals wanting to distribute risk over the lifetime in this manner could form risk-
sharing arrangements with other individuals who belong to other generations or with
cohorts that overlap in time. Martin Feldstein, in a series of recent papers, argues for
the use of the private market to trade risk through time in this way(Feldstein and
Ranguelova 2000; Feldstein and Ranguelova 2001; Feldstein and Samwick 2001;
Fieldstein and Liebman 2001). Feldstein develops several models for how individuals
belonging to older generations may shift risk via the financial markets to individuals
in younger generations.26 When these workers are close to retirement, they can shift
the risk to yet younger cohorts.
First, a general problem with these types of market solutions is that they are based on
assumptions of well-informed rational individuals who are both capable and willing to
undertake such trading of risks. In the real world people in general have little
26 Another model discussed by Feldstein is for future retirees to purchase guarantees that their combined benefits will not be less than some level. Feldstein argues for a privately provided guarantee of the real value of the pension deposits (Feldstein and Samwick 2001). “In the language of financial derivatives, the future retiree buys a “put option” and finances it by selling a “call option”. Such a combination is referred to as a collar (...) Some life insurance companies sell “annuity collars” in which individuals purchase a variable annuity (i.e., an annuity whose payoff depends on the level of an index of stock prices or of stock and bond prices) that contains a guaranteed minimum payment which is financed by foregoing some portion of the return above that level or some higher level. “(Feldstein and Ranguelova 2000:4)
64
Risk Sharing
knowledge of the functioning of financial markets,27 and are likely to be myopic with
regard to their saving (i.e., they save less than they should have done according to
their overall plan). It is therefore unrealistic tosuppose that individuals will be
sophisticated enough to engage voluntary in such risk sharing. Second, an obvious
weakness in Feldstein’s model is that risk sharing can only take place between
generations that overlap in time. However, the market cannot buy and sell risks
between present and as-yet unborn generations. As already mentioned, the
government is in a unique position to provide such risk sharing.
The latter category of financial risks, here called volatility risks, is more clearly one of
generational risks. The extreme example of such a risk is a complete break down of
the financial markets. Even with rather stable markets, however, equity and bond
returns show high fluctuations. The risks of high fluctuations in financial markets
affect individuals at their time of exit from the labour market. Even though the age of
retirement varies from individual to individual more than it did only a decade ago,
people approximately the same age still exit the labour market at approximately the
same time. If they have an investment-based pension plan, they would realise their
pension investments at approximately the same time. At their point of exit, the
different generations of pensioners will therefore be faced with rather different
financial market conditions. Each generation will experience windfall gains or
unexpected losses that are unrecoverable once retired.
Purchasing fixed annuities can reduce some of the risk of volatile markets. Fixed
annuities can provide some protection against volatile markets since they provide a
guaranteed income. Annuities can either be variable (dependent on the return on
stocks and bonds) or fixed (pay the same amount every month). Fixed annuities
provide an insurance against volatility risks from the time the annuity is bought until
the time the individual dies. However, as discussed under demographic risks, the
market for annuities is subject to adverse selection problems. In addition, it is likely
27 A recent country-representative survey from Norway by the consultancy firm Accenture supports this claim (Aftenposten January 28, 2002, Morning Edition p.26).
65
that such annuities, if they are provided, would be very expensive since the insurer
would want to be compensated for taking over the risk of low returns. Furthermore,
fixed annuities provide insurance against volatile markets only from the time the
annuity is purchased, usually the day of retirement. Returns before then are still
exposed to the risk of volatile markets.
Feldstein has proposed a model for inter-generational risk sharing against financial
market volatility. The model discussed by Feldstein is that future retirees purchase a
guarantee that their combined benefits will not be less than some level. Feldstein
argues for a privately provided guarantee of the real value of the pension deposits
(Feldstein and Samwick 2001). In the language of financial derivatives, the future
retiree buys a “put option” and finances it by selling a “call option”. A put option is a
contract that gives its holder the right to sell some asset at a pre-specified price at
some future date. A call option is a contract that gives its holder the right to buy some
asset at a pre-specified price at some future date. Such a combination is referred to as
a collar, and contains a guaranteed minimum payment financed by foregoing some
portion of the return above that level or some higher level (Feldstein and Ranguelova
2000:4). Currently there is no market for call and put options with expiry dates this far
into the future.
4.2.2. Macroeconomic Shocks
A typical example of a macroeconomic shock is an unexpected fall in productivity.
All forms of consumption smoothing will be affected by a fall in output (Barr
2001:90). If we look at the real wage bill growth in a selection of OECD countries
high fluctuations are evident (OECD 2000). If the demand is high for insurance
against a particular outcome that, if it occurs, would affect many people
simultaneously, the price for that insurance would necessarily also be high. Thus,
insurance against an economic breakdown is bound to be expensive. Whether there
will be a market for this type of insurance at all, depends on whether an individual
would want to insure against the opposite risk. Such an actor must be willing to spend
money when the economy is down and earn money when the economy is going well.
66
Risk Sharing
The advantage of the government is that it is able to have a much longer planning
horizon than that of any other agent. In the long run, increased revenues in one period
would compensate for a deficit in another.
Other macroeconomic factors that influence retirement income are inflation and wage
growth. Increasing prices and wages reduce the real value of future entitlements,
other things being equal. Insurance against inflation is provided through some sort of
indexing. However, there is no private market for insurance against inflation.
Insurance companies cannot offer inflation indexed or real annuities. The government
must ensure that indexed government bond markets exist in order to help these
companies to provide protection against inflation risk.
An inflationary shock, however, is an example of a generational risk. Individuals
approximately the same age, facing the same pattern of changes in wages and prices,
will realise their savings at approximately the same time. Thus, a great potential for
intergenerational risk sharing with regard to this risk should exist. If one generation of
retirees experiences a particularly bad episode of inflation, some of the burden of that
could be transferred onto younger, working generations (Stiglitz 1988:332).
Inflation is a typical example of a risk where the probability distribution of future
levels is unknown and the probabilities facing present living individuals are not
independent of each other. Empirical evidence supports the claim that a private
market for insurance against inflationary shocks is as good as non-existent (Bodie
1990).
4.2.3. Demographic Shocks
The risk of having a longer than expected life (the risk of longevity) is a type of risk
that the private insurance market is accustomed to dealing with. Problems occur,
however, in the private market because insurance against this risk is prone to market
failures. We do not know how long we will live. A long life means that what one has
to live on after retirement must be distributed over a larger number of years. Annuities
67
insure against the risk of longevity. Annuities pay a fixed amount every month from
the age of retirement, for a certain predetermined period (term annuities) or until the
individual dies, no matter how long he or she lives (life annuities). With life annuities,
those who die young subsidise those who die old. The benefit of these annuities is
that all workers are guaranteed that, after retirement, their monthly income will
continue for as long as they live.
The market of insurance against longevity is subject to severe adverse selection
problems.28 Those with low risks have little or no incentive to provide insurance for
people with higher risks then themselves. The result is a diversified market for
insurance, where only those with the worst risk profile purchase the same insurance,
and thus cause premiums to increase. The information concerning people's risk is
asymmetric; those who buy insurance know more about their own risk profile than the
insurance company. If the premium is based on average risk, only people of average
risk and above will buy the policy. For the insurer, this is not profitable. In order to
adjust for this problem, annuities in the private market are usually expensive.
As already mentioned, annuities favour those who end up having a long life. Women
statistically live longer than men. In the private market for annuities, women must
therefore pay higher premiums than men. There is also a statistically relevant
difference between generations; younger generations have a higher risk of longevity
than older generations. Increased life-expectancy is reflected in the private market for
annuities, where younger workers must pay a higher price for their annuities than
older workers. Thus, a pooling of the risk of longevity is favourable to younger
generations.
However, life-expectancy rates may also show large fluctuations. This is particularly
true for developing countries. In developed countries, the demographic changes may
also be substantial. Unexpectedly high birth rates together with higher life-expectancy
28 For an estimation of adverse selection problems in the market of life annuities, see James and Vittas 1999 (James and Vittas 1999)
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Risk Sharing
rates represent serious problems for pension systems. Large demographic changes
affect the ratio of worker to retiree, influence the level of output, and in turn, tend to
exert downward pressure on benefit levels and/or upward pressure on social security
taxes and pension premiums.
Furthermore, even when demographic projections in principle can be made with great
accuracy, governments may nevertheless systematically under-predict demographic
changes such as improvements in longevity and declines in future fertility rates.
According to Richard Disney, this is what has occurred in many OECD countries. He
adds that it is not clear whether these errors arise because of incompetence or whether
they are intentional and have a political motivation (Disney 2000:F11).
Demographic changes have severe effects on payg public pension systems where the
current workforce pays for the pensions of today’s retirees. Some believe that
demographic fluctuations also affect the returns on stocks and bonds. This association
between population age and asset prices, however, is less evident (Poterba 2001).
Using slogan-like phrases such as “the demographic time bomb” and “the old age
crisis”, demography is often presented as the main threat to public pension systems
(WorldBank 1994; Sterling and Waite 1998; Lee and Skinner 1999). Private pension
insurance is often marketed as insurance against the instability of public schemes
caused by large demographic fluctuations. Such schemes however, expose their
members to other risks, particularly the risk of volatile financial markets.
4.2.4. Political Risks
Political risk is usually defined as the tendency of politicians to reform or change the
existing pension system (direct political risk) or change the conditions for private
pension markets (indirect political risk) (Pedersen, Hatland et al. 2001). The core idea
of public pension for old age is to guarantee a decent level of security to all citizens
when they reach retirement age. What this “guarantee” amounts to differs from
country to country. Usually it is presented as a promise of a stable and predictable
system, but this promise is never an absolute one. Firstly, governments always want to
69
have a door open to the possibility of adjusting their policies either to new
circumstances or to changing priorities. Secondly, the degree to which present
generations should be allowed to restrict the freedom of choice of future voters and
their governments is questionable. I develop this second point further in Chapter Six.
The direct political risks are greatest in payg pension plans, where promises of fixed
benefit levels are financed by future workers. Direct political risks may be reduced by
various strategies of pre- commitment. Pre-commitment means that the government
does something to tie its own hands. One pre-commitment strategy could be to
legislate strong constitutional guarantees for public pension rights. Another strategy
could be to remove the question of pension reforms and adjustments from the political
agenda through, for example, automatic indexing and automatic methods of pension
calculation. In this manner, politicians insure themselves against themselves, which is
obviously a bit peculiar. The idea that the society or the government can form such
pre-commitments is the topic of Chapter Five.
Note that political risks are not solely related to the government's provision of
pension. Similar risks also occur in the private pension market. To separate these risks
from those involving government politics, we could call them “management risks”.
The fall of Enron illustrates how private providers of pension seriously failed to live
up to their pension responsibilities. Private insurance companies may also perform
badly. They can either go bankrupt or they can manage the pension money poorly.
Hence, regulatory policies that promote the solvency of insurance companies are
needed.
There is, however, an additional category of political risk that is seldom referred to in
the literature on public pension. Political decisions strongly shape and influence the
overall economic conditions faced by the retiree. What occurs if, for example,
politicians launch a new social policy that severely reduces participation in the
workforce (lowering the ratio of employed to retiree)? Or what occurs if the fraction
paid by the individual for public healthcare services severely increases (reducing the
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Risk Sharing
purchasing power of the pension money)? People would most likely want to be
insured against these risks, but such insurance seems difficult to provide. First, it is
difficult to determine which political changes should be insured against and when and
how the insurance should apply. Second, it is difficult to imagine the government
providing insurance against the effect of its own political changes.
Many political risks are obviously generational risks. Private insurance, however, does
not seem to be within reach, and the government is incapable of providing insurance
against its own behaviour, except in the form of pre-commitment strategies such as
those discussed in Chapter Five. The remainder of this paper will concentrate on
insurance against three categories of generational risks: volatile financial markets,
macroeconomic shocks and demographic shocks. The next section develops an ideal
model of intergenerational risk sharing.
4.3. Intergenerational Risk Sharing
The standard answer to the question from policy makers concerning the way in which
to deal with risk and uncertainties in pension schemes has for many years been a call
for risk-diversification (WorldBank 1994; OECD 1998; Holzmann 1999:9). The
intuitive idea is that it is better to not put all the eggs in one basket. By diversifying
the investments, the overall risk is reduced while keeping the expected pay-off the
same. Risk diversification is normally proposed as a system of pension “pillars” or
“tiers”, exposing pensioners to a diversified portfolio of risks, including those we have
defined as generational risks. A combination of the following three pillars is usually
suggested: a state provided basic pension, a system of compulsory private or public
supplementary pension, and a private pension plan. These discussions have a
tendency to present risk diversification as the sole solution to the problem of risk, and
to leave out the difficult question of how to weigh different risks against each other.
A rarely discussed alternative to risk-diversification is to spread risks across the
generations. As we have seen, a major advantage of public versus private insurance is
that the government is in a better position to secure against intergenerational risks; it
71
can impose taxes, build up funds and take up loans. Two variants of intergenerational
risk sharing will be presented below.
4.3.1. Two Variants of Consumption Smoothing
The aim of all pension systems is to provide people with an income after they retire
from work. Part of what individuals produce during their working years is allocated to
future consumption. There are two, and only two ways of smoothing consumption
over the individual life cycle (Barr 2001:90). One may either store current production
for future use or exchange current production for a claim on future production. In a
world of perishable goods, the first alternative obviously does not provide much in
terms of future consumption. The next alternative, to exchange current production for
a claim on future production, can be done in either two ways:
1) invest money that will be available for future consumption at an interest rate
2) give up part of current production (in terms of a general tax or pension premium) in return
for a promise of a share of future production (in terms of pension benefits)
These two routes to consumption smoothing correspond with the two main variants of
pension design, presented here in their extreme forms. In defined contribution (DC)
schemes, the amount you pay in is fixed, and what you receive back may vary. In
defined benefit (DB) schemes, the opposite is true, the final pension (the benefit or
what you receive) is fixed, whereas the premium may vary. In the following, these
two principles of organising a pension system will be the basis for the construction of
two examples of intergenerational risk-sharing arrangements. Sherman gives a more
comprehensive definition of the basic concepts (Sherman 1999:48):
“Defined contribution” schemes are those where the contributions are the basis for the
benefits in so far as the benefits are totally dependent on the contributions paid in and the rate
of return earned on these contributions.
And:
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Risk Sharing
In the “defined benefit” scheme, it is the benefit that is defined in advance, based on other
criteria than the rate of return on investment of contributions paid. Mostly such schemes are
defined in terms of prior earnings and/or service levels rather than previous contributions and
rates of return. The contributions become a function of the benefits, and they are set at a level
to cover the benefit payments. The financial arrangements in mature schemes are often pay-
as-you-go which means, that the benefit payments for one particular year are financed by
contributions paid in during the same year. (Sherman 1999:49)
Defined contribution schemes are almost always funded. It is possible to partially fund
a defined benefit scheme or, in principle, to make it fully funded. As we shall see later
on, funding of defined benefit schemes introduces an additional element of
intergenerational risk sharing. However, for the sake of this argument, and in order to
visualise the two basic methods of consumption smoothing, the two models will first
be presented in their extreme forms: funded defined contribution versus unfunded
defined benefit schemes.
With regard to risk, unfunded DB schemes and funded DC schemes “leak” in
opposite ends. In DC schemes, contributions are fixed and individual. The
generational risks are therefore linked to unexpected changes in benefits (which again
depend on the rate of return on contributions). A financial market breakdown will, for
instance, severely reduce the accrued pension. In DB schemes, benefits are fixed,
whereas contributions vary due to changes in demographic and macro-economic
conditions. Thus, contributions are given as a function of changes in total pension
liabilities (which are influenced by macroeconomic and demographic conditions).
Risk sharing in the two models will therefore look rather different.
4.3.2. Insurance Behind a Veil of Ignorance
Insurance against generational risks means that each insured individual would be
compensated if the insured-against eventuality happened to them. The generations that
are unlucky and need to make insurance claims will, therefore, most likely end up
receiving far more than they contributed . “Lucky” generations, on the other hand, will
pay premiums, but never need to make claims. Risk sharing arrangements of this sort
73
will therefore prima facie look like redistribution politics. It is, however, misleading to
think of this as redistribution since differences in return depend only on which
generation “cashes in” the insurance premium.
The basic idea of intergenerational risk sharing can be visualised with the aid of a
Rawlsian thought experiment (Rawls 1971). Imagine that representatives from
present and future generations are gathered to decide on a risk-sharing arrangement.
The parties are behind a veil of ignorance, they do not know to which generation they
belong. They do, however, have full information about long term development in
economic conditions, financial markets, and social and demographic factors such as
birth and mortality rates, unemployment, etc. Three additional conditions apply:
1. Equal expected return. The expected return of the alternatives available to any of the parties
are equal, since they do not know to which generation they belong.
2. Fixed risk preferences. The preferences for risk do not vary over time or between
generations.29
3. Risk aversion. The parties are risk averse; i.e., they prefer a smaller (riskless) outcome to one
that is attended by higher risk conditions. Thus, there is demand for insurance and low-risk
alternatives.
The next step is to imagine that the representatives of the different generations will be
presented with the possibility of risk sharing within a Defined Benefit and a Defined
Contribution model respectively.
4.3.3. Model 1: The Rationale for Risk Sharing in Defined Benefit Plans
Consumption smoothing can be achieved through an intergenerational contract:
Generation 2 pays for the pension entitlements of Generation 1 with the expectation
that Generation 3 will do likewise. The risk element in this model is normally
understood to be the credibility of the promise. Assume now, however, that the
29 This assumption may not be realistic, see for instance James March (March 1999) According to March, risk taking depends on historical and reference group conditions, and will for instance be influenced by the decision makers current wealth.
74
Risk Sharing
promise is as good as gold. There are no risks of broken promises and no other
political risks. Hence, individual benefit levels are held constant. Is such an
arrangement risk free? Upon closer inspection, clearly not. Demographic fluctuations
will, for instance, influence the ratio of pensioners to workers and result in a
subsequent increase in the dependency burden. With guaranteed benefits, however,
the risks are in Period 1 only. The risk in this model will then be as follows: how
much will I end up paying in terms of contributions for a future fixed and predefined
amount of pension benefits? Looking at a number of generations, from under a veil of
ignorance, without knowing who I am, I will realise that I will either belong to a
“losing” generation, and must pay a large contribution in return for my final (fixed)
pension, or I will belong to a “winning” generation and pay a small contribution in
return for my equally fixed final pension.
If the size of each generation is uncertain and there is a guaranteed consumption in
Period 2, then there is a risk concerning how much consumption must be given up in
Period 1. Intergenerational risk sharing in this model implies stabilising the
contribution rate. The manner in which that can be accomplished is less intuitive than
risk sharing in the Defined Contribution model (Model 2). Obviously the government
may use general revenues or special funds to compensate those generations with a
high dependency burden, but the manner in which those who end up paying smaller
contributions could contribute to the insurance is less evident.
4.3.4. Model 2: the Rationale for Risk Sharing in DC Plans
Consumption smoothing can be achieved by investing part of present income for
future consumption. In a defined contribution plan, each participant pays a fixed
amount each year during his working years which is invested at a rate of return in
order to obtain consumption after retirement. The risk element in this kind of pension
plan is the return on savings. How much, for example, would a NOK 100
contribution, be in terms of future consumption? As a result of the factors that
determine the rate of return from pension saving (including the risk factors defined
above), it is evident that each generation can either “lose” (become one which obtains
75
a very low return compared to the average expected return) or “win” (become one
which obtains a high return).
A Formalisation of the Rationale for Risk Sharing30
Consider a chain of generations (1,2,3...etc.). Each generation lives for two equally
long periods: Period 1 and Period 2. They work in Period 1 and retire in Period 2. The
generations overlap in time, so that 1, 2 (Generation 1, Period 2) and 2, 1 (Generation
2, Period 1) coincide in time.
Furthermore, consider an individual who earns an income Y in Period 1, and who
places equal weight on consumption in the present and the future, with the utility
function U[C1]+U[C2], where the function U[C] is illustrated in Figure 4.1. C1 and
C2 are the consumption levels in the two periods. When the return is equal to one, the
individual will chose to save half of his income in Period 1 for consumption in Period
2 (Consume Y/2 in Period 1 and save Y/2 for consumption in Period 2).
In a situation without risk his expected utility is 2*U[Y/2], which, in Figure 4.1 is
equal to 2*A.
In a situation with risk, the return on his investment is high (1+2*g) with probability
½, and low (1-2g) with probability 1/2. His expected utility is then:
U[Y/2]+1/2*U[Y/2*(1+2*g)]+1/2*U[Y/2*(1-2*g)]
which, in the Figure is equal to A+B2.
With risk sharing between generations there would be risk in both periods (+/- g), but
the variability would be less (g and not 2*g). His expected utility is then
1/2*U[Y/2*(1+g)]+1/2*U[Y/2*(1-g)]+1/2*U[Y/2*(1+g)]+1/2*U[Y/2*(1-g)]
which, in Figure 4.1 is equal to 2*B1. As 2*B1 is higher than B2+A it is clear that risk
sharing between generations is to the benefit ofall.
30 I am grateful to Halvor Mehlum for helping me with this formalisation.
76
Risk Sharing
Figure 4.1
F
th
e
T
c
c
th
a
in
w
la
B1
B2
A
consumption
utili
ty
Y/2(1-2g)Y/2 (1-g)Y/2 (1+2g)Y/2(1+g)Y/2
ull intergenerational risk sharing would imply a sharing of these gains and losses so
at expected return equals real return. This may for instance be achieved by taxing
xcess return and subsidise subnormal return.
he situation is analogous for the Defined Benefit model (Model 1). In this model, the
onsumption in Period 2 is Y/2 and the risk is associated with the amount of
onsumption must be given up in Period 1 in order to consume Y/2 in period 2. Note
at the two risk-situations are similar only under the condition that the generations
re behind a veil of ignorance. In a real life situation, risk sharing will prove difficult
DB plans, since the “lucky” generations will know already in Period 1 that they are
inners and will obtain a high return from the pension system. They will therefore
ck the incentives to share their excess returns with other generations.
77
4.3.5. In Summary:
The two thought experiments above reveal that, in principle, all present and future
generations could gain from forming insurance against generational risks together
with other generations. Thus, rational self-interested (risk averse) generations would
have a reason to opt for the insurance.
Note that the risk in Model 1 lies solely in Period 1only, while the risk of Model 2 lies
solely in Period 2 only. By spreading the risk over both periods it is possible to do
better. A combination of both models will distribute risk more evenly over the
individual life cycle. This would be an example of the type of risk diversification
discussed in the beginning of this section. This section also shows, however, that all
individuals can do better by forming various kinds of risk-sharing arrangements
between the generations. The two next sections discuss implementations of the two
variants of risk-sharing arrangements.
4.4. DB + Buffer Fund
This section illustrates how an interpretation of Model 1 would be a defined benefit
plan with a buffer fund. Defined benefit schemes cope with the risk of volatile
financial markets, but are vulnerable to other risks such as demographic shocks. In
defined benefit schemes without funding (also called payg schemes), today’s pensions
are paid from contributions made by tomorrow’s workers. In other words, workers
give up part of their current production in return for a promise of a share of future
consumption. The pensioner receives a defined level of income, usually linked to
previous earnings.
Section 4.2 showed that all generations could gain if the government were to provide
intergenerational risk sharing by withdrawing money when real returns were greater
than expected returns (and investing this money in a fund). Similarly when real returns
are lower than expected returns, the government covers the loss, either by using
money from the funds or, if necessary, taking up loans. Such a system would be in
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Risk Sharing
equilibrium, since gains and losses would be spread over the generations. The role of
the government is to provide a “buffer”. The surpluses from some periods are used to
boost pensions in others. This section intends to draw practical implications from the
general model.
A defined benefit system pays an annuity based on the previous wage-level of the
insured for (Barr 2001:91). The retiree is therefore not faced with any risk of low
returns from financial markets. Important in public “pay-as-you-go” pension systems
is the ratio of workers to retiree. Declines in birth rates, increased unemployment,
lower retirement age or higher disability figures are examples of parameters that
influence this ratio of workers to retiree.31 Whether these risks are placed on retirees
or future taxpayers, depends on whether benefits are easily modified to avoid
projected jumps in expenses, or whether raising taxes could cover the entire increase.
Again, we assume for the sake of this argument, that benefits are guaranteed. The
crucial factor in determining the rate of return is therefore the dependency ratio
(workers to retirees).
The dependency ratio can to some degree be controlled politically. Much of the debate
concerning the design and future of public pension systems is centred around the
question of how to find the best possible way to obtain a stable and sustainable ratio of
workers to retiree. Workers near retirement age are encouraged to stay in the
workforce, laws are changed to make it easier to import labour, and different variants
of “workfare” policies are designed to keep people off unemployment and reintegrate
them into the workforce. Family policies are designed to give women incentives to
work outside the home. Yet another example of a reform that has been increasingly
adopted in a number of OECD countries (OECD 1998) is a raise in the official
retirement age. However, these parameters are also subject to fluctuations beyond
political control. The return earned by any particular birth cohort will vary in response
31 Chand and Jaeger denote a reform connected to one of the parameters above a “parametric reform” of the pension system. (Disney 2000:F14)
79
to changes in the ratio of retirees to workers caused by, for instance, changes in labour
force participation, birth rates and death rates.
The rate of return in unfunded defined benefit schemes can be expressed in the so-
called Aaron-Samuelson condition: the growth of the population plus the wage growth
rate (Aaron (1966) and (Samuelson 1958)). Each generation pays a pension to each
preceding generation, such that the implicit return on the contract is equal to the
growth rate of the population. Aaron further developed the Samuelson condition:
Aaron linked the equilibrium “return” of the pension system to the growth rate of
earnings, by stating the condition as the sum of earnings per head and the population
growth. However, in many OECD countries, this real rate of return has steadily
decreased. (Feldstein and Ranguelova 2001:2).
The Samuelson and Aaron condition shows that with economic growth and steady
population growth, a payg system is profitable for all generations. Since the return on
storing perishable goods is negative and population growth is likely to be positive, the
scheme would be socially optimal. It is possible in principle for every generation to
receive more in pensions than it paid in contributions. However, none of these
conditions can be counted on in the present economies of OECD countries.
In the present climate of unfunded payg public pension schemes, the risk of high
fluctuations in demographic and macroeconomic conditions can be dealt with in either
of two ways:
1) by constructing an actuarially fair pension system, or
2) by providing an intergenerational insurance that compensates for the loss ex-post.
The first alternative has become popular under the name “notional defined
contribution accounts (NDC)”. Notional accounts have recently been adopted in
various countries, including Latvia, Italy, Sweden and Poland. 32These reforms are
32 Germany has introduced a reform meant to reduce risk in its payg state pension system. This reform has been known as the Riester reform after Labour Minister Walter Riester. The basic idea of the reform is to build up private funding to keep contributions rates in the payg system steady. Partial private funding is introduced in to
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Risk Sharing
characterised by the establishment of individual accounts in which contributions
notionally accrue. Notional accounts are not funded in any real sense, but the
individual's claims on future benefits are designed as if they were funded. Each
individual has an account which mimics a private defined contribution system (Disney
1999:7). The NDC approach appropriates the vocabulary of funded individual
accounts and uses it to define payg benefits.
An argument often used in favour of notional defined contribution accounts is that
they are actuarially fair. An actuarial equilibrium in a pension system is when “the
present value of all future benefits is equal to the amount of reserves at any given
point in time”(Cichon 1999:93). With an actuarially fair insurance, the pension system
would always manage to pay out benefits without having to increase the contribution
rates (Cichon 1999:93). Advocates of notional accounts point to this “sustainability”
as a great advantage (Palmer 1999:5). These systems are intended to be balanced in
such a way that the contribution rate can be kept unchanged indefinitely (Sherman
1999:47). Demographic and macroeconomic preconditions are incorporated directly
into the pension calculation.
Two comments can be made with regard to the feasibility of such schemes. First, not
all NDC schemes are actuarially fair in any strict sense. In actuarially fair insurance,
the pension premium equals the expected value of the probabilities of the accident
(Laffont 1990:125). When you retire, your pension would reflect the contributions
made plus interest, and the length of time you were likely to spend in retirement. An
actuarially fair insurance will therefore automatically reflect the predicted average
longevity of the cohort and expected productivity growth. In addition, at retirement
the accrued pensions can be adjusted to real growth ex post. The new Swedish pension
the state pension scheme. The reform came into force on January 1, 2002. Riester also proposed a new formula for calculating pensions in order to keep the level of pension benefits and the level of contributions steady. In 1997, the previous conservative government introduced a “demographic factor” into the pensions formula in response to people's increasing life expectancy, with the effect of reducing pensions. Riester proposes abolishing this demographic factor and replacing it with a “compensation factor”(Ausgleichsfaktor), also aimed at dealing with the longer life-expectancy and further lowering the contribution burden on the younger generation. The proposal was never accepted.
81
system has so called “automatic balancing” (see Hatland et al 2001, p.160). The
benefits are indexed by a formula that takes into account any deviation in real wage
growth from a growth norm. These calculations are designed to adjust generational
rates of return to the underlying growth of the economy (Disney 1999:15). However,
not all notional defined benefit accounts are really truly actuarially fair. Scherman
shows how demographic development still has a great impact on total pension
payments in notional accounts (Sherman 1999:36). Indexed contributions to real
earnings growth will reflect macroeconomic shocks. However, demographic shocks
are still not reflected. The automatic indexing does not reflect reductions in the size of
the active population that will, as we have seen earlier, increase the cost of the pension
system.
In a full-fledged actuarially fair insurance, the individual purchases a variable annuity.
With a variable annuity unexpected changes in, for example, productivity or post-
retirement longevity are also reflected in the accrual rate of pensions. However, all of
the NDC reforms referred to above have fixed rather than variable annuities.
Unexpected changes in these variables must be covered by other government
revenues, and the risk is borne by the public budget (Disney 1999:12).
Second, a true actuarial equilibrium can only be reached if “beneficiaries” (i.e., the
pensioners) bear the full risk of demographic change (increasing longevity and
decreasing fertility) as well as adverse economic development (as expressed in lower
wages and contracting levels of employment). Given high fluctuations in economic
growth, specifying a norm for wage bill growth for use in notional accounts is very
difficult (Disney 1999:29). A notional account will, therefore, expose individuals to
generational risks. Adjustments to real wage growth at retirement imply that
pensioners incure a potential loss at a time when there is little possibility for them to
recover it.
What notional accounts actually do is simply to transfer the risks from workers to
retirees. Each generation or cohort must be held responsible for the demographic and
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Risk Sharing
macroeconomic conditions facing their generation at the point of retirement. Notional
defined contribution accounts do not share risk. They only move risk from the first
period to the second period of consumption for each individual. The need for
insurance remains equally as large. In this case, however, people who belong to large
generations or who realised their pension benefits in periods of low economic growth
are the losers.
The question then is rather, how can risks in unfunded defined benefit schemes be
shared between the generations? The risk of changing demographics cannot be fully
dealt with in the NDC approach, and thus the creation of a “buffer fund” is required.
In France, a contingency fund was set up in 1999 to offset the “retirement boom”
linked to mass retirement between 2005 and 2010. The “pension gurarantee fund”
(Fond de garantie des retraites) was financially strengthened with the implementation
of the 2001 social security funding law. The fund was initially financed by the
surpluses of the Fund for Old Age Solidarity (Fonds de Solidarité Vieillesse), an
agency created to fund the minimum pension for older retirees. This reserve fund was
then invested in the financial markets and managed by the government. In Norway,
proposals have been made to earmark the Government Petroleum Fund for future
pension payments in order to preserve the national insurance scheme. This proposal
will be discussed in greater detail in Chapter Seven.
However, as will become clear in Chapter Five, such pension funds are difficult to
insulate from political interference. They are weak pre-commitment devices and
therefore are subject to problems of time-inconsistency. Public management of
pension funds makes retirees vulnerable to political risk. A study conducted by
Inglesias and Palacios for the World Bank concludes that publicly managed pension
funds are often used to achieve objectives other than providing pensions and are often
difficult to keep away from political decisions (Inglesias and Palacios 2000). Another
worry is that political interference will hinder such funds from being invested wisely.
83
Furthermore, as noted earlier, a funding solution should not only compensate for high
contribution rates, but should also withdraw money when real returns are greater than
expected returns (and invest this money into the fund). If the fund is based on general
revenues, the latter part of the risk sharing arrangement is not properly taken into
account.
4.5. DC + Guaranteed Real Return
One interpretation of Model 1 could be a defined contribution plan with a government
guarantee of real return. One of the latest trends with regard to pension reform is a
transition from defined benefit to defined contribution schemes. Defined contribution
schemes are being increasingly introduced both in private occupational pension
schemes and public pension schemes.33 Workers save in order to build up their own
pot of assets.
In funded defined contribution accounts, the important risks are financial market
volatility and, if not annuitised, the risk of longevity. On retirement, employees may
use their pot of money to buy an annuity or they may take the lump sum. In these
schemes, employees must bear the investment risk. If the funds are managed poorly,
and investment returns are not so high, they will receive less retirement income. A
characteristic of investment-based defined contribution schemes is that the retirement
income is based on the level of contributions by both employee and employer, as well
as on the return on these contributions in the stock market. This section presents a
33 In many industrialised countries, private companies increasingly introduce defined contribution pension schemes instead of defined benefit pension schemes. One advantage of defined contribution plans for private companies is that they make it less expensive to hire older workers, and that they ensure lower company costs for pension systems (seen as a tax on labour). The NAPF (National Association of Pension Funds), the leading industry body in Britain, reports that leading companies now shift away from defined benefit schemes to defined contribution schemes, no longer providing their employees with a guaranteed percentage of their final salary. Leading companies such as Lloyds TSB, J Sainsbury, British Telecommunications, ICI, and Whitbread have stopped offering employees defined benefit schemes. David Cranston, Director General of NAPF warns of the risk of volatile financial markets: “In recent years, retirees have had it pretty good under the final salary schemes. But for whole generations of future retirees, they are going to get much less than expected with defined contribution schemes” (Financial Times, Thursday December 6. 2001)www.ft.com/pensions. Regulatory requirements to maintain minimum funding levels exist in the UK. Such regulations were introduced after Robert Maxwell plundered The Mirror’s pension fund. Norway has only recently opened up for defined contribution schemes in private sector. In 1999 the special tax rules where changed in order to make this type of private scheme more favourable.
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Risk Sharing
model of intergenerational risk sharing where the risk of low returns is reduced or
even eliminated by government guarantees.
Pension reforms of recent years have typically aimed at shifting financial burdens
away from public sector tax revenue by “privatising” the public welfare burden, in the
sense that the market, family, or community have been urged to provide a larger share
of income protection (Goodin 2001:7). The reform in Sweden took one step in this
direction with the introduction of an individual retirement account on top of a
traditional pay-as-you-go system. Returns on the individual account depend solely on
stock market performance. Defined contribution schemes are more portable, which
suits employees who do not remain with a single employer for most of their career.
However, the investment risk is transferred to employees. If returns from the
management of their pension funds are low, they will receive less retirement income.
A public DC is similar to a private defined contribution plan with the exception that
the government mandates the level of contributions that individuals and/or their
employers must contribute. Each individual has a personal retirement account into
which funds are deposited during working years. Those funds are invested in a
portfolio of stocks and bonds and upon retirement, the accumulated funds are used to
finance an annuity or paid out as a lump sum. With the increase in the introduction of
defined contribution plans, both in the private and public pensions, there is also a
growing interest in finding solutions (either private or public) that may reduce the risk
of volatile financial markets.
How can the government provide risk sharing against volatile financial markets? One
alternative would be the introduction of a minimum guarantee. A commission on
Global Ageing appointed by the Center for Strategic and International Studies (CSIS)
delivered its final report in 2001 after two years of work. One of the report’s main
recommendations is that nations undertake a gradual transition to market financing of
public pension systems, provided that such reforms retain a public guarantee of an
adequate retirement income beginning at a specified eligibility age (CSIS 2001).
85
Such government guarantees could take many forms. Most public pension systems
have a basic pension component: a minimum pension one receives no matter what. In
addition, the government could provide a guarantee that the outcome of an
investment-based pension should not be lower than some predefined benchmark.
The latter can be a fixed rate of return guarantee or a rate of return that is relative to
other pension funds, such as that provided by the government of Chile. Relative
guarantees do not attempt to deal with market risk, but rather insure against
incompetent or inefficient asset management. Countries such as Switzerland and
Hungary have introduced absolute guarantees (Rocha and Hinz 1999:22). These
guarantees take into account the risk of volatile markets by introducing some measure
of inter-generational risk pooling. In both countries, the guarantees are backed by a
central guarantee fund supported by mandatory contributions from all pension funds.
An argument against state guarantees is that they have a tendency to create moral
hazard problems. Individuals and companies may expect to be bailed out by the
government, and may take higher financial risks when choosing their portfolios than
they would otherwise have done. To prevent moral hazard problems with regard to
companies, regulations to ensure that they have adequate capital and reserves should
be imposed.34
Should governments, however, bail out pensioners who have unluckily earned low
returns? Robert Goodin argues strongly against the idea that the state serve as
underwriter of last resort if returns from capital markets fail to meet commitments:
It amounts to saying that private providers should be allowed to make whatever profit they
can by running private pensions, so long as things go well− but that the state should step in to
bail out when things go badly wrong. In effect, this means “privatising profits” and
“nationalising losses”. (Goodin 2001 20)
34 For a detailed list of regulations proposed by the OECD, see (OECD 2000). The EU has also developed common principles for the regulation of pension schemes (See
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Risk Sharing
Note, however, that in the Model 2 developed above, moral hazard problems of this
type are not likely to occur. The insurance provided by the government is financed by
the taxes from individuals whose returns were very high. This guarantees a minimum
return at the expense of reducing upside returns. The two most important advantages
of this model are first that it avoids moral hazard problems, and second that it is self-
financing.
4.6. Concluding Remarks
This chapter has shown that all generations will in principle gain from sharing risk
across the generations. I have also argued that the government is in the best position to
provide this type of risk sharing. Two variants of risk sharing have been discussed.
The first model is insurance against volatile financial markets in a defined
contribution plan. The second model is insurance against volatility in the ratio of the
tax base to pension entitlements in a defined benefit scheme.
“Fifteen principles for the regulation of private occupation pension schemes” , www.oecdconference.org/documents/23principles.doc).
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5. Pre-commitment
5.1. Introduction
Pre-commitment arguments come in many forms, but their basic substance is that
constraints can be imposed on the freedom of individuals, legislators or democratic
assemblies, protecting them against their own irrational, passionate or short-sighted
behaviour. Pre-commitment is a device against the tendency of agents to pursue their
short-term self-interests instead of extending their horizon to their life as a whole
(Elster 1992:46). The image often used is that of Ulysses, who bound himself to the
mast to avoid being tempted by the song of the Sirens (Elster 1979).
Strategies such as destroying your cigarettes to give up smoking, taking antabus to
stop drinking, or leaving credit cards at home when shopping are examples of
individual self-binding. However, a pre-commitment argument is also frequently used
to describe situations where the agent is the “society,” “politicians,” “voters” or “the
government.”35 The first part of this chapter presents the idea of pre-commitment, and
points out some reasons for such pre-commitment.
Problems emerge, however, when the individual analogy is transferred to collective
actors. The second part of this chapter asks whether the idea of society being able to
bind itself is at all viable. I will investigate Jon Elster’s earlier account of pre-
commitment (Ulysses and the Sirens 1979), attempt to incorporate later revisions
(Ulysses Unbound 2000), and develop a new and revised version of the argument.
One reason for pre-commitment is to overcome time inconsistency. Time
inconsistency means that the future is discounted in such a way that preferences
35 The most recent example I know of was stated by Øyvind Østerud the leader of the Norwegian research project “Power and Democracy”: “For å gjenvinne stabilitet har politiske organer bundet seg som Odyssevs til masten fordi de vet at de er svake for kortsiktig opinionspress” (Aftenposten 7.mars 2002).See also (Smith 2000)
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Pre-commitment
change simply due to the passage of time. Time inconsistency makes it impossible to
carry out a long-term plan. The third part of this chapter asks whether there are
problems of time-inconsistency with regard to the politics of public pensions that
should be solved through some strategy of pre-commitment. Two examples are given.
First, I consider the case in which the body politics may wish to be pre-committed to a
long-term saving plan. Second, I present a situation in which the government may
apply a pre-commitment strategy to ensure that their promises of future pension
entitlements remain credible.
5.2. The Pre-commitment Model
In Jon Elster’s book Ulysses and the Sirens (Elster 1979), pre-commitment is a
strategy for achieving rationality by indirect means. The strategy adopted by Ulysses
is a response to a problem of weakness of will: Ulysses wanted to think ahead and
commit himself to a master plan. He knew that, in the course of his actions, his will
would weaken and he would have the inclination to deviate from his own long-term
plan. His overall goal was to return to Ithaca, where his wife and children where
waiting. He could foresee that he would be tempted by the song of the Sirens, and
realised that a rational strategy was to pre-commit himself to his overall plan by
having his men tie him to the mast. A strong, long-run or rational self imposes
limitations on a future weak, short-run or irrational self.36
There are basically two main reasons why individuals might want to pre-commit
themselves: strong passions or interests and problems of time-inconsistency. As we
shall see, these reasons cannot automatically be transferred to political actors, and a
number of other reasons for pre-commitment may emerge when the level of analysis
is the societylevel. Pre-commitments created by the body politics may, for instance, be
motivated by efficiency reasons. I will return to this later. However, in the classic pre-
commitment model, the main reasons for binding oneself comprise strong passions
and problems of time-inconsistency.
36 Here I follow a standard definition of rationality: A rational agent is one who has consistent and complete preferences at any given point in time (Elster 1979:65).
89
The first reason is rather straightforward, and does not warrant much explanation, at
least not at the individual level. It is easy to find examples of situations in which
people under the influence of strong feelings such as lust or anger do things that they
would not want to do, all things considered. Pre-commitment involves taking
measures during calm, lucid moments in order to prevent some foreseeable and
unwanted actions from a future passion-driven self. Many writers have emphasised the
analogy to the level of politics. In a tradition following James Madison, constitutions
are interpreted as necessary restrictions on democratic majorities, which are assumed
to be driven by passions and short-term interests. In the words of Friedrich Hayek, a
constitution is Peter sober while the electorate is Peter drunk (Hayek 1960).
Consequently, according to this view, citizens need to be protected against their own
irrational and short-sighted behaviour. The claim that society needs to protect itself
against passion-driven democratic majorities is problematic for many reasons. First, it
expresses a fundamental (and I think unreasonable) distrust in democratic majority
rule. Second, it hinges on the assumption that constitutions are important because they
impose necessary limitations on democracy. Constitution and democracy are being
viewed here as essentially contradictory. For further discussion of the relationship
between constitutional constraints and democratic rule, see Chapter Six, Democracy.
For now it will suffice to note that political pressure from powerful majorities can be a
reason for politicians to pre-commit themselves. Budget restrictions and public
funding, for instance, are often described as devices to counteract the pressure
inherent in day-to-day politics to spend money on all good purposes now.
This chapter focuses primarily on the more recent argument that pre-commitment can
help us to overcome the problem of time-inconsistency. In economic theory,
problems of the sort faced by Ulysses are grouped under the heading “time-
inconsistency problems.” A great deal has been written on how to deal with such
problems (Asheim 1997), (Phelps and Pollak 1968; Pollak 1968; Kydland and Prescott
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Pre-commitment
1977; Kotlikoff 1988; Akerlof 1991; Cowen 1991).37 Two variants of time-
inconsistency are normally identified: time-inconsistency caused by hyperbolic
discounting and time-inconsistency caused by strategic interaction.
An actor is subject to hyperbolic discounting if she prefers one apple today rather than
two tomorrow, but prefers two apples in 51 days to one apple in 50 days (Torsvik
1998). Hyperbolic discounting implies that preferences change exogenously due to the
passage of time. The traditional assumption in economic theory is exponential
discounting, with a discount rate constant but less than 1 (welfare at t units into the
future is discounted to present value by a factor of r_t, where r(<1) is the one period
discount factor). The famous “life-cycle model” is based on exponential discounting,
but with constant time preferences. The first assumption implies that people value the
present more highly than the future for various reasons. The second assumption
implies that a given time delay leads to the same degree of time discounting regardless
of when it occurs. Hyperbolic discounting, on the other hand, implies that welfare at t
units into the future is discounted to present value by a factor of 1/(1+kt), where k>0
(Elster 2000:25). There are two versions of hyperbolic discounting: inconsistent time
preferences and endogenous preferences.
Inconsistent time preferences are preferences that change systematically with the
passage of time (Elster 1979:65). To give an example38: constant time preferences
mean that if you prefer an expensive French dinner in twelve months to a nice Chinese
dinner in eleven, you should continue to prefer the French dinner even when the actual
date for the Chinese dinner arrives. A person with inconsistent preferences for time,
however, who preferred the French restaurant over the Chinese when the former was
twelve and the latter eleven months forward in time, would be likely to opt for the
Chinese dinner when it becomes immediately available. In his classic study from
37 Different solutions to time-inconsistency problems have been proposed: consistent planning (Strotz), private side-bets (Anslie), social contract (Kotlikoff, Persson, Svensson), partial commitment (Persson, Svensson, Lukas, Stroke), rules rather than discretion (Prescott/Kydland), government reputation (Rogoff). 38 This example is taken from the preface to the book Choice over Time edited by George Loewenstein and Jon Elster (p. xiii)
91
1955, Strotz found evidence that time preferences are likely to change along the way
(Strotz 1956). This assumption has been supported by later work, for instance Ainslie
and Haslam (Ainslie, 1992). One psychological mechanism behind inconsistent time
preferences that seems realistic is procrastination: people tend to postpone unpleasant
tasks until tomorrow (Asheim 1997:427).
Hyperbolic discounting may also be caused by endogenous preferences. Endogenous
preferences mean that an agent is inclined to change his time preferences along the
way. Endogenous preferences, in other words, are preferences that change
endogenously due to the person’s choice of action. These preferences reflect a kind of
“path-dependency.” Your preference depends on the path you have been following –
or on previous decisions and their ramifications. A psychological mechanism leading
to endogenous shift in preferences is intoxication. Geir Asheim gives an example that
I can easily relate to personal experience:
After work, some people would prefer to go by the local pub to have one beer instead of
going straight home. At the pub, after the first beer, it may however seem preferable to
consume three additional beers. These preferences are time-inconsistent if, when leaving
work, going straight home is preferable to consuming four beers at the pub (Asheim
1997:427)
If an agent has either inconsistent or endogenous time preferences, he will face a
problem of meta-planning, a conflict between two variants of the self (Torsvik
1998:376): an “agent” is in potential conflict with a “planner.” The agent is inclined
to change his time preferences along the way, and the planner faces the problem of
how to follow a certain plan in spite of the agent’s having this inclination. If the
planner does not stop the agent, he will not be able to follow the meta-plan. If we
assume that politicians are subject to hyperbolic discounting, some kind of strategy for
self-binding may make it easier for them to follow their long-term interests.
A pre-commitment strategy is often used as a means to achieve something in
interaction with other agents. Agents often act on each others’ decisions. For instance,
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Pre-commitment
what person A does at time t0 may affect the choice of person B at time t1. Game
theory deals with problems of this nature. Time inconsistency due to strategic
interaction occurs when a plan does not depict modular rationality. Modular
rationality is when an agent is facing a sequence of choices, “her plan should specify a
rational choice at each choice point, relative to her situation at that choice point
(Skyrms 1996:22).” Modular rationality is a condition that must be met in order for a
promise or a threat to be credible. Take for instance the famous example from Stanley
Kubrick’s film Dr. Strangelove. A doomsday machine is designed to be set off by
tampering. Commitment to retaliate is built into the machine. This is done to guard it
from any second thoughts its builders might have. (Note also that the doomsday
machine can only be an effective strategy of deterrence if people know this. Similarly,
other threats and promises are credible only to the extent to which they effectively
influence the choices and actions of other agents). The example of the doomsday
machine is a pre-commitment strategy to avoid a threat’s becoming time-inconsistent.
After being attacked, the best thing to do would have been to destroy the doomsday
machine. However, if that was possible, and if the other party knew that it was
possible, the threat of retaliation would not have been credible. In order to make the
threat credible, retaliation is built into the machine. The doomsday machine is an
example of an elimination of an option or of “burning one’s bridges” (Elster 2000:42).
It also has an external mechanism built into it. It is therefore a strong pre-commitment
device.
We can also find situations where pre-commitments are designed to make time-
inconsistent promises credible. Suppose Adam has to make a decision first (l or r),
then Eve another decision (L or R), and then they both get payoffs on the basis of
both their choices. Figure 1 shows the structure of a non-credible promise. (Elster
2000:39) Adam knows that once he has moved left it will be in Eve’s interest to move
right. Her threat to move left is therefore not credible.
93
l
Figure 5-1 Non-credible promise, FD structure
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Elster asks in
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94
e on to discuss problems o
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Pre-commitment at
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tiny. Is the notion of an agent binding himself
ty writ large? This is also the question Jon
e pre-commitment model.
the Level of Society
of society amount to? Constitutional budget
ous central banks are examples of internal
inister a country’s economic resources.
regulations are examples of external binding.
tal or externally imposed, but a society may
a deliberate strategy of pre-commitment. In
for instance, imply imposing costs, eliminating
Elster questions to what extent it makes sense
ster quotes Norwegian historian Jens Arup
e never try to bind themselves, only to bind
basic content of Seip’s statement, Elster
Pre-commitment
revises his earlier position with regard to constitutional pre-commitment (Elster
2000:278).
The descriptive interpretation of Seip’s statement is uncontroversial. Obviously, pre-
commitment at the level of society always amounts to putting constraints on specific
agencies by transferring power to others. Take a decision by the political community
to delegate responsibility for monetary policy to an independent central bank. If we
look at it purely factually, the central bank binds or restricts the government.
However, Elster uses Seip’s statement to (at least partly) reject his earlier claims that
constitutions are pre-commitment devices (in the intentional sense) and that societies
ought to bind themselves by constitutional pre-commitment. His position now is that
“these claims are eminently contestable, on conceptual, causal, and normative
grounds”(Elster 2000:167). 39
The aim of this section is to compare Elster’s statement of pre-commitment in his
early work Ulysses and the Sirens (1979) with his more recent position in Ulysses
Unbound (2000).
In Ulysses and the Sirens, Elster identifies five elements in a definition of pre-
commitment (Elster 1979:39). First, pre-commitment is:
(i) to carry out a certain decision at time t_1 in order to increase the probability that one will
carry out another decision at time t_2. (Elster 1979:39)
In other words, in a strategy of self-binding, “the expected change in the probability of
the later action must be the motive for the earlier one” (Elster 1979:39). This
definition excludes unintended or forced binding, and focuses entirely on those actions
that have pre-commitment as their explicit strategy.
39 Elster does say that in a certain sense and under certain conditions it makes sense to say that a society “binds itself” (Elster 2000:90). In a literal sense, it may make sense to talk about self-binding when the parliament decides to give up some of its power to another branch of government, or when a majority in the constituent assembly also expects to be the majority in the first legislation (Elster 2000:96). Elster nevertheless devotes a whole chapter to a critique of the idea of society binding itself (chap. II).
95
With regard to constitutional pre-commitment, this first requirement is revised in
Ulysses Unbound, where Elster argues that such pre-commitments are not necessarily
deliberate strategies. He usefully distinguishes between constitutions as incidental
constraints and constitutions as essential constraints. Essential constraints are willed
and planned actions with the explicit purpose of self-limitation. They are established
for the purpose of restricting the freedom of action of the individuals who voted for
them and that of similarly placed individuals in the future. But pre-commitments may
also be incidental constraints. According to Elster, this is particularly true with regard
to constitutional restrictions. Rather than being created, they evolve, and they are
often the result of incidental and incremental rather than willed and planned processes
(Elster 2000:89).
However, Elster goes on to say that the fact that constitutional restrictions are
sometimes incidental should not make us discard them as pre-commitments. When
constitutional restrictions are first established, they may very well be justified by
reference to the fact that constitutional protection has a disciplinary effect on political
actors. Elster argues:
We may ask whether existing constitutional provisions as a matter of fact tend to have
salutary restraining effects on a subset of the political actors, regardless of why and by whom
the constraints were set up in the first place (Elster 2000:90).
Elster’s initial restricting of the definition to essential constraints also had
methodological consequences for his theory. Elster admits that his focus on only
essential constraints in the first version of Ulysses and the Sirens led him into an
implicitly functional explanation of constitutions. Because he did not distinguish
clearly enough between the intention and the effect of pre-commitment, he assumed a
functional explanation without having adequate support for that assumption.
Observing, for instance, that the system of periodical elections had the effect of self-
binding, he assumed that this was also the intention behind this arrangement (Elster
2000:90).
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Pre-commitment
The revision of the first requirement is first and foremost conceptual. The concept of
self-binding has now been broadened to include those constitutional restrictions where
there was no intended or planned pre-commitment strategy to begin with. Including
incidental constraints in the definition makes it easier to view constitutions and other
constraints on political authorities as pre-commitment devices.
The second requirement in Elster’s initial definition was that in order to speak of pre-
commitment, some options must be removed from the opportunity set of the agent:
(ii) If the act at the earlier time has the effect of inducing a change in the set of options that will
be available at the later time, then this does not count as binding oneself if the new feasible
set includes the old one (Elster 1979:42).
In Ulysses Unbound, Elster grows increasingly doubtful as to whether a society can
have the power to bind itself in the first place. Constitutions, he argues, do not remove
options entirely, they only make some options less available. It is uncontroversial to
argue that constitutional restrictions are a matter of degree. How effective the binding
power of constitutional restrictions is depends in part on how the constitutional
procedures are formed. But Elster’s claim is more radical. When he says that
constitutions do not necessarily have binding force, he is alluding to the idea that
“there is nothing external to society” (Elster 2000:95). When society obligates itself, it
can always in some way undo its own obligations. In the words of another prominent
constitutional thinker, Stephen Holmes, promising yourself that you will go jogging is
far less committing than making an appointment with your tennis partner (Holmes
1988:209).
If there is nothing external to society, Elster argues, then binding one’s will in some
external causal mechanism is not an option. This observation leads Elster to the
rejection of constitutional pre-commitment with reference to the third requirement set
out in Ulysses and the Sirens – that there must exist a causal mechanism:
97
(iii) The effect of carrying out the decision at t_1 must be to set up some causal process in the
external world. (Elster 1979:43)
According to Elster, “our intuitive notion of what it is to bind oneself seems to require
that we temporarily deposit our will in some external structure” (Elster 1979:43).We
should, however, appreciate that there are internal structures that can have a binding
force on society. An autonomous central bank is one example. The central bank is
instructed to operate independently by government. Independent central banks are
assumed to be subject to less political pressure, making monetary policy more
predictable. By giving authority to a central bank, the state becomes capable of doing
what it otherwise would have difficulty implementing due to the temptations, pressure
and short-sightedness inherent in ordinary politics. The central bank is not external to
society, but it is external to those political actors who are predicted to be subject to
weakness of will. Jeremy Waldron makes a similar point: “Even though the
constraints are not external to the framework, they are in the relevant sense external to
the particular agencies in which the ‘will of the people’ is embodied for purposes of
ordinary political decisions” (Waldron 1998:277).
Similarly, commitment can be credible when power is divided between the executive
branch, an independent judiciary and a democratically elected legislature. Elster
admits this (Elster 2000:149). True, nothing is external to society, but with effective
separation of powers, the political authority is not omnipotent. However, Elster’s
recent position is that this is not an illustration of self-binding, but rather of how one
branch of government constrains another (Elster 2000:99). In my opinion, this
definition of self-binding is too narrow. True, the division of power ipso facto means
that one branch binds another. But constitutional restrictions are also clearly examples
of a delegation of power to the judiciary accompanied by general instructions vested
in higher law, with the purpose or effect of imposing constraints on the political
community as a whole.
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Pre-commitment
One might, however, object altogether to the idea of a causal mechanism, whether it is
external or internal. Jeremy Waldron goes as far as saying that “anyone who thinks a
narrative like this [the development of constitutions] is appropriately modelled by the
story of Ulysses and the Sirens is an idiot”(Waldron 1998:283). Waldron objects to
the analogy to self-binding partly because he perceives the absence of a causal
mechanism in constitutional pre-commitment. Constitutional constraints do not imply
giving an instruction at t1 that will be automatically followed at t2. Rather, Waldron
argues, they involve a form of submission by A at t1 to whatever judgement made at
t2 by another agent, B, in the application of very general principles that A has
instructed B to take into account (Waldron 1998:280). Because there is no causal
mechanism, constitutional pre-commitment involves judgement. It means “having
themselves constrained by others’ judgment” (Waldron 1998:279). According to
Waldron, one problem with constitutional restrictions, therefore, is that they allow for
discretion by someone who is not democratically elected.
However, the view that constitutional constraints allow for independent judgement
should not in itself make us discard these constraints as pre-commitments. I have
argued that the existence of a causal mechanism completely outside society should not
be a requirement for constitutional pre-commitment. Similarly, all laws and rules must
be interpreted along a continuum where mechanical exercise of the rule represents one
extreme and full discretion represents the other. Rule implementation always involves
both elements. Waldron is right in claiming that the absence of a causal mechanism
implies an element of discretion. It does involve others’ judgement. What I think
Waldron does not fully emphasise is that “others’ judgement” is restricted and defined
through the initial assignment.
When, as in Waldron’s example, I entrust a friend with my car-keys to make sure I do
not drive while intoxicated, I do not thereby give him permission to do whatever he
wants with them. He has them in his custody in order to protect my interests. His
instructions are to take care of my (overall) best interests as I interpret them in my
calm and lucid moments. (One such moment made me realise that I would probably
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be subject to weak will and will try to drive home from the party while drunk). I
trusted my friend because I believed that he would know better than I what is in my
best interests at t2 (at the party). So Waldron’s reference to the judgement of others is
not, in my opinion, a good reason for dismissing the pre-commitment argument.
However, I agree with Waldron that discretion may pose a problem to the idea of self-
binding when there is uncertainty regarding exactly to what the political community
has committed itself.
Once it becomes unclear or controversial what the people have committed themselves to,
there is no longer any basis in the idea of precommitment (…)(Waldron 1998:281)
Contrary to Waldron, however, I am inclined to believe that the implications of this
observation should be to make stronger pre-commitments. Clear instructions reduce
the element of discretion. When a pre-commitment, for instance in the form of a
constitutional right to a pension, is given in general and vague terms, the uncertainty
about what the pre-commitment really comprises in that particular case will leave
room for a large component of discretion. Conversely, expressly stipulated and formal
rules of instruction imposed on independent agencies such as central banks will come
much closer to a mechanical exercise of an initial plan.
The fourth and fifth requirements in Elster’s definition both concern the motivation
for pre-commitment. Since we have already broadened the definition to include not
only essential but also incidental constraints, these two requirements become less
important for our purposes.40
40 The fourth and fifth requirements are: Fourth, (iv) The resistance against carrying out the decision at t_1 must be less than the resistance that would have opposed the carrying out of the decision at t_2 had the decision at t_1 not intervened. This requirement is intuitively necessary. The agent must have enough willpower to force himself to take the steps necessary in order to establish a pre-commitment. Recall that requirement iii) states that pre-commitment involves a causal mechanism. Pre-commitment takes the form of having said or done A, then B will automatically follow. But doing A must be within an agent’s motivation or willpower. Fifth and last, (v) the act of binding oneself must be an act of commission, not omission. This simply implies that pre-commitment is taken to be the entering into a new state rather than a decision not to leave the current state. In practice, this distinction may be hard to draw. Elster also admits that acts of commission (for instance a man desperate for cigarettes watching the tobacconist close his shop but not entering) may rightfully be characterised as strategies of pre-commitment. What Elster wants to exclude from the definition of pre-commitment are situations where
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Pre-commitment
What are the conclusions that can be drawn after this discussion? The findings so far
can be summed up in a new and revised definition of constitutional pre-commitment:
(i)’ Constitutional pre-commitment can comprise either essential or incidental constraints,
and should be evaluated according to its effect.
(ii)’ Constitutional pre-commitment means that some options are made more costly or available
only with a delay .
(iii)’ In order to qualify as pre-commitment, power and decision-making control must be
transferred or restricted in such a way that (ii)’ is satisfied.
Recall the statement by Elster, referred to earlier, that the claims that constitutions are
pre-commitment devices and that society ought to bind itself are “eminently
contestable, on conceptual, causal, and normative grounds ”(Elster 2000:167). Thus
far, the discussion has focused mainly on conceptual and causal objections to the use
of the pre-commitment argument at the level of society. However, Elster’s main claim
is that constitutional pre-commitment is not morally permissible since it involves
binding future generations:
It is arbitrary to let one generation impose a virtual ban on abortion or a right to abortion, or a
ban on income taxes, or a right to bear weapons, unrestrained freedom of contract or a right to
an adequate income, on its successors. There is no cant-free way in which these procedures
can be referred to as self-binding. The fact that a later generation may be welcomed being
bound is neither here nor there, since founding generations will rarely be in a position to
anticipate this preference. (Elster 2000:170)
However, it is unclear whether this argument makes Elster reject the use of pre-
commitment arguments to explain constitutional constraints. He seems to accept a less
transaction costs and uncertainties play a significant role. In his view, a decision to stay in a current state is often highly influenced by these two factors. However, I do not see how excluding acts of omission from the definition prevents transaction costs and uncertainties from entering into the picture. Pre-commitment as acts of commission surely involves both elements. The decision to enter a new state always involves considerations tied
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stringent variant of the pre-commitment argument with regard to constitutions. He
notes: “Creating a constitution that binds future generations may also, in a looser
sense, be seen as an act of self-binding, namely, if future political agents are expected
to have the same reasons for wanting to be restricted as the founding generation
”(Elster 2000:96). And: “If the problem to which the constitution is offered as a
solution can be expected to persist indefinitely, the framers can say with some
justification that they are acting on behalf of a temporally extended ‘self’ that also
includes future generations” (Elster 2000:168). Some reasons for pre-commitment, he
argues, are stable over time – i.e. they are reasons for both present and future
generations to want to bind themselves. On the other hand, Elster rejects the
assumption of a unitary actor: “No group has the inherent claim to represent the
general interest”. “Society has neither an ego nor an id”.(Elster 2000:168). 41
The analogy to individual self-binding has some obvious shortcomings when it is used
at the level of society, the most important being that democratically elected political
decision-makers are not the same over time. Ulysses bound only himself or a future
self. A rather different question is whether the present politicians can bind future
politicians – and to put it another perspective, whether present generations have the
right to bind future generations. This question will be touched upon in chapter six,
Democracy. For the sake of the previous discussion we may now add a fourth
requirement to the revised version of the pre-commitment argument:
iv) Pre-commitment can be legitimately understood as a society binding itself where the “self” is
temporally extended to include future generations if and only if the reasons for doing so are
reasons for both present and future generations.
to the exit of the current state. In my view, acts of commission and acts of omission seem to be two sides of the same coin. 41 One may rightfully question whether it makes sense to talk about the government as an autonomous agent capable of rational choice. If we take account of classic aggregation problems such as Condorcet’s paradox and Arrows impossibility theorem, the answer tends to be negative (Hylland 1984).
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Pre-commitment
This section concludes that the model of pre-commitment in its new and revised
version is viable, and may be helpful in explaining some of the situations in which the
government has had its power constrained.42
What may qualify as reasons for pre-commitment is a question that cannot be solved
at a general level, but must be tested out in each particular case. In the following, I
will discuss two situations where problems of time-inconsistency may be an argument
for the government to adopt a strategy of pre-commitment. There are at least two
long-term concerns with regard to public pensions where time-inconsistency might
represent a problem, and it may be preferable for a society to bind itself. First, there is
the problem of national saving. Saving is necessary in order to fulfil public pension
entitlements already accumulated in the system (pension entitlements will constitute a
financial challenge in most OECD countries in 15-20 years). At the same time, it is
often assumed that politicians have a bias towards the kind of spending by the state
that gives immediate effects, and therefore have a tendency to under-save. Second,
there is the problem of making political promises credible. Predictability and stability
are general long-term goals, and are particularly important with regard to old-age
pensions. Because people must rely on the system when planning for their retirement,
rules must be stable and entitlements predictable. At the same time, politicians may
have an inclination to try and free themselves of parts of the financial burden
represented by the public pension entitlements.
42 It is, however, unclear what Elster’s new position is with regard to the usefulness of the pre-commitment model at the level of society. At least two interpretations are possible. One plausible interpretation is that Elster makes an effort to save the pre-commitment model from the critique referred to above. There is some evidence in the text for the interpretation that he wishes to defend the analogy to individual self-binding, and ends up with a new and revised version, something similar to i)’-iv)'. A second and, I think, equally plausible interpretation is that he now dismisses the usefulness of the Ulysses metaphor altogether when it comes to describing or explaining collective actions, particularly constitutional constraints. Due to the many problems above, the model fails to explain constitutional constraints, or any other constraints imposed on the political bodies for that matter. The model he seems to advocate instead is that constitutions are enabling rather than disabling. Rather than being necessary constraints on the tendency of people or institutions to behave irrationally (due for instance to time-inconsistency or passions), constitutional constraints are there to give us the ground rules, or the procedures required for a well-functioning democracy. This argument will be discussed in greater length in Chapter Six, Democracy.
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5.4. Saving
As we have seen elsewhere, the total costs of a pay-as-you-go public pension scheme
are highly dependent on demographic variables. However, in contrast to other factors
determining the future costs of pension entitlements, changes in demography are to a
large degree predictable. Accurate predications have been made which show the
increasing burden of public pension schemes in the OECD countries from around
2015-2040. If nothing is done to accumulate money in advance, the result will
obviously be increased burden of payment for the younger generations, and less
economic freedom for future governments.
In a well-run household economy, costs are evenly distributed. The total expenses
over the year are summed up and divided by twelve. Based on this calculation a fixed
amount of money is withdrawn every month to even out the otherwise high
fluctuations in monthly expenses. When large bills arrive, there is enough money put
aside to cover them. When large public expenses can be predicted, there are good
reasons for governments to adopt a similar strategy.43
Assume now that policymakers are influenced by short-term considerations. If they
are, they will be tempted to make economic choices on the basis of the immediate
social consequences. They may also be likely to postpone unpleasant tasks
(procrastinate). Saving in advance to cover the predicted rise in future expenses will
prove difficult if the government has such inconsistent time-preferences. A
government with inconsistent time-preferences will value the present more highly than
the future, but will value the future more evenly, and will end up saving less than the
initial plan. Saving is a good idea – in the future. But when the future arrives, it
always does so in the form of a new present, to which the same reasoning applies
(Elster 2000:143).
43 Needless to say, I do not assume from this that models of private saving can always be successfully transferred to questions of public saving.
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Pre-commitment
One strategy of pre-commitment against under-saving would be to separate the
accumulation of long-term saving from the national budget process. One way to
achieve this is through some variant of funding, another is through what is termed
“mental accounting.”
One main reason for choosing funding may be to keep long-term savings out of the
hands of spendthrift politicians. Separating the accumulation of saving from the
ordinary budget process may make it more difficult for politicians to deviate from
their initial saving plan. However, in order to evaluate the effect of funding, it is
important to distinguish between funding in a “broad” and “narrow” sense (Stiglitz
and Orszag 1999:9). We have funding in a narrow sense when the pension system is
accumulating assets against projected payments. Pre-funding in a “broad” sense,
however, requires an increase in national saving. Narrow pre-funding may go hand in
hand with increased public debt (due for instance to increased borrowing or increased
public expenditures). Thus narrow funding does not necessarily imply broad funding,
and only broad funding has an impact on national saving. If the government does not
reduce its expenditures and instead borrows money to finance the budget deficits, the
assets of the fund are offset by government debt. An example of narrow funding was
when the US Government introduced partial funding in 1983 in order to build up extra
reserves to cover predicted hikes in social security expenses. However, from 1984, the
national budgets ran higher deficits (Economist 2002 13). Two other examples of
such “under-funding” are the Alaska Permanent Fund and the Alberta Heritage Fund.
Both Alaska and Alberta have in effect reduced their financial wealth by running a
public budget deficit while at the same time building up funds (Hannesson 2001).
The building up of a public fund is a good example of a situation where it is difficult
for a society to pre-commit itself effectively. Public funding does not alone make
some options less available. Little prevents the government from undoing its own
obligations. This conclusion is supported by empirical analysis of various countries’
experience with oil funds (Davis, Ossowski et al. 2001).
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Certain additional requirements may be stipulated in order to make public funding
more effective. Constitutional protection of the use of the money placed in the fund is
one alternative. In Alaska, the Permanent Fund is meant to preserve the state’s mineral
wealth for the indefinite future. The money in this fund is protected by the
constitution. A clause in the constitution dating back to long before the discovery of
the petroleum wealth in Alaska prohibits the earmarking of state revenues for specific
purposes. The money in the fund can therefore not be withdrawn unless the
constitution is amended, which in Alaska requires a referendum. This constitutional
entrenchment of the Permanent Fund is probably an important guarantee for the
preservation of the fund (Hannesson 2001:59). This was demonstrated in the
referendum in September 1999, when a proposal to use part of the money to cover
public deficits was voted down. The constitutional clause is also a telling example of
an incidental constraint. As Hannesson writes, it is possible to view the constitutional
entrenchment as
… a case of an institution, or a set of rules, coming about by chance but surviving because of
their usefulness. (Hannesson 2001:59)
Yet another feature of the Alaska Permanent Fund is worth noting. As a strategy to
preserve the state’s mineral wealth for future generations, the return on the fund is
distributed among the people of Alaska in the form of a dividend. Hannesson has
investigated the Permanent Fund, and argues that giving individuals a stake in such
funds would be likely to promote the preservation of mineral wealth (Hannesson
2001). Giving each individual a stake in the fund is likely to secure support for a
saving policy that is successful in financial terms, he argues (Hannesson 2001:78).
However, the discussion of narrow funding pointed out that neither the constitutional
pre-commitment nor the dividend programme have succeeded in preventing the state
of Alaska from running high public deficits.
A more radical pre-commitment strategy would be to leave the responsibility for
funding to private insurance companies. However, counter-arguments immediately
emerge. The government would have to give away the power and responsibility over
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Pre-commitment
such issues as investment policies and distribution initiatives, unless these can be
safeguarded through public regulations. Furthermore, individual pension accounts in
private funds will be more exposed to financial market risks. We may conclude that
public funding does not seem to be an effective device against the government’s
tendency to under-save. Funding managed by private companies, on the other hand,
may be effective, but is not desirable.
Note that the effect of funding on national saving also depends on what happens to
private saving. It is generally the case that actors in the private sector adjust their
behaviour according to the economic policy. In a classic article, Kydland and Prescott
(Kydland and Prescott 1977) observe that “economic planning is not a game against
nature, but rather a game against rational economic agents.” Their main thesis is that
current decisions of economic agents depend in part on their expectations regarding
future policy actions. They give the following example: Some people consider
building their houses where there is a danger of flooding. If they know that the
government will provide economic protection for houses in the flood area, they may
decide to build their houses there despite the initial danger of flood because they know
they will be protected against the risk of damage to their houses. The Kydland-
Prescott-thesis is also thought to have implications for constitutional law:
A majority group, say the workers, who control the policy might rationally choose to have a
constitution which limits their power say, to expropriate the wealth of the capitalist class.
Those with lower discount rates will save more if they know that their wealth will not be
expropriated in the future, thereby increasing the marginal product and therefore wage and
lowering rental price of capital, at least for the most technological structures. (Kydland and
Prescott 1977:486)
How does the Kydland-Prescott thesis apply to the question of saving and pre-
commitment to public pensions? One hypothesis would be to assume that individuals
save less when they are relatively certain they will receive their public pension. One
may expect that individuals who know they will be entitled to pensions in their old
age will not save, or will save less for their retirement. Public funding will then be a
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substitute for retirement saving: instead of saving money each month for retirement,
workers pay a tax on their wages. Retirees receive checks from the government
instead of drawing on their assets. More predictable and reliable public pension
entitlements may reduce rather than induce private saving. This taken into account, the
government may rationally choose not to pre-commit to a saving strategy since the
possibility of the later defect may induce economic agents to save privately more than
they otherwise would.
Whereas Kydland and Prescott argue for rules rather than discretion, the proscription
with regard to public pension entitlements would instead be the opposite: Discretion is
preferable to rules, since one would expect individuals’ private savings to increase
when there is greater uncertainty surrounding future entitlements. The Kydland-
Prescott thesis presupposes full information, and their results rely greatly on this
assumption. However, withholding information or sending unclear signals with regard
to how the government will deal with future pension entitlements may be used
strategically by the government to increase private saving. Conversely, pre-
commitment with the intention of increasing public saving may have an adverse effect
on private savings. It is important to note, however, that the effects of funding on
private saving are difficult to measure (CBO 1998). 44
44 For an alternative approach, see (Kotlikoff, Persson et al. 1988) According to Kotlikoff et. al, the question of pre-commitment against under-saving is redundant once a pay-as-you-go pension system is adopted. They argue that a pay-as-you-go system solves the problem of inconsistent time preferences since it represents “a social contract that specifies the ex ante optimal policy and that can be ‘sold’ by successive old generations to successive young generations” (Kotlikoff, Persson et al. 1988:662) The argument rests on the assumption that each generation pays for the social contract by paying a larger share of taxes than it would otherwise. Therefore, it is assumed that the system results in higher private saving. There is, however, little empirical evidence for this. The Congressional Budget Office (CBO) memorandum reviews the evidence from a number of studies on the impact of Social Security in saving ( CBO 1998). The main theses in Kotlikoff et.al is that an equilibrium exists in which the first generation chooses the social contract, and all following generations comply (Kotlikoff, Persson et al. 1988:663-4). This is supposed to represent a subgame-perfect equilibrium: no generation has an incentive to deviate unilaterally from the strategy. The model presupposes that, for the young generation, the economic advantage of purchasing the social contract exceeds its price as well as the economic gain from setting up a new social contract. The transaction costs involved, for instance, in changing from a pay-as-you-go to a fully funded pension scheme are normally thought to be very high. However, this may not be the case if a country has “windfall” money. In Norway, proposals have been made for introducing a funding system by using part of the revenues from the petroleum sector. Furthermore, it is not unlikely that many countries, in order to cover the increased costs of their public pension system, will have to increase taxes to such an extent that the price of reform is less than the costs of the initial social contract. In the model the transfer (Q) between generations is held constant: contributions and benefits are not allowed to vary between generations. But in the real world that is very much what happens.
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Pre-commitment
In the argumentation for a Norwegian Oil Fund it was emphasised that the fund would
also have the effect of making the petroleum money visible. If the budget process
became more transparent, one assumed it to be more difficult for politicians to use the
money without a thorough discussion. In addition, funding would involve the creation
of disciplinary guidelines. (Olsen 1995:12)45
A further elaboration of the funding strategy is to earmark public wealth in order to
prevent it from becoming subject to discussions of how to use the money now. By
earmarking money for certain purposes, the government ties its own hands. The
tendency of politicians to consume too much now, and save too little for the future can
thus be curtailed. A rather unique example of this strategy is the Norwegian decision
to earmark the petroleum wealth for public pension entitlements. The petroleum
resources in the North Sea have made Norway one of the five richest countries in the
world. For almost four decades, the money from the petroleum sector has made it
possible to keep unemployment low, and to develop an extensive welfare state. The
national policy is now to earmark the Petroleum Fund to cover the expected increases
in pension entitlements.
The rationale behind earmarking the Petroleum Fund for public pension was largely
the same as the rationale for placing the petroleum money in a fund. The main
objective in both cases was to “lock in,” and thereby separate, the money from the
ordinary budget process, in order to increase governmental saving (Olsen 1995:12).
By earmarking the petroleum fund, the money is prevented from being subjected to a
constant discussion in the Storting (the Norwegian national assembly) about its use for
all kinds of purposes. In this perspective, earmarking can be defended as being a
strategy of long-term saving (Torsvik, NOU 1998:10:220).
In what sense is earmarking really a strategy of self-binding? First, it signals how the
money is supposed to be used, thus making it more difficult to deviate from the
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announced saving plan. Second, there may be a mechanism of “mental accounting” in
play. Economists often assume that the name you choose to give your bank account is
of no relevance to the amount of saving you accomplish. Advocates of the theory of
“mental accounting” do not agree (Shafir, Diamond and Tversky). This theory is
based on the belief that the label you put on your account is in fact likely to have an
effect on your priorities between consumption and saving (Torsvik 1998:380).
According to the theory of “mental accounting,” earmarking will make it more
difficult for the agent to follow his immediate impulses which are to use too much of
the money now.
In a pay-as-you-go public pension system, the future entitlements are normally not
explicitly indicated on the deficit side of the budget. An alternative method of
visualising the costs of public pension rights is through generational accounting
(Auerbach 1991). For a Norwegian variant, see (Steigum 1993). The aim is to
incorporate the future commitments of entitlement programmes such as Social
Security into the deficit side of public budgets. Generational accounting is thought to
reveal the degree of “present orientation” of existing fiscal measures and the effects of
taxes and public expenditures on the level of private saving and economic growth.
Generational accounting may force the government to keep these expenses in mind in
their long-term budget planning. The implicit debt is made more explicit. However,
the use of generational accounting is controversial. Such accounts have been
criticised, for instance, for neglecting the benefit to citizens of the increase in the
value of public assets (Haverman 1994). For a further discussion of generational
accounting, see chapter three, Redistribution.
Pre-commitment against under-saving may also come in the form of political
guarantees. Political guarantees have the effect of imposing costs because they
represent strong public announcements. Imagine that your goal is to improve your
jogging capacity enough to participate in the New York Marathon, but you are afraid
you will not have the willpower to carry out a training programme that will enable you
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Pre-commitment
to complete the run. One strategy could be to sign up for the game and announce
publicly to all your friends and family that it is your intention to run. If you do not
manage to pull yourself together and implement your training programme enough in
advance, you will suffer what James Fearon has called audience costs (Fearon
1994).46 In Ulysses and the Sirens, Elster includes an example of audience costs (“to
tell your friends your intention so as to invite their sarcastic comments if you are
backsliding”) among his specifications of what he means by pre-commitment in the
form of a “causal machinery” (Elster 1979:37). Political guarantees of future pension
entitlements clearly involve potential audience costs. Giving explicit promises of
future payment makes it more difficult for politicians to run away from the obligation
to acknowledge pension entitlements because it will imply losing face and credibility.
How large these audience costs will be depends on a number of variables: how far into
the future these obligations mature, the memory of voters, the frequency of change in
political power, etc. Audience costs that mature far into the future are easier to ignore
because they do less harm to the politicians who are now in office. Stable
governments (that remain in power over a long period) must take account of audience
costs to a larger extent, since they are more likely to be held accountable for their
policy. An obvious problem with government guarantees is that they are weak pre-
commitment devices. Again, the situation of under-saving in the USA may be used as
a case in point. As mentioned above, the partial funding of Social Security in 1983 did
not result in much increase in public saving. In response to this problem of under-
saving, the two parties agreed in 1999 to put a “lock-box” on the social security
surplus. However, this agreement was broken in 2001, after the terrorist attack on
America, when the money was needed to finance increased federal spending
(Economist 2002 13).
Pre-commitment may also take the form of legal guarantees. Legally guaranteed
pension rights imply what Elster calls “sinking costs.” Sinking costs are costs that will
have to be incurred regardless of what happens later (Elster 2000:42). One may
46 Focusing on international crisis, James Fearon argues that domestic political audiences influence the likeliness of a state to concede in a confrontation (Fearon 1994).
111
assume that this kind of pre-commitment has an effect on the anticipated tendency of
governments to under-save. If breaking with the savings plan (not to save enough to
cover future increases in expenses) is more costly with than without such pre-
commitment, it is likely that it will have some effect on government behaviour. When
politicians know that pension entitlements materialise no matter what, the costs of the
pension system may be more difficult to ignore. Knowing that they are bound by
increasing costs of pension rights may make it more difficult to neglect the need to
save money in advance. However, this assumption is not very compelling. First,
nothing prevents politicians subject to hyperbolic discounting from continuing their
under-saving. Recently, I wanted to motivate myself to work out at least three times a
week, and signed an expensive one-year contract at a health studio. Now, I do not
exercise any more than I did before I signed the contract, but the costs of not doing so
have definitely increased. Second, the sinking costs of public pension commitments
are greatest well ahead in time. The costs of under-saving do not make themselves felt
immediately, thus giving politicians a tendency to procrastinate because there is no
incentive to change their behaviour. A country’s ability to bear sinking costs also
depends on its initial wealth. However, as we shall see in the next section, legal
guarantees may be effective pre-commitment devices in order to make political
promises of future pension entitlements credible.
5.5. Credibility
Income equalisation over the individual life cycle can be accomplished in one of two
ways: either by accumulating money (saving) or by giving up part of present
consumption in return for a promise of a share of future consumption. The latter is
often referred to as an inter-generational contract. In a pay-as-you-go pension system,
the working part of the population pays directly to support the people that have
retired. They must in turn rely on the next generation to pay for them when they grow
old.
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Pre-commitment
During its productive years, each generation pays to support those who are dependent on it,
assuming that when its own dependent phases come, it will be supported in turn by successor
generations. (Laslett and Fishkin 1992)
Recall from chapter five, Risk-sharing, that a major concern in Samuelson (1958) was
how the inter-generational social contract inherent in un-funded social security
schemes could be enforceable. Individuals are given a generalised commitment to
replacement of earnings. The problem of pre-commitment is how to make this
promise credible. As Richard Disney writes: “only if there are design features that
make reneging on pre-commitments costly (for example, costs to changing
institutions, or the possibility of punishment strategies) can contracts of this type be
enforceable (…)” (Disney 1999:22). This section investigates the idea that the
government binds itself to making such a contract sustainable.
All variants of pre-commitment involve an element of promise. In the case of Ulysses,
it was a promise he made to himself. In the case of pension rights, it is a promise
given to future pensioners to be executed by future politicians. Intentionally creating
expectations in others implies a degree of moral responsibility. When you lead
someone to form expectations about your future conduct, they should be reasonably
certain that you will do what you have led them to believe you will, unless they
consent to your not doing it. It is morally wrong to neglect what we owe to certain
people when we lead them to form expectations about our future conduct (Scanlon
1990:209).
One of the central normative implications of a promise is that the person who makes
the promise is to do the thing described. The normative force of the promise lies first
of all in what the promisor owes to other people when he or she has led them to form
expectations about the future. The obligation generated by a promise depends on the
fact that in making the promise, the promisor creates an expectation that the promisee
cares about (Scanlon 1990:216). When a promise is made under the right conditions,
it would be wrong, in the absence of special justification, for the first party not to
perform. In addition, the second party has “a right to rely” on this performance: that
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is, the second party has grounds for insisting that the first party fulfil the expectations
he or she has created (Scanlon 1990:209).
There are two main reasons why the promise inherent in a pay-as-you-go system may
not be credible. First, politicians may be tempted to introduce changes in the pension
system in order to reduce the increases in public expenditures. Without a clear
element of pre-commitment, the pensions will be generally conceived of more in
terms of all other welfare policies, and thus equally open to continuous changes and
revisions. Second, in a pay-as-you-go system” there is a risk that future generations
will not honour the obligation to pay for public pensions ( NOU 1998:10:18). When
this risk is high, peoples’ confidence in the pension system will tend to fall, and they
may wish to find insurance elsewhere.
The promise from the government is not credible if it has inconsistent time-
preferences. Legal guarantees, for instance in the form of constitutional constraints,
may be used as a pre-commitment device. Three problems with this strategy should
be noted.
First, it is important not to forget the problem of future generations. Recall that in
order to be legitimate, the reasons for pre-commitment must also be reasons for future
generations. It is important to note that pre-commitment in the form of legal
guarantees may work, not in the interest of future tax-payers, but rather to advance
the interests of a powerful majority of soon-to-be pensioners. The parts of the
population that are close to retirement or already retired are large and powerful voting
groups. These groups have the power to change the pension system in such a way as
to protect their own interests at the expense of a minority of younger voters. We can
call this “pension populism”: people may use their voting rights to boost the legal
guarantee of those spending programmes from which they are most likely to benefit.
This might explain why the Norwegian Party of Progress (FRP) was the party that
most eagerly advocated stronger constitutional guarantees for public pension rights.
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Pre-commitment
Second, a problem for legal guarantees that complicates our pre-commitment model
but does not represent an explicit problem in the story of Ulysses is uncertainty.
Circumstances may change in such a way that it is rational to change one’s mind
((Elster 1992:42),(Hylland 1984:101), (Torsvik 1998:369)). Because the future is
uncertain, some degree of flexibility is necessary. If, for instance, the economic
situation 15 to 20 years down the road turns out to be so difficult that paying for
public pension entitlements will result in neglecting all other good purposes, the
government should arguably not be committed to do so. On the other hand, it is not
always easy to know when the new circumstances should open for a revision of an
earlier commitment. This dilemma is clearly expressed by Jon Elster:
The ensuing dilemma is very tight. On the one hand, one might wish for the constitution to
allow for unforeseen and unforeseeable emergencies. On the other hand, some of the
occasions that will be claimed to have emergency status will be the very situations in which
the constitution was supposed to act as a protection. An alcoholic will always be able to
specify some way in which today is special and exceptional. (Elster 1992:189).
All long-term planning involves decisions under some degree of uncertainty. In a
situation of uncertainty, one would assume, the best strategy is to be as open and
flexible as possible. This seems to imply the complete opposite strategy of that of pre-
commitment. Is it possible to bind oneself rigidly enough to avoid the negative
ramifications of a weak will, but at the same time not so rigidly as to inhibit the ability
to adjust to new and changing circumstances?
Third, a problem with the use of legal guarantees as a strategy of pre-commitment is
that politicians can always find other ways of reducing the accessible income of
pensioners, for example through increases in income taxes or increased co-pay of
public services. It is always possible to “give with one hand and take with the other.”
A much weaker pre-commitment strategy would be to form a political consensus. This
happened in Sweden following the major pension reform. The five largest political
parties launched the reform together (Moderate Party, Centre Party, Liberal Party,
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Christian Democratic Party, and the Swedish Social Democratic Party). The parties
agreed to a contract that gave each of them a veto against changes. This is some of the
background: In 1994, a working group composed of members of the Riksdagen
(Swedish national assembly) presented its proposals for a reform of the public pension
system (SOU 1994:20). On 8 July 8 of the same year, the national assembly adopted
guidelines for the reform. The proposition was based on an agreement between the
five parties. The reform was aimed at making the public pension system easier to
adjust to economic and demographic changes, and restoring the connection between
contribution and benefit. In order to implement the reform, the Government decided to
appoint a working group within the Ministry of Health, again with representatives of
the five largest political parties. The mandate of this group was to continue the reform
process and protect the cross-political agreement. In Norway, a reform of the pension
system is now being considered by a “pension commission” similar to the one in
Sweden. The commission will deliver its report in 2002. There are several good
arguments for conducting this kind of deliberation process. First, it gives the political
parties a chance to reach a joint conclusion. Second, the parties are forced to provide
principal justification for their standpoints. Third, and most important in this context,
is the potential effect of political consensus on stability and predictability. Populism
and rent-seeking are not so much an option because the pension issue is temporarily
removed from the agenda of day-to-day politics. The promises of public pension
entitlements become more credible since the politicians’ hands are temporarily tied
against changes. However, the example from the American context referred to in the
previous section illustrates just how vulnerable such a political consensus can be when
new circumstances emerge.
5.6. Concluding remarks
This chapter has shown how the two problems discussed above (long-term saving and
credible promises) can be met with various pre-commitment strategies. Public
funding, I have argued, is not an effective remedy against under-saving. This is
because the pre-commitment is not strong enough. The government can still “under-
save” by under-funding, i.e. can open up for larger deficits in other parts of public
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Pre-commitment
budgets. Second the effect of funding on private saving is likely to be reduced and the
effects on public saving are not clear. We may conclude, therefore, that although the
pre-commitment model in its revised version is descriptively useful in the case of
public funding, this pre-commitment device is too weak to have much of a bona fide
effect. One solution would be to leave the funding to private providers. That would be
a much stronger pre-commitment device, but may not be acceptable for other reasons.
Pre-commitment through legal guarantees, however, is assumed to have a strong
effect with regard to making political promises credible. An important problem is that
such pre-commitments must balance the need for stability against the need to cope
with unforeseen emergencies. Strong pre-commitment to enforce stability and
predictability may therefore be very effective but not desirable.
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6. Democracy
6.1 Introduction
Which limitations, bonds or constraints may be legitimately imposed on future
generations? This question is relevant in each of the three previous chapters. In
Chapter Three, Redistribution, the question arises in the discussion of whether a
pension system should redistribute income across the generations. The classic
Rawlsian hypothetical thought experiment is used as the discussion’s framework:
what, from under a veil of ignorance, could representatives of all generations agree
on? Chapter Four, Risk Sharing, presents an argument for a risk-sharing arrangement
between the generations. In this chapter, bonds or limitations imposed on future
generations are regarded as legitimate, as long as forming common risk-sharing
arrangements is in the rational self-interest of all generations. In Chapter Five, Pre-
commitment, binding the freedom of choice of future generations is explained using a
model of self-binding. It is assumed that such binding is legitimate only if the reasons
for pre-commitment are valid for both present and future generations.
This chapter seeks to answer the question of which limitations and bonds may be
legitimately imposed on future generations by reference to democracy. A constant
tension is normally thought to exist between “constitutionalism”, the ideal of
government constrained by law, and “democracy”, the ideal of government by act of
the people (Michelman 1999: 4). However, a popular position held in modern
constitutional theory is that, rather than limiting democracy, a constitution serves to
set the important ground-rules and procedures necessary to a well-functioning
democracy. This chapter investigates what this view implies with regard to the
question of legitimate constitutional binding of future generations in a public pension
system.
The argument from democracy (i.e., that constitutionalism and democracy go
together) contains two main components. First, the existence of a constitution with a
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bill of rights represents a necessary pre-condition for democracy. Without a
constitution in place, it is impossible to mediate effectively between different
opinions, values, and standpoints in ways that may be regarded by all as both
legitimate and just. Second, because reasonable pluralism weakens the prospects for
mutual agreement, most questions should remain largely open to ongoing debate and
alteration.
With regard to the constitutional protection of pension rights, the argument from
democracy implies that the only right that should be vested in constitutional law is the
right to a minimum pension. Exceptions are rule-of-law clauses, such as a ban on
retroactive effect, which should enjoy general protection. In general, the argument in
this chapter is more restrictive than those in the three previous chapters: we should
think twice before setting up public pension systems that imply strong legal and
political obligations on behalf of future generations of voters.
6.1. The Enabling Character of Constitutional Democracy:
Holmes’ Argument
“Without tying their own hands, the people would have no hands” (Holmes
1988:231). This sentence formulates, in a nutshell, Stephen Holmes’ position with
regard to constitutional pre-commitment. In Holmes view, pre-commitment is not a
response to irrationality, but rather a way to achieve more of what one wants. As the
discussion in Chapter Four illustrates, pre-commitment may be used to make promises
more credible or to overcome problems of time-inconsistency. Holmes emphasises
another effect of constitutional constraints: he believes such pre-commitments
strengthen rather than weaken democracy.
Holmes opposes what he views as a mythic tension between democracy and
constitutionalism. As already mentioned, the term “constitutional democracy” has
traditionally been regarded as an oxymoron, a marriage of opposites. One tradition in
political theory regards a constitution as nothing but a device for limiting the power of
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government. Another tradition views constitutionalism as essentially anti-democratic
and argues that the deceased have no rights to bind the living. Holmes’ point is that
those on both sides of this debate exaggerate the conflict and mistakenly perceive it as
a question of either-or. Either they favour constitutional regulations in order to protect
against the passions and irrationality that they see as inherent to democracy, or as
sworn democrats they view constitutional restrictions as threats to democracy.
Holmes’ view is rather that democracy and constitution presuppose each other in the
sense that a constitution enables democracy to function better. If we value democracy,
we should also accept constitutional regulations as binding constraints, even though in
one sense this involves less self-government. We should accept these restrictions
because they provide more of what we value, namely more democracy. It follows
from this position that constitutional restrictions are seen as legitimate as long as they
are necessary preconditions for a well-functioning democracy. Democracy can be
more functional and efficient if we are able to spend less time discussing “the
framework”, i.e., the democratic procedures, and more time discussing and solving
concrete political problems.
If we can take for granted certain procedures and institutions in the past, we can achieve our
present goals more effectively than we could if we were constantly being side-tracked by the
recurrent need to establish a basic framework for political life.(Holmes 1988)
Holmes also argues that constitutional requirements, such as supermajority and delays,
give political decision-makers incentives to make long-term investments and plans,
and force them to think thoroughly through important decisions by moving some
questions away from the agenda of day-to-day politics (Holmes 1988:231). Thus, in
addition to having a constraining effect, constitutional restrictions also force politics to
slow down in order to think through a number of questions more carefully.
Recall from Chapter Four that Jon Elster supports Holmes’ view that constitutional
restrictions are enabling rather than disabling. This also coincides with Elsters’ main
theses in Ulysses Unbound: sometimes “less is more”. Having fewer options is
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sometimes preferable to having more (Elster 2000). This, Elster argues, is also true
with regard to democracy. By imposing some constraints (for instance periodic
elections, division of power, and delays), democracy works more efficiently (Elster
2000:272). In this way, constraints may actually increase freedom rather than reduce
it. When we agree to bind ourselves to certain procedures for decision-making on the
constitutional level (la politique politisante), we have more time to concern ourselves
with the problems of everyday politics (la politique politisèe).47 Note, however, that
although Holmes uses the pre-commitment metaphor rhetorically, this argument has
no analogy to the model of pre-commitment discussed in Chapter Five. The claim that
constitutional constraints are enabling has nothing else in common with the Ulysses
metaphor.
Constitution and democracy, we may conclude, rather then being in opposition are instead mutually supportive: constitutional constraints enable democracy. This position, while interesting, is both broad and vague: which types of constitutional constraints are enabling in this sense, and what is the relationship between constitutional rights and popular sovereignty?
6.2. Democracy and Rights: Habermas’ Argument
In his book Between Facts and Norms (Faktizität und Geltung), Jörgen Habermas
develops a justificatory basis for constitutional democracy (Habermas 1996). His
point of departure is that modern democratic societies cannot rely on particular
metaphysical principles for the regulation of the state. Opinions and forms of life
differ. We need to establish a constitutional basis, a number of basic political rules,
which would enable us to live peacefully together despite our differences. The
question for Habermas is what constitutional rules democratic people should give
themselves in order to govern their political life. Habermas uses the expression
“constitutional patriotism” to denote this constitutional basis:
A liberal political culture is only the common denominator for a constitutional patriotism
(Verfassungspatriotismus) that heightens an awareness of both the diversity and the integrity
of the different forms of life coexisting in a multicultural society (Habermas 1996:500).
47 This distinction is further explained in (Elster 1979 p.91ff)
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However, Habermas wants to develop a purely procedural justification for
constitutional constraints. For Habermas, the question of the content of constitutional
democracy is not to be answered by reference to any substantive principles. 48 It is
rather we the people, through rational discourse, who are to decide what these basic
principles and rules ought to be.
For Habermas, the principle of self-government is of ultimate importance (Habermas
1996:89). Habermas uses what he calls a “post-metaphysical” argument for attaching
so much importance to the principle of self-government. When normative
considerations can no longer be deduced from an external authority, the only choice
left is to make people the author of their own moral principles. In a world where no
common external or metaphysical moral principles exist, nothing outside of the
individual has the power to decide what is good or bad, or right or wrong for each
individual. Norms and values must therefore be judged from the point of view of the
first-person plural.
What, then, does Habermas say about the relationship between constitutional rights
and principles and democratic self-government? Habermas talks about “a logical
genesis of rights” (Habermas 1996:121). Democracy and self-government are made
possible solely through a system of rights. Individual rights can be deduced as those
rights that are necessary for democratic self-government. This is a variant of the
enabling rights argument presented in Section 6.5.
However, Habermas rejects the idea that individual rights set limits on the exercise of
democratic self-rule. Individual rights cannot claim normative independence from and
48 A substantive account stresses the importance of the constitution as the protector of basic principles and rights. These rights and principles are “pre-political” in the sense that they require an independent justification. A procedural approach to constitutional democracy, on the other hand, maintains that such consensus is neither preferable nor possible to obtain, and that constitutional principles should be both the product of,and open to, an ongoing process of deliberation and revision. In the literature on constitutional democracy, these positions have many names. I have already used the distinction “substantive” versus “procedural”. Habermas distinguishes between “the liberal view” and the “republican view” (Habermas 2001), p.770, Michelman distinguishes between “democracy-as-rights” versus “democracy-as-procedure”. (Michelman 1999)p.10, Rawls distinguishes between “constitutionalists” and “majoritarians”. (Rawls 1995)p.172. 48
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higher legitimacy than the principle of self-governance, Habermas argues (Habermas
1996:89). On the other hand, Habermas is also eager to avoid what he regards to be
the communitarian trap.49 Communitarian thinkers look for the answers to normative
questions in the prevalent moral or normative convictions of a society. For
communitarians, what is just is, therefore, relative to culture and tradition. Habermas
wants to reject the view that individual rights are shaped by any substantial vision of
the good life. The problem, as Habermas puts it, is precisely how to strike a balance
between the idea that norms and principles can be imposed on us from above, a view
he relates to traditional liberal thinkers, and the communitarian idea that individual
rights are the products solely of opinions, preferences, and traditions of a given
society.
Some sort of agreement is the solution, because only self-governed individuals can,
according to Habermas, author the principles under which they live. But the
agreement needs to be qualified: not any agreement should be the basis of the political
principles that are to guide our conduct. Not all preferences, opinions, or value-
judgements are legitimate bases of such an agreement. Faktizität, or reality, is not
enough. We also need Geltung, or validity. Validity, for Habermas, is secured if the
principles are the outcome, not of actual agreement, but of reasonable or impartial
agreement. This is formulated in what Habermas calls the discourse principle,
Principle D:
D: Just those action norms are valid to which all possibly affected persons could agree as
participants in rational discourses (Habermas 1996:107) .
The discourse principle is intended to explain the point of view from which norms of
action can be impartially justified (Habermas 1996:108). His view is that citizens must
be able to view all their political principles, even those establishing individual rights,
as rooted in their autonomous political will (Larmore 1999:617). This is what
principle D expresses. But the question of what gives authority to Principle D itself
49 “Civic republicanism” is the term used by Habermas to denote what is normally labelled “communitarianism”.
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still remains. Habermas does not seem to offer a satisfactory answer to this question. 50
Let us return, however, to the critical point in Habermas’ account of constitutional
democracy. Habermas argues that individual rights cannot claim normative
independence from or higher legitimacy than the principle of self-governance.
Individual rights do not determine democratic self-government nor does democratic
self-government determine individual rights. Rather, individual rights and self-
government mutually presuppose each other. . The internal connection between them
is what he calls co-original (gleichursprünglich). The idea is difficult to grasp, and
seems to be contra-intuitive, because it does not explain which comes first. How can
individual rights be both the result of and the presupposition for democratic self-
government? Individual rights are not natural obstacles to democracy, Habermas
argues. Rather, all individual rights must be deduced from the principle of democratic
self-governance. But democratic self-governance is not possible without individual
rights. The way it is presented now, the argument seems to be circular: individual
rights are important because they enable democratic-self-governance. Democratic
self-governance is important because it constructs and creates individual rights. This
makes sense if and only if Habermas is willing to make up his mind concerning which
comes first. Which is his first premise, individual rights or democratic self-
government? Habermas obviously does not want to make an argument for either. This
is highly inconsistent. As Frank Michelman puts it:
In order to judge that it was indeed a democratic procedure to which you were submitting the
question of democracy’s requirements, you would have to know the answer to the question
before you submitted it. It absolutely is not possible to appoint democracy to decide what
democracy is (Michelman 1999:34).
50 It is possible that his theory on discourse ethics could help us in this respect. However, in a comment to Habermas’ conception of constitutional democracy, Charles Larmore convincingly shows how Habermas’ ideal of democratic governance is not freestanding, but dependent on a principle of respect for persons (Larmore 1999:621).
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Habermas replies to this criticism. He argues that a constitution should be interpreted
as “an ongoing process of constitution-making that continues across generations”
(Habermas 2001:768). Because constitutions are self-correcting learning processes,
the founders need not have had the right answers straight away. This, however, is an
extremely optimistic view of what “deliberation” and “reflection” can accomplish.
Why should we believe that deliberation and time are factors that necessarily make
our society more democratic? Next, how are we to judge whether this is actually what
occurs? In Habermas’ model as it is presented in Between Facts and Norms, there is
no yardstick to measure which way we are going. No substantive principles, except
perhaps the principle of self-government, can help us determine what democracy
really is or should be.
A closer reading of Habermas may reveal a number of normative principles that he
believes are given to us by the history of constitutional democracy. However,
regardless of Habermas’ theory, it is important to note what a purely procedural
account of constitutional democracy cannot do. In order to make sense of the idea of
democracy, a number of substantive principles and rights must be defined. The
problem with a substantive account of constitutional democracy, however, is that
substantive principles are often subject to disagreement.
6.3. Reasonable Disagreement: Waldrons’ Argument
Jeremy Waldron refers to reasonable disagreement as the core problem for
constitutional pre-commitment. Not only do people in general disagree, they
reasonably disagree. People disagree about most things, and this is a persistent
phenomenon in society. 51 How can we talk about a community binding itself through
constitutional rules when this “self” contains people in constant disagreement,
Waldron asks. Even in their calm and lucid moments people are unsure of what their
higher interests are, and are torn (Waldron 1998:283).
51 As Charles Larmore rightfully points out, disagreement even exists about pluralism (Larmore 1996)(Larmore 1996:12). Pluralism is the position that there is no single answer to moral questions applicable to all human beings everywhere, and that there is no divine authority to which we can all appeal.
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The alternative model proposed by Waldron is to think of constitutional democracy as
the story of Bridget. Bridget feels herself torn between competing conceptions of
religious beliefs. One day she is convinced and adopts a fundamentalist faith in a
personal God. She locks all her books on different religions into her library and gives
the keys to a friend. She soon comes to doubt her decision, however, and asks for the
keys. Should the friend return them? If she does not return the keys, she is taking a
side, Waldron argues. Her decision to keep the keys will favour one answer over other
equally reasonable answers, in a situation where there is no agreement as to what the
right answer is, or if it exists at all.
In Waldrons’ view, it is always a loss to democracy when constraints, even though
they are conditions of democracy, are imposed by a non-democratic institution
(Waldron 2001:302). He therefore opposes the very idea of constitutional democracy
with judicial review. To him, constitutional constraints are not enabling, they are
merely constraints on what he calls “the right of rights”, the right to participate in the
making of the law (Waldron 2001:282). He admits it is contra-intuitive to claim that
democracy can decide what democracy itself is (recall the previous discussion of
Habermas’ argument). He claims, however, that it is equally unsatisfactory to appeal
to judicial review or any political procedure to define the basic principles and rights
associated with democracy. These principles and rights, no matter how basic to
democracy, are also subject to reasonable disagreement. Our only solution, given that
people disagree, is to assign issues regarding democracy to popular participatory
procedures, Waldron argues (Waldron 2001:302). He then asks the following
rhetorical question. “Does the conclusion to which we have been driven, not leave
everything up for grabs?” And his answer is in the affirmative.
Nevertheless, Waldron acknowledges the value of basic individual rights. The rights
he emphasises are (Waldron 2001:283):
a) rights which are actually constitutive of the democratic process, and
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b) rights which, even if they are not formally constitutive of democracy, nevertheless embody
conditions required for its legitimacy
Among the rights in the first category, Waldron mentions the right to participate on
equal terms. Free speech and freedom of association are rights that belong to the
second category. Waldron calls the two categories of rights “rights associated with
democracy” (Waldron 2001:284). However, he does not explain the status of these
rights or how they were developed. Are they merely the incidental outcome of some
specific historical processes of doubting and believing, which have accidentally led
people to choose exactly those rights? Waldrons’ account of rights is objectionable
for at least three reasons: first, according to Waldron, these principles and rights are
legitimate solely because they are those that the people (or a majority of them) want as
the principles governing their society. There is no guarantee whatsoever that these
rights and principles are also just. Second, these rights are of little value without a
protection of the rights-holder. If these rights can be altered, or even erased, by a
single majority vote then little remains of the right’s protective aspect. The protection
of a claim is central to what we usually mean when we say that an individual has a
right to something. We may ask whether it makes sense to talk about “a right of
rights”, the right to participation, the way Waldron does, when this right is not
protected against the majority’s will. Third, we may ask what remains of the idea of
constitutionalism if the supermajorities and delays inherent in constitutional
constraints are removed, and there is no room for judicial review. Such a constitution
seems to be of very little value.
What we need is a conception of rights, which may very well be deduced from the
idea of democracy, but that cannot depend on popular support for its existence.
6.4. Constitutional Essentials: Rawls’ Argument
How can we form a constitution that incorporates and takes into account the fact that
people disagree? This question is the point of departure in John Rawls' Political
Liberalism:
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[H]ow is it possible for there to exist over time a just and stable society of free and equal
citizens, who remain profoundly divided by reasonable religious, philosophical, and moral
doctrines? (Rawls 1993:4)
In short, his answer is that we do best not to assume that there are generally acceptable
answers for all or even many questions. The best we can hope for is to settle some
questions within the political domain. Thus, he terms his project “Political
Liberalism” (Rawls 1993:156). The essential aim of his political liberalism is to
provide a basis for justifying political neutrality. The answers given by political
liberalism are meant to be “free-standing” (Rawls 1992:374). In order to understand
how, in Rawls' opinion, political liberalism can be freestanding, we must consider his
idea of an overlapping consensus. An overlapping consensus means that principles
guiding central political institutions are not to be deduced from particular religious or
moral world-views, but should be acceptable to all on an equal basis. They are
legitimate if they could have been subject to what he calls “reasonable agreement”.
This position is summed up in the liberal principle of legitimacy:
(…)[O]ur exercise of political power is proper and hence justifiable only when it is exercised
in accordance with a constitution the essentials of which all citizens may reasonably be
expected to endorse in the light of principles and ideals acceptable to them as reasonable and
rational (Rawls 1993:217).
The type of agreement Rawls refers to here is hypothetical agreement in the original
position. The content of the overlapping consensus is determined by asking what
reasonable people in an original position could have agreed to. The liberal principle of
legitimacy states that basic principles should be subject to reasonable agreement.
According to Rawls, these principles cannot be determined in a democracy by simple
majority vote. There is no such thing as reasonable agreement in a democracy partly
because people are not reasonable in their voting, and partly because, even in a
democracy, voters have a tendency to permanently suppress the interests of minorities
and favour those of the persistent majority. Thus, the outcome of a democratic
decision procedure is not impartial in the sense that it does not give equal weight to
the interests of all participants (Rawls 1995:172-174). The alternative, then, is that
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political institutions should be guided by principles that could have been subject to
agreement in an ideal world without such defects. This is what the hypothetical
thought experiment models. 52 The first requirement in Rawls’ definition of
constitutional rights is, then, that these rights could have been subject to reasonable
agreement. 53
According to John Rawls, constitutions may be conceived of as protecting two types
of principles: those regulating the composition and organisation of the fundamental
political institutions and those specifying fundamental rights and liberties of
citizenship. In Rawls’ terminology, these two categories constitute what he calls the
“constitutional essentials”. The constitutional essentials are (Rawls 1993:227):
a. fundamental principles that specify the general structure of government and the political process:
the powers of the legislature, executive, and the judiciary; the scope of majority rule; and
b. equal basic rights and liberties of citizenship that legislative majorities are to respect: such as the
right to vote and to participate in politics, liberty of conscience, freedom of thought and of
association, as well as the protections of the rule of law.
The definition of constitutional essentials marks a distinction between basic rights and
liberties that should be protected by a constitution, on the one hand, and other political
questions that can be regulated by ordinary law, on the other. Rawls’ idea of
constitutional essentials reflects a common notion of the types of principles that
should be included in a liberal society’s constitution. First, the constitution should
specify the basic principles for the organisation of the state. These are principles for
the division of power and distribution of authority between the different organs, and
52 For a more thorough presentation of this method, see Chapter Two. 53 Jürgen Habermas has criticised Rawls for attempting to set up just institutions once and for all (Habermas 1995) This, in Habermas view, leads to less than full political autonomy, since citizens can do no more than live under these institutions. In his reply to Habermas, Rawls stresses that the basic political principles must be subject to continuous deliberation and testing against our considered judgements. (Rawls 1995) ,p.155. The method of reflective equilibrium is relevant here. The constitution is not a project that is completed once and for all. The ideal of a just constitution is always something to be worked towards, he argues. (Rawls 1995)p.154. Through the exercise of political citizenship, people have the possibility to engage in processes of deliberation and critical examination which lead to altering, adjusting, interpreting anew the existing constitution. (Rawls 1995).p.155.
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the political procedures of election and decision-making. Second, the constitution
should guarantee the protection of basic individual rights.
Note that economic, social, and cultural rights are not explicitly included among the
essentials. However, a closer reading of the text reveals that Rawls includes other
rights, some of which cannot be classified as classic civil or political rights. For
example, a social minimum that covers citizens’ basic needs counts as a constitutional
essential.
[T]he most reasonable political conception of justice for a democratic regime will be, broadly
speaking, liberal. This means it protects the familiar basic rights and assigns them special
priority; it also includes measures to insure that all citizens have sufficient material means to
make effective use of those basic rights (Rawls 1993:157).
The last part of the above paragraph expresses what may be called the enabling rights
argument. This argument holds that no individuals can fully enjoy or exercise any of
the rights that they are supposed to have if they lack the essentials such as food and
shelter. A right can be violated by depriving the right-holder of the resources needed
to actually do what one has a right to do (Jacobs 1993). No one can fully, if at all,
enjoy any right that is supposedly protected by society if he or she lacks the essentials
for a reasonably healthy and active life (Shue 1980:24). Individuals must have their
basic needs met in order to be able to participate in a democratic society’s political
system and to be heard in such a system. By implication then, it is necessary for a
democracy to fulfil these needs (Fabre 2000:120). In the same vein, Rawls argues that
constitutional rights can be defined as those that are the necessary preconditions for
people to participate in society as citizens:
The constitutional essential here is rather that below a certain level of material and social
well-being, and of training and education, people simply cannot take part in society as
citizens. What determines the level of well-being and education below which this happens is
not for a political conception to say(Rawls 1993:166).
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Democracy
Important to note is that social and economic rights, if they are included at all, are
assigned only instrumental importance. They are valued to the degree that they
contribute to enabling people to make use of their political citizenship. Rights are
accorded as long as they are necessary pre-conditions for this citizen’s full use of his
or her civil and political rights.
The last sentence in the previous citation of Rawls is also worth noticing. What
determines the exact contents of and limits on these social and economic rights are
“not for a political conception to say”. Thus, social and economic rights are not
afforded the same status as the classic political rights, since the manner in which these
rights are to be defined and interpreted is left to a given society and its changing
majorities to decide.
It is even more surprising that neither of Rawls’ two conditions for social and
economic justice qualify as essential.54 Neither Rawls’ principle of fair opportunity
nor his difference principle is included among the constitutional essentials (Rawls
1993:230). This is surprising because these principles are so central to Rawls theory of
justice, which again he claims is neutral and “freestanding”(Rawls 1993:10). 55
Rawls also excludes the right to property from the constitutional essentials. The right
to property, also in the sense of private ownership, has traditionally belonged among
the most self-evident and important liberal rights. Nevertheless, according to Rawls,
the right to property should not be included among the essentials. Rather reluctantly,
Rawls admits:
54 The second of Rawls’ two principles of justice reads: b. Social and economic inequalities are to satisfy two conditions: first, they are to be attached to positions and offices open to all under conditions of fair equality of opportunity; and second, they are to be to the greatest benefit of the least advantaged member of society. (Rawls 1993), p.6. 55 Rawls lists four reasons for giving stronger constitutional protection to the principles specified by constitutional essentials than to principles governing social and economic inequalities: a) the two principles specify different roles for the basic structure b) it is more urgent to settle the essentials dealing with the basic freedoms, c) it is easier to tell whether those essentials are realised, d) it is much easier to gain agreement about what the basic rights and liberties should be, not in every detail, but about the main outlines. (Rawls 1993:230).
131
This implies for example, that the question of private property in the means of production or
their social ownership and similar questions are not settled at the level of the first principles
of justice, but depend upon the traditions and social institutions of a country and its particular
problems and historical circumstances(Rawls 1993:338).
He goes on to say that this right is not consistent with what he has defined as a basic
right even though there seem to be good philosophical arguments for including the
right to property that may convince “us and a few like-minded others”, (Rawls
1993:338). Among the essentials, only rights that could be agreed upon by all are
included. Other rights, since they are merely parts of a particular ideological or
religious world-views or value judgements (that which Rawls calls comprehensive
doctrine), cannot reach the same level of “neutrality” in terms of mutual support.
How can we interpret and explain Rawls’ sorting mechanisms regarding the
constitutional essentials? That the principles could have been the subject of
agreement in the original position, is obviously not a sufficient condition since neither
the principle of fair opportunity nor the difference principle is included. At least one
additional requirement must be met. As we shall see, Rawls argues that these
principles should be of the sort that can be defined and protected by un-elected
Supreme Court justices. The logic is that the inclusion of rights in the constitution
should be restricted to certain minimum standards necessary for a well-functioning
democratic system.
Rawls’ discussion of the constitutional essentials clearly refers to the so-called
“preferred position principle” in American judicial theory. The main idea behind the
preferred position principle is that rights can be lexically ordered, and that different
categories of rights should enjoy different degrees of constitutional protection. Among
the rights that are given priority are the right to freedom of association, the right to fair
trial and the presumption of innocence, the right to vote in free and genuine elections,
and the freedom of speech. Rawls also explicitly refers to the judicial context:
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Democracy
Indeed, the history of successful constitutions suggests that principles to regulate economic
and social inequalities and other distributive principles, are generally not suitable as
constitutional restrictions. (Rawls 1993:337)
Justice Stone was the first in the history of the American Supreme Court to formulate
the preferred position principle. He did so in a footnote in United States v. Carolene
Product Company in 1938 and it became accepted doctrine under Chief Justice
Warren (1953-69) (Schwartz 1993 260-261). The principle was introduced in
American judicial theory after the economic crisis in the 1930s. In the period when
Roosevelt was initiating the New Deal, the Supreme Court attempted to defend a more
rigid constitutional protection of what they regarded as established economic rights,
against the will of the legislative assembly. From 1934 through 1936, the Supreme
Court rendered twelve decisions declaring New Deal measures invalid (Schwartz
1993:234). This judicial activism lasted until 1937 when the praxis of the Supreme
Court changed to one of judicial restraint. The Supreme Court’s 1937 withdrawal
from the area of protecting economic rights has been called a “constitutional
revolution”, a radical transition from judicial supremacy to judicial restraint.
(Schwartz 1993:234). The judicial activism of the mid− 1930’s is often used as an
example of how the Supreme Court exceeds its rightful authority by playing a political
role and effectively blocking the power of the two other government branches.
The question of judicial review is obviously highly relevant to the discussion of the
relationship between constitution and democracy: who should have the competence to
decide on the constitutionality of a law? It is not a logical necessity that this
competence rests with the courts. However, it is nonetheless reasonable to assume that
the body politics, if they are set to act as their own judges, will feel freer to adjust the
higher law according to their own needs and interests (Smith 2000 20).
Judicial review is a mechanism for interpreting and enforcing the constitution. In so
doing, it also serves to prevent other organs of the state from usurping power. Judicial
review can only perform this function, however, if it is reasonably independent of
those organs. On the other hand, appointed judiciaries obviously do not have the same
133
democratic accountability as elected legislators. The appropriate role of the Supreme
Court is a question of considerable debate. There are roughly two main strategies of
judicial review: judicial activism and judicial restraint. Judicial activism is when the
Supreme Court plays an active and independent role toward the legislative assembly.
Judicial restraint, on the other hand, is when the Supreme Court largely refrains from
opposing the will of the legislative assembly. However, one may fear that if the
Supreme Court is allowed to decide what does and does not violate the spirit of the
constitution, rather then being a constraint on majority rule, an un-elected court would
be able to supplant the majority as the main legislator. A solution to this potential
problem, suggested implicitly in the preferred position principle, is to restrict the
domain of judicial review to the protection of democratic procedures and to leave the
definition of substantive principles of justice solely to the legislature. .
A serious objection to the preferred position principle is that it seems to presuppose a
hierarchy of rights: classic political and civil rights are accorded higher constitutional
status than social, economic, and cultural rights. However, there is now wide
consensus concerning the position that these rights are “indivisible”. Civil, political,
social, economic, and cultural rights are seen as interdependent and interrelated, and
the moral and analytical distinctions between them are far from sharp.56 Rawls,
however, does not seem to make the same mistake. Rawls' requires that the rights in
question must be necessary preconditions for a well-functioning democracy. As we
have seen, other rights are included as long as they are necessary for democracy (i.e.,
the enabling right argument).
56 See for instance (Shue 1979), NOU 1993:18:109. One of the central reaffirmations of the equal nature of these two sets of rights is found in the General Assembly resolution 32/130 of 16 December 1977, which asserts (para. 1):
a. All human rights and fundamental freedoms are indivisible and interdependent; equal attention and urgent consideration should be given to the implementation, promotion and protection of both civil and political, and economic, social and cultural rights;
b. The full realization of civil and political rights without the enjoyment of economic, social and cultural rights is impossible; the achievement of lasting progress in the implementation of human rights is dependent upon sound and effective national and international policies of economic and social development, as recognized by the Proclamation of Teheran of 1968;
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Democracy
According to Rawls, his two principles of justice specify different roles for the basic
structure in the sense that only those he calls basic rights and liberties enter essentially
into the specification of a just political procedure (Rawls 1993 336). Whereas the
second principle of justice regulates social and economic inequalities, the first
principle of justice states that each person has an equal claim to a fully adequate
scheme of equal rights and liberties which is compatible with the same scheme for all
(Rawls 1993 5). What he means when he says that the two principles specify different
roles is that only the first is necessary for the construction of a democratic procedure.
The main aim of a constitution, in Rawls’ view, is precisely to specify the conditions
for such a procedure.
(T)he constitution is seen as a just political procedure which incorporates the equal political
liberties and seeks to assure their fair value so that the processes of political decision are open
to all on a roughly equal basis. (...) The emphasis is first on the constitution as specifying a
just and workable political procedure so far without any explicit constitutional restrictions on
what the legislative outcome may be.(Rawls 1993 337)
Rights that should be constitutionally entrenched are either those that directly specify
basic democratic conditions or those that are necessary for the exercise of these basic
democratic rights. The right in question must be the sort that can be entrusted to the
judiciary for protection against the democratic majority. Because constitutional rights
reduce the scope of democratic decision-making, they must be legitimised as
necessary preconditions for the very existence of a democratic procedure.
6.5. Constitutional Protection of the Right to Public
Pension
The question of constitutional protection of the right to public pension gained
increased importance in many European countries in the 1990’s (Krause 2001 287).
This is due largely to ageing populations and maturing pension systems, which have
led to economic pressures and calls for reform.
135
Public pension rights are legal guarantees. The strength of these legal guarantees
varies from country to country. In some countries, such as Germany, they take the
form of constitutional guarantees. In most countries, public pension rights are
protected by rule-of-law clauses in the constitution such as a ban on retroactive effect.
In some countries, social and economic rights (including a right to social security) are
included in the constitution, and human rights treaties and conventions are partly or
completely included in national law.
Extensive and long-lasting public pension schemes may also have led to the
development of constitutional conventions, or “semi-constitutional” pension rights.
While constitutional rights are written in formal law, semi- constitutional rights are
principles that have developed as a new practices in the court system, but have not
been implemented formally into the constitution (Berg 2000 129).
It is worth noting, however, that at least with regard to the Nordic countries, there is
no strong tradition for defining welfare services and benefits in terms of “rights”, at
least on the constitutional level(Scheinin 2001 13). In the case of Finland, Catarina
Krause has observed rather weak constitutional protection of pension rights. Although
a large portion of the retrogressive legislation adopted in the 1990’s has concerned
pension benefits, the Constitutional Law Committee nevertheless has been entirely
unwilling to use the constitutional provisions on social security rights when it
addresses lowering particular benefit levels, no matter how substantial the cuts have
been (Krause 2001 346).
We can say, roughly, that public pension systems normally consist of two basic
elements: a basic pension and a supplementary pension. The basic pension is often
calculated on the basis of the insurance period, and is independent of previous income
and contributions paid. The supplementary pension is related to prior contributions
and income, and is designed to prevent a marked decline in the standard of living upon
retirement. From this it follows that the right to pension may be divided into two
different components:
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Democracy
a) the right to a certain minimum income after having retired (the right to basic
pension)
b) the right to a pension accumulated according to certain rules which stand in relation
to previous income and contributions paid (the right to supplementary pension)
Basic pension is a universal benefit that aims to provide a minimum income and can
thus be regarded as a minimum right to subsistence. As noted above, the consequences
of applying the enabling rights argument is that the right in question should then be
afforded the same protection as political and civil rights, since it enables people to
properly use these rights. The right to supplementary pension, on the other hand, is
more extensive, and should not be given status as a constitutional right.
This conclusion has wider implications. As it should have become evident throughout
this dissertation, and as we have seen particularly in Chapter Five, constitutional rights
are far from being the sole restrictions imposed on the freedom of future voters. The
argument from democracy states that such limitations and bonds can only be
legitimate to the degree that they may be seen as basic conditions for a well-
functioning democracy.
References
137
7. The Case of Norway
7.1. Introduction
The National Insurance Scheme (Folketrygden) is a two-tier system with a universal
flat-rate pension applicable to all (basic pension), combined with an additional
earnings-related supplementary pension. The scheme has existed since 1967 and is run
on a pay-as-you-go basis, whereby those employed finance current pensions.
Norway faces much of the same problems as other OECD countries with regard to its
pension system. The “greying” of the population combined with a maturing pension
system and earlier retirement, presents challenges to both the financial viability of and
public support for the state pension scheme. A conflict of interest between generations
is also easy to notice. The elderly population is worried that the state will not honour
its obligations and that their pension entitlements will be much lower than what they
feel they have been promised. The younger generations fear that they will be left with
a pension bill that would require a considerable tax increase.
In contrast to other OECD countries, Norway has great reserves of oil and gas. This
places Norway in a privileged position with regard to its state finances. However, it
also presents Norway with a special “problem”: how should it make best use of the
petroleum wealth? The debate is intense concerning how to use this economic
advantage in order to finance and reform the public pension system.
After several years of inaction, there is currently a general political willingness to
consider reforming the National Insurance Scheme. In 2001, the government
appointed a pensions commission with a mandate to clarify the main objectives and
principles of a national pension system. The commission consists of representatives of
the political parties in the Storting as well as independent experts. In addition, a
council has been established, consisting of the largest interest organisations. The
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The Case of Norway
commission has been given a two and a half- year timeframe and will present its final
report in Autumn2003.
The debate concerning Norway’s public pension system has mainly been carried out
from an economic perspective. At the centre of the debate have been questions such as
how the future financial burden of pensions should be managed, and of how the
petroleum money should be used. As this thesis has shown, however, there are also
other important issues at stake in a public pension system: issues of distribution of
costs and risk over generations, of pre-commitment and of constitutional guarantees of
pension rights. In order to achieve a thorough and complete debate concerning
pension reform, these perspectives must enter into the discussion as well.
This chapter draws practical implications from the theoretical points made in the
previous chapters. In the first part I will present four issues central to the debate
concerning Norway’s pension system reform. I will then show how the notions of
redistribution, risk sharing, pre-commitment and democracy place these issues in a
new light, and may lead us to slightly different conclusions than if they were
discussed from a purely financial perspective. The second part of this chapter
proposes four concrete policy recommendations for a pension reform.
7.2. Four Issues of Discussion
The debate concerning the pension system can be divided in four main issues. First,
there is the problem of financing. Who should pay the historically huge pension bill?
This is largely a question of intergenerational redistribution. Second, should the basic
structure of the present pension system be preserved, or should a reform include a
stronger element of individual funding? This question relates very much to
discussions of risk and risk sharing. Third, how can the government ensure that it does
not spend too much money too fast? A particular challenge in the Norwegian context
is the management and use of the oil fortune. This question raises the issue of pre-
commitment. Fourth, over the last decades, due to several incremental changes, the
real value of the pension entitlements for those above the minimum level have been
139
reduced. This development has led to a strong call for greater legal protection of the
pension entitlements. This introduces the question of the degree of constitutional
protection that should be afforded to these pension rights.
7.2.1. The Problem of Financing
The National Insurance Scheme will face a financial problem in the years to come.
Due to smaller child cohort and the increase in life expectancy, the number of people
above the age of 67 will increase sharply in the period after 2010 (St.meld.30 2000-
2001 115). In addition, there is a substantial increase in early retirement. The average
retirement age for men over 50 years of age declined from 67, in 1970, to
approximately 63 at the turn of the century (Gjedrem 2002 9). For the total workforce,
the average retirement age is 58 (NOU1998:19). Together, these trends imply a sharp
increase in the number of old-age pensioners in the National Insurance Scheme.
At the same time, the average old-age pension will increase as the pension system
matures. More people will have had the opportunity to earn full pension entitlements.
All in all, this will result in a sharp increase in the national expenses to old age
pensions, and will in turn increase the economic burden on the economically active
population and exert pressures on government budgets. Total national insurance
disbursements on old age and disability pensions are estimated to increase from 7.8
per cent of GDP in 1999 to 9 per cent 2010, thereafter rising rapidly to nearly 16 per
cent in 2030 and almost 18 per cent in 2050 (St.meld.30 2000-2001). If the financial
burden related to pension financing is to be paid by an increase in taxes, it would
require a raise of the tax percentage on an average income from 30% to 50%(LO 2002
6).57
The increase in pension expenditures will occur together with a projected decline in
government petroleum revenues. Figure.7.1. illustrates this development. From the
57 The present value of pension entitlements amounts to NOK 2800 billion, or approximately two times GDP (St.meld.30 2000-2001:327).
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The Case of Norway
shape of the two curves and their expected effect, former Minister of Health and
Social Affairs, Gudmund Hernes labelled the figure “the gin trap” (“revesaksa”).
Fig.7.1
Source: Statistics Norway and Ministry of Finance, Vedlegg 4: St.meld 30 2000-2001: Long-Term Programme, chart 3.1
The method of generational accounting presented in Chapter Three is used in order to
evaluate the distributive effects of today’s fiscal policy on different generations. In
Norway, the method of generational accounting has been used in the federal budgets
since 1995 (Steigum 2002 4-7). Generational accounting estimates and compares the
expected tax burden of future generations with the tax burden today. Generational
accounts are also used in order to estimate the degree to which fiscal budgets must be
strengthened today in order to avoid retrenchments for future generations.
There has been a gradual improvement in the generational balance since the 1995
introduction of generational accounting. Chapter Six and Appendix Four in the Long-
term Programme presents estimates of the generational accounts for Norway
(St.meld.30 2000-2001). These projections show that it will be possible to finance the
estimated increase in government expenditures with approximately today’s tax level.
141
These projections however, largely depend on the accumulation of substantial capital
in the Government Petroleum Fund, and a later use of this money to cover the
increased expenses. The generational accounts depend on the estimated size of
government wealth. The current value of the government’s share of petroleum wealth
accounts for the bulk of what is considered government wealth (St.meld.30 2000-2001
39). We will see in Section 7.2.3, however, that entering the money from the
Government Petroleum Fund into the calculation in this way is inconsistent with
common notions of responsible and equitable use of non-renewable mineral wealth.
Recently, it has been decided to allow for a limited use of the petroleum money. Since
2001, Norwegian economic policy has rested on a fiscal rule (“Handlingsregelen”)
that allows petroleum revenues to be gradually phased into the economy. This rule
implies that the use of petroleum revenues over the fiscal budget is equivalent to the
expected real return on the Government Petroleum Fund (St.meld.30 2000-2001 55).58
In its 2001 annual report, the International Monetary Fund (IMF) expresses a concern
that the policy of using more of the oil wealth in the near-term has raised the risk to
the long-term sustainability of public finances. Without a substantial reform of the
public pension regime, the implementation of the fiscal rule will imply a drastic future
squeeze on non-pension public spending, since the oil revenue will be depleted at a
higher pace (IMF 2002 33 ) and box 2.p.23.
Chapter Five has questioned the notion of generational equity embedded in
generational accounting. . The principle of horizontal equity was supplemented with a
principle of vertical equity. Even if economic growth slows somewhat in the period
ahead, as compared to the last few decades, future generations will in all probability
enjoy a considerably higher standard of living than today (St.meld.30 2000-2001 39).
Thus, according to the principle of vertical justice, redistribution from future to
current generations can be defended.
58 The rule amounts to raising the government budget deficit by an additional 0.4 percentage points of mainland GDP on average per year to 5 per cent in 2010(IMF 2002:23).
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The Case of Norway
Contrary to what the IMF suggests, the fiscal rule is not necessarily in conflict with
intergenerational equity. On the contrary: the fiscal rule is an expression of a principle
of sustainable use of non-renewable resources. According to the rule, the real value of
the petroleum wealth is to be preserved while the return is invested in the national
economy. The time-horizon of this investment strategy is in principle indefinite, and it
should secure a fair share of the money for all future generations. What is
questionable, however, as I will elaborate on in Section 7.2.3, is whether the
petroleum money should be used to cover the entire expected increase in pension
expenditures.
7.2.2. The Introduction of Defined Contribution Plans
In Norway as well as internationally, the focus on defined contribution schemes as a
possible reform both of state and private pension schemes has increased. While
defined benefit plans calculate benefits using a pre-defined formula, in defined
contribution plans, benefits depend on earlier contributions and the investment
earnings on these contributions.
From 2001, new government regulations have allowed for extended use of such
schemes in the private sector (Ot.prp.71 1999-2000). The new regulations intend to
spur the establishment of new occupational pension schemes. A substantial number of
employees are covered by occupational pension schemes at the workplace. However,
as many as 900,000 employees (or approximately two-thirds of the workers in private
sector) must rely solely on the National Insurance Scheme for their old age pension.
The Pension Act of January 2001 has given companies (especially small ones)
radically new possibilities to offer their employees occupational pension plans. The
following advantages are normally attributed to defined contribution pension plan:
- It is less expensive to employ older employees - It is easier for companies to estimate future pension costs - It implies incentives to work longer: later retirement provides higher pensions
(counters early retirement)
143
- Increased anticipated longevity results in lower pension or increased pension premiums59
- Pension financing is moved from the national budget to the individual’s pension account
- Job mobility is made easier
The new act implies a choice between three different administrative models: regular
administration, collective investment or individual investment. Regular administration
can only be established in a life insurance company or a pension fund. Funding in this
arrangement is completely managed by the institution, and all members are guaranteed
a minimum return of 3 per cent (as of 1 January 2001). With collective investment, all
members of the arrangement agree on an equal investment strategy. A managing
board for the arrangement is then established. The third model, individual investment,
implies that the individual chooses freely how to invest his or her money. The most
common alternatives are bank savings accounts, money market funds, bond funds, and
stock funds.
With regard to the introduction of defined contribution plans in state pension systems,
institutions such as the World Bank and OECD have for many years advocated
reforms including elements of defined contribution (WorldBank 1994) (OECD 2000).
In Norway, a proposal from the Norwegian Savings Banks Association
(Sparebankforeningen) and others, involves a transformation of part of the National
Insurance Scheme to a defined contribution plan (letter to the Pension Commission
23.04.2002).
The reform options to the National Insurance Scheme are sometimes presented as a
choice between a state-based defined benefit scheme (such as the current National
Insurance Scheme) and a market-based defined contribution scheme (a “
privatization” of pensions) (LO 2002 3).
59 This is also regarded as a disadvantage of such systems, since it in principle implies unequal treatment of men and women. Women have higher life expectancy than men and should therefore be charged higher premiums. However, government regulations have been designed to prevent this kind of inequality(Ot. prp. 42 2000-2001),(Ot.prp.100 2001-2002).
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The Case of Norway
Framing the issue in this manner is inaccurate and does not reflect the complexity of
the issue. As already mentioned in the introduction (Chapter One), there are both
private and public defined benefit schemes. Occupational pensions in Norway have
until recently been largely defined-benefit schemes. Similarly, defined contribution
schemes are not confined to the private sector. Sweden’s new pension reform
illustrates this. In Sweden, a specified amount of the supplementary pension is now
designed as an individual account where the final pension benefit depends on financial
market return: a defined contribution scheme. Hence, the public-versus-private issue
should not be confused with the debate on defined benefit versus defined contribution
schemes.
However, a real worry is that the introduction of defined contribution schemes will
present pensioners with financial market risks. When contributions to these pension
plans are mandatory, individuals will be subject to financial market risks that they had
not previously faced in a government-sponsored defined benefit plan.
Chapter Four argued that government-provided insurance between generations could
elevate this risk. It is clearly the case that introducing a defined contribution scheme
comes at the cost of greater financial market risk. However, the government may offer
insurance against bad outcomes in a defined contribution scheme, and thus effectively
assist in intergenerational risk sharing.
The model proposed in Chapter Four contains both a “floor” and a “ceiling”: up-side
returns are taxed in order to finance a compensation for down-side returns. This
system has two important assets: first, it is self-financing and second, it avoids the
moral hazard problem usually associated with government guarantees (that individuals
take higher risks on the expectation that the society will bail them out if returns are
low).
Some general comments with regard to financial market risks in pension schemes may
also be warranted. As argued elsewhere, if the pension system contains some element
145
of funding, the choice between a defined benefit and a defined contribution scheme is
largely a question of who is to bear the risk of volatile markets. Two examples from
the Norwegian context may serve to illustrate this point.
Occupational pensions for municipal workers are regulated in partly funded defined
benefit plans. Part of this pension capital has recently been invested in stocks. Local
authorities are now experiencing the consequences of a two-year stock-market
downturn. Dramatic stock market losses have led KLP Insurance, a captive insurance
company for Norwegian municipalities (Kommunenes Landspensjonskasse, KLP) to
claim NOK 2.5 billion from their customers who are most of Norway’s local and
regional counties. In addition KLP needed NOK 2.5 billion to cover increased pension
obligations resulting from, among other things, wage increases. Last year the
customers thereby were presented with a NOK five billion unexpected and
unwelcome premium increase.
The financial market downturn implies that companies delivering pension insurance to
municipalities have a small or negative return on their investments. All life insurance
companies are obliged to add a guaranteed interest rate to the premium reserve
(buffers). When returns from the stock market fail, the buffers must be reduced or,
when the buffers are too low, an additional premium must be summoned from the
municipalities in order to secure the workers’ pensions.
The local authorities may subsequently transfer the costs of stock losses to the
individual indirectly by increasing the municipal tax, decreasing municipal services or
increasing the co-pay for municipal services. Or they can go beg the state to
compensate their losses. In a letter to the state, the Norwegian Association of Local
and Regional Authorities (Kommunenes Sentralforbund, KS) writes:
Increased pension costs will worsen the economic imbalance in the local sector and the
government and the Storting [Norwegian national assembly] cannot ignore pension costs if
one wishes the local sector to fulfil its duties with respect to welfare services for old people,
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The Case of Norway
schools, day-care and psychiatry (letter dated 9 September 01 from KS to the Norwegian
Ministry of Local Government and Regional Development, my translation).60
The above example illustrates how financial market losses may represent a risk to
individuals even in defined benefit plans. A similar example can be drawn from the
financing of the National Insurance Scheme. It is political consensus that money from
the Government Petroleum Fund serves as a guarantee for the financing of future
pension entitlements. However, due to falling stock market prices, the fund has lost
approximately NOK 60 billion from April to July 2002,. It is to early to anticipate
how this loss of income to the fund may affect the fund’s current policy, but it
illustrates the vulnerability of the fund’s value to changing performance in financial
markets.
The introduction of defined contribution schemes might be the right way to go when
reforming the pension system. However, such schemes introduce problems of their
own, especially because they subject individuals to risk they would not need to bear in
a defined benefit scheme. Although through the mechanisms outlined above the
government can reduce some of this risk, it is not removed all together.
7.2.3. The Question of Funding and Oil
A government report has examined different methods of public pension system
funding (NOU1998:10). In this section, I will discuss two recently proposed
alternatives for establishing a stronger element of funding of future pension
expenditures. One proposal is to earmark the current Government Petroleum Fund for
future pension entitlements. The other is to introduce an element of private funding
through individual accounts in the National Insurance Scheme.
The Norwegian Labour Party (AP) and the Norwegian Co-federation of Trade Unions
(LO) have proposed earmarking the Government Petroleum Fund for future pension
60 The State authorities and the local sector have agreed to establish a committee in order to investigate the question of future pension costs in relation to local economy.
147
payments to preserve the National Insurance Scheme. (DNA 2002), (LO 2002). In
practice, this proposal will not deviate in any substantial way from the current
government policy.
It is generally agreed that a substantial share of the currently large fiscal budget
surplus should be set aside in the Government Petroleum Fund to cover the higher
expenditures that will arise in the period after 2015, particularly as a result of the
growing burden of pension entitlements referred to above.
Norway has transformed a substantial amount of its petroleum wealth into renewable
wealth. In 1990, a decision was made to channel part of the oil and gas revenues into
an investment fund (the Government Petroleum Fund). However, no deposits were
made to the fund until 1995. The Central Bank of Norway, Norges Bank , is
responsible for the management of the Government Petroleum Fund on behalf of the
Ministry of Finance. A separate wing of the central bank, Norges Bank Investment
Management (NBIM), carries out the operational management of the Government
Petroleum Fund.
The idea of a petroleum fund was first presented in 1983 in a report on the appropriate
rate of petroleum extraction (NOU 1983:27). The report argued in favour of placing
part of the oil revenues in a special fund. The idea was to prevent the income from the
petroleum industry from becoming part of the ordinary national budget and
expenditures. By separating the saving from the use, it was argued, the Storting could
commit itself to a more resistant, long- term saving strategy. It is, however, unclear
whether a purpose of the Government Petroleum Fund is also to preserve the wealth
for all future generations, or if the aim is solely the shifting of consumption over time
(Hannesson 2001 15). I will return to this later.
Petroleum revenues have been substantially higher over the past years than earlier
assumed. This has resulted in large transfers to the Government Petroleum Fund. At
the end of 2000, NOK 386.4 billion had been invested in the fund (St.meld.30 2000-
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The Case of Norway
2001 54). The market value of the fund was estimated to be NOK 625 billion at the
end of the first quarter 2002.(NorgesBank 2002 1). The annual deposit to the fund is
the amount that remains of the revenues from the extraction of petroleum wealth, after
the federal budget has been balanced. Thus, the amount invested each year depends
on political decisions. The rule was implemented to allow for a limited increase in the
use of the petroleum revenues, while at the same time securing long-term fiscal
sustainability. The use of fiscal rules is not a new phenomenon in Norwegian
economic policy. Such rules have been applied both in the financial and monetary
policy since after the Second World War. (Gjedrem 2002 1).
In Chapter Five, I have shown how the mere existence of a fund is not sufficient to
ensure an effective strategy of long-term saving. The current binding on the use of the
petroleum money seems insufficient to guard against politicians who are tempted to
use too much of the money now. Despite the fiscal rule, the annual deposits and
withdrawals of the fund are still very much at the discretion of the parliamentary
majority.
First, leading politicians disagree as to how and when the fiscal guideline should be
applied. Former Prime Minister Jens Stoltenberg has accused the sitting government
of not being cautious enough with regard to spending money from our petroleum
wealth. Stoltenberg writes, “[I]t seems like the sitting government thinks it can use the
return from the oil money regardless of the economic projections”(Stoltenberg 2002).
He points to a general and much discussed challenge: if too much of the revenues are
used in a situation with full capacity utilisation, we risk an excessively high level of
activity in the economy with subsequent pressures on the interest rate level and strong
price and cost inflation (St.meld.30 2000-2001 56). When the expected rate of return
from the Government Petroleum Fund is high, and the economy is nearing capacity
limits, there is still nothing that prevents the use of the entire rate of return, regardless
of whether this will create inflationary pressure.
149
Second, there is an explicit link between the fund’s asset accumulation and fiscal
policy. The size of the expected rate of return is to determine the amount of the
petroleum money that is channelled into the economy. The fiscal rule is meant to be
the independent variable. However, different economic models may be used to
calculate the exact content of the fiscal rule, and these calculations are inaccessible to
the general public (Bjørnland 2002). If the measuring of the expected rate of return is
equivocal, discretion is left with the experts at the Ministry of Finance, who in turn
may be influenced by political signals. The fiscal rule, therefore, may not be that
which decides the amount of petroleum money we are to spend each year, but rather
the other way around: other public sector spending decisions are likely to affect the
manner in which the rate of return is measured.
For these reasons, it is therefore questionable whether today’s Government Petroleum
Fund with the current fiscal rule is effective with regard to the need to save part of the
oil revenue to cover future pension costs.
More importantly, it is not obvious why the petroleum money should be earmarked for
the purpose of paying for pension entitlements. In the theory of “mental accounting”
discussed in Chapter Five, a visualisation of the saving in terms of a fund is likely to
make it more difficult for an agent to follow his or her immediate impulses to use the
money now. An earmarking of the Government Petroleum Fund for future pension
entitlements may therefore reduce rent-seeking activities (i.e., lobbying and pressure
from various agents to use the money for this or that important purpose). There is no
obvious reason why pension should be placed in a position more privileged than that
of other good purposes. Why should we not have an earmarked fund for education, or
social services, or unemployment? The focus on the pension system’s financial
problems should not make us regard the current pay-as-you-go system as so important
that we use all our petroleum wealth in order to preserve it. A fund for education
would actually make more sense, since spending on education is a direct investment in
the future of all future generations.
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The Case of Norway
What the earmarking proposal does not emphasise is the obligation to preserve the
petroleum wealth for coming generations. Using the petroleum fund to finance the
pension burden is a short-term strategy. It is restricted to handling the problems facing
the Norwegian economy in 15-20 years time. However, there is no reason to think that
we will be better prepared to deal with retirement payments in the future. If we follow
the proposal for a general earmarking of today’s Government Petroleum Fund, no
fund will exist to cover similar problems in the future. Recall from the discussion in
Chapter Five that Alaska has a constitutional ban against earmarking of state finances.
It is normally taken as a rule that non-renewable mineral wealth should be invested in
a sustainable matter for the sake of all future generations. Norway should therefore
consider a ban on earmarking rather than earmarking the Government Petroleum Fund
for pensions.
Furthermore, earmarking the Government Petroleum Fund would be incompatible
with the current fiscal rule. As shown in Section 7.2.1, the value of already
accumulated pension entitlements will represent a financial challenge in the years to
come. Money from the Government Petroleum Fund may be used to cash out these
pension rights. However, if the use of this money is to benefit all future generations,
reforms must be made in the pension system that would in turn reduce the chance that
a similar situation will occur in the future, when there would be no petroleum money
to rescue future generations from an unbearably heavy tax burden.
A second alternative for increased funding of the National Insurance Scheme is a
partial introduction of a defined contribution plan with individual accounts. This
alternative is often presented as a solution to the financial problem.61 This is
misconceived for at least two reasons. First, transition costs associated with a shift
from defined benefit to defined contribution tend to be very high. Once an extensive
public pension scheme is developed on a pay- as-you-go-basis it is very difficult to
introduce fundamental alterations because they would represent a double-payment
61 See for instance the policy document of the coalition government (“Sem-erklæringen”). In Chapter 11, it is argued that funding part of the National Insurance Scheme will ease the burden of future pension costs.
151
problem: tax-payers must continue to finance current retirees while at the same time
saving for their own retirement. Petroleum money equal to the expected rate of return
from the fund could be used to ease this transition, but a transition is likely to be
incompatible with upholding the fiscal rule. Second, as I have discussed in several
places in this thesis, funding does not in itself represent a solution to the financial
problem. The mere existence of a fund is not sufficient to ensure an affective strategy
of long-term saving. Furthermore, it is misleading to believe that funding
automatically secures the future pension burden. In order to be successful, funds must
lead to higher government aggregate savings. With reference to the economic
literature, we saw in Chapter Five that the effect of funding on total saving is
indeterminate.
However, funding in individual accounts, although not necessarily the best way to
cover increased expenditures may be important in order to protect individual pension
entitlements. In a system where the pension expenditures are covered by already
accumulated savings, the costs of the pension system are more visible. Future
entitlements in such a scheme are easier to protect by property-right clauses. Thus
pension entitlements can be given a stronger legal and even constitutional protection
which will make them subject to less political risk (recall the discussion of time-
inconsistency and credibility in Chapter Five).
7.2.4. The Question of Constitutional Pension Rights
Two main factors have largely transformed the Norwegian state pension plan over the
last couple of decades. The first factor is the changes introduced in 1990-1992 in order
to reduce future expenditures. The Storting decided by the act of 21 December 1990
no. 80 to change some of the rules in the National Insurance Scheme. Restrictions to
the possibilities to accumulate supplementary pension were introduced together with
income testing of supplements for children and spouse. The value of future
supplementary pension was reduced accordingly. The second factor is that the annual
indexation of pension rights has not kept up with the wage growth rate in society at
large. This under-regulation of the so-called “basic amount” has reduced the value of
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The Case of Norway
pension entitlements. Since 1967, the basic amount has been under-regulated by
approximately 27-30%. For lower income levels, this under-regulation means that in
order to gain the rights to a pension above the basic pension, one must earn an income
above NOK148,000. Income below this level does not result in any right to a pension
above the minimum level of the basic pension. In the same period, the value of the
minimum pension has been increased through an increase in the “special supplement”
(“særtillegget”).
The aim of the 1967 legislation was that the pension should compensate for
approximately 2/3 of the previous level of income. The level of compensation for
previous income has been significantly lower than was originally intended. Today it
amounts to only around fifty per cent of previous income. However, this picture
changes somewhat when we look at after-tax income. The special tax exemptions for
pensioners contribute to a substantially higher degree of compensation than the pre-
tax pension indicates. After tax, the level of compensation for an average income rises
from 52 to 63% (LO 2002 3). These rules have been under political debate and
pressure, however, and in 1995 removing the favourable tax-rules for those with
higher and middle incomes was proposed. (St.meld.35 1994-95 212-227).
The 1992 changing of rules combined with the under-regulation of the basic amount
have resulted in a smaller difference between the highest and the lowest pension
levels. If this trend continues, the National Insurance Scheme will develop into a
scheme that provides only a minimum pension for all, regardless of previous income.
These changes have been incremental and not subject to any thorough political and
public debate. Many pensioners therefore feel that they have been cheated.
Expressions like “pension robbery” and “breach of promise” are frequently used. 62
This development also illustrates the problem of the time-inconsistency of political
promises discussed in Chapter Five. Politicians may be subject to pressure and
62 Siv Jensen i Spørretimen onsdag 13.mars kl.10, 2002: " "Det dette dreier seg om er å få klarhet i hva som er Regjeringens holdning til det gjentatte tjueriet av pensjoner som vi nå ser i Norge". Bemerkning fra Presidenten: Presidenten vil få lov til å bemerke at "tjueri" etter norsk lov er straffbart, og at anmeldelse bør innleveres andre steder enn i stortingssalen, hvis man mener alvor med det."
153
induced to follow short-term interests and therefore be unable to honour earlier
promises.
In Chapter Five I have discussed how constitutional restrictions may be effective pre-
commitment devices against such problems of time-inconsistency. Proposals have
been made in Norway for stronger constitutional protection of pension rights. In 1996,
the leader of the Norwegian Party of Progress, Carl I. Hagen, proposed including a
new article of the Constitution which would explicitly give protection to social
security and public pension rights (Dokument.nr.12 1996). In the preparation leading
up to a new act of legislation on social security, ensuring extended constitutional
protection of public pension rights was proposed (NOU1990:20).
In Norway, the formal constitutional protection of public pension rights is rather
weak. The written constitution has been reformed to a small extent with regard to
rights inclusion (Smith 1993 47). There is no article of the Constitution that gives
explicit protection for social and economic rights. The Norwegian Constitution does
not reflect the development of an extensive welfare state. The only exceptions are
Article110, a sleeping article stating the right to work, and Article110c concerning the
status of human rights conventions, which I will return to later.
With regard to the constitutional protection of public pension rights, a rather
paradoxical situation occurs: those rights that are afforded the strongest protection
under the Constitution are those that are closest to contract rights and rights of private
property. The supplementary pension is therefore likely to be better protected than the
basic pension (Kjønstad and Syse 2001: 71). This is contrary to the recommendations
in Chapter Six. The claim in this chapter was that the right to basic pension should be
given much stronger constitutional protection than the right to supplementary pension.
The articles of the Constitution that may be appealed to for the protection of pension
rights are Article 97 (against retroactive effect) and Article 105 (property rights).
154
The Case of Norway
However, recent adjudication in two social security cases illustrates that these articles
afford rather weak protection of rights to public pension. 63
The background for the two social security cases was the 1992 rule change. The
question in both cases was whether the changes in the rules of supplementary pension
and the supplement for spouse should be made effective for already accumulated
pensions. They both appealed to Article 97 in the Constitution (“no law must be given
retroactive effect”). The two cases were therefore treated together by the Supreme
Court.
The case of Stig Borthen (lnr 76B/1996 no. 160) involved the new rules for income-
testing of the supplement for spouse (“Forsørgertillegget”). The question was whether
new rules for income testing could be made effective for a person who had already
been granted old age pension with the supplement for spouse (Rt.1996 s.1415).
The other case, that of Anstein Thunheim (lnr 77B/1996 no.224), concerned the
accumulation of supplementary pension. The so-called “knekkpunktregelen” was
changed so that the maximum possible number of pension points one can receive was
lowered. In the Thunheim case, the question was whether the new rules resulting in
lower future pension points and thereby lower future supplementary pension could be
made effective for a person who was already recieving disability pension (Rt. 1996
s.1440).
Borthen lost his case in a 4-3vote in the National Insurance Appeals Court
(Trygderetten), but won in a 4-3 vote in the Court of Appeals (Lagmannsretten).
Thunheim won his case in a 7-0 vote in the National Insurance Appeals Court, but lost
in a 4-3vote in the Court of Appeals. Both cases were then appealed to the Norwegian
Supreme Court.
63 Case 76 B 1996 no.160 to the Supreme Court, Case 77 B 1996 no.224 to the Supreme Court
155
The Supreme Court unanimously decided that there was no violation of the
Constitution in the case of Borthen. In the Thunheim case, the Court came to the same
conclusion in a 16-1vote. Behind this unanimity were three fractions. A majority of
ten of the Supreme Court justices came to the conclusion that pension rights in
principle are protected by Article 97 of the Constitution. A minority of six justices
concluded that the Constitution does not provide any protection for public pension
rights. The third fraction, consisting of one justice, claimed that pension rights should
be granted stronger constitutional protection.
The two cases are not only important from the perspective of social security
legislation, they are also interesting reading for anyone interested in the workings of a
constitutional democracy. They illustrate the classic trade-off between popular
sovereignty and the freedom of the national assembly on the one hand and
constitutional binding of the very same freedom on the other. Both cases concerned
the right to receive a pension according to certain rules, as opposed to the legislature’s
right to a considerable freedom of action with regard to changing these rules.
In both cases the Supreme Court concluded (with 16 of 17 justices) that pension from
the National Insurance Scheme cannot be compared to private insurance or insurance
agreements in the work place. The pension premium paid is to be regarded as a tax.
The pension entitlements in the National Insurance Scheme, therefore, do not have the
status of rights that can be claimed from the state in the same way as a private
insurance customer can claim the right to pension from an insurance company. What
the majority of the Supreme Court justices confirmed is that pension entitlements are
tax-based rather than insurance-based, and consequently that the government is in
principle free to do with its tax-raised revenues much as it pleases. This position, in
principle, allows large freedom of action on behalf of politicians who want to induce
changes and reforms in the pension system.
The majority coalition based its position on what is known as Knophs’ “standard
theory”. The standard theory states that Article 97 and Article105 are based on
156
The Case of Norway
standards of reasonableness and that these standards change over time and according
to different circumstances. The standard formulated by the majority coalition was that
only “obviously unfair and unreasonable” retroactive effects should be covered by
Article 97. The practical implication of the use of this standard is that the legislative
assembly’s freedom of action (in the Norwegian Constitution regulated in Article 75
a) and d)) is given considerable weight (Odberg 1999 87).
As part of the argumentation in support of this standard, the majority coalition referred
to the “preferred position principle” presented in Chapter Six. In 1975 Former Chief
Justice Carsten Smith was the first to introduce the preferred position principle to the
Norwegian debate (Smith 1975). Recall that the main idea behind this principle is that
rights can be lexically ordered, and that different categories of rights should be
afforded different degrees of constitutional protection. Smith argued that “also in our
country, we should accept that personal freedoms should be ranked higher in the
hierarchy of democratic values than economic rights, and therefore to a larger extent
be subject to judicial review”(Smith 1975:302). On behalf of the majority, the first-
voting justice in the Borthen Case acknowledged this division as one of basic
importance (“grunnleggende riktig”) (s.1429).
The Norwegian Supreme Court has on several occasions emphasised the distinction
between civil and political rights on the one hand and economic and social rights on
the other (Kløfta-dommen RT 1976 pp.5-6 and p.22, The Kjuus-verdict RT 1997
s.1821). Justice Backer, the only dissenting justice, had important objections to this
principle (s.1438). The principle has also received criticism from prominent judicial
theorists ((Andenæs 1998),(Smith 2000), (Kjønstad 1997 263). One can not find
support for this principle in the manner in which the Norwegian Constitution is
phrased or in earlier praxis (Smith 2000:28). Even thought the principle was accepted
by the Supreme Court in the so-called Kløfta-case, a majority nevertheless afforded
economic rights considerable protection.
157
The “preferred position principle” implies a division of the articles in the Constitution
into three different categories (Kjønstad 1997):
1. Protection of individual freedom and security (bestemmmelser til vern av enkeltmenneskets
personlige frihet og sikkerhet)
2. Protection of economic rights (bestemmelser til vern av økonomiske rettigheter)
3. Regulation of the distribution of tasks or competence between the different branches of
government (Bestemmelser som regulerer statsmaktenes arbeidsmåte eller innbyrdes
kompetanse )
In Norwegian legislation, the ramification of applying this principle is that an act of
legislation regarding economic rights should be subject to judicial review only when it
is obvious or without doubt that the law violates the Constitution. Rights higher up in
the hierarchy, on the other hand, should be afforded a greater protection (Smith 2000).
In practise, the preferred position principle will imply judicial restraint rather than
judicial activism with regard to social and economic rights. An important result of
applying the principle in Norwegian legislation would therefore be a degrading of the
constitutional protection of these rights (Vislie 1999:82).
From the discussion in Chapter Six it follows that a modified version of the preferred
position principle should be applied to the question of constitutional protection of
pension rights. A modified preferred position principle implies that rights can be
lexically ordered with regard to constitutional protection, but that the sorting
mechanism is not whether they are civil, political, economic or social rights, but rather
whether they can be said to be necessary pre-conditions for democracy. An
application of a modified preferred position principle would afford strong protection
to a basic pension, but not the same protection to supplementary pension under the
National Insurance Scheme. This does not imply, however, that the right to
supplementary pension should not be protected by general rule-of-law-clauses, such as
a ban on retroactive effects. In the case of Norway, Article 97 should still be relevant
with regard to all retroactive legislation, also when pension entitlements are affected.
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The Case of Norway
The claim is that the right to supplementary pension is not a type of rights that should
be constitutionally entrenched.
However, a modified preferred position principle does call for strong protection of the
right to basic pension. The two cases referred to above indicate that the right to basic
pension is not well protected in the current Norwegian Constitution. Even the
introduction of new human rights legislation does not alter this picture. In 1994,
reforms were made to afford stronger protection to human rights in Norwegian
national legislation. This work resulted in a new article, Article110c, of the
constitution. This article states that it is the responsibility of the authorities of the state
to respect and ensure human rights, and that specific provisions for the
implementation of treaties shall be determined by law. By the act of legislation of
May 21, 1999, no.30, three conventions were incorporated into national legislation:
the European Convention on Human Rights (ECHR), the International Covenant on
Civil and Political rights (ICCPR) and the International Covenant on Economic,
Social and Cultural Rights (ICESCR).
In the European Convention, as in nearly all such documents, there is a requirement
that the compliant has exhausted all domestic remedies in the original country of
appeal. This is one of many features that serve to emphasise that the primary
responsibility for upholding human rights lies not with the international organs but
with the state parties.
To the question of the legal protection of rights to public pension, Article 22 in the
Universal Declaration on Human Rights, and Article 9 in the ICESCR are of particular
relevance. Article 22 states that all individuals, as members of society have a right to
social security.64 Article 9 reads, “[t]he States Parties to the present Convenant
recognize the right of everyone to social security, including social insurance”.
64 Article 22 reads: “[E]veryone, as a member of society, has the right to social security and is entitled to realization, through national effort and international cooperation and in accordance with the organization and resources of each State, of the economic, social and cultural rights indispensable for his dignity and the free development of his personality”.
159
Because of their very general and vague formulations it is questionable, however,
whether any of these articles will have any practical impact on the legal protection of
pension rights. In addition, the rights in the ICCPR are said to be immediately
effective and self-executing while the rights in the ICESCR require progressive
implementation.
The European Social Charter is not yet incorporated in national legislation. Article 13
in the European Social Charter states the right to social protection. Under the Charter,
states must guarantee the right to the protection of health, social security, social
assistance, and social services. The ILO convention no.102 gives excessive rules and
standards for the protection of social security rights. The compensation to a family
after having lost its income should be, according to the convention, between 40-50 %
of previous income (Kjønstad and Syse 2001 76). The implementation of the
European Social Charter is therefore likely to support the protection of a right to a
basic pension.
However, a general problem with these conventions is that of “operationalising” the
different rights in a judicially enforceable format. Both the UN Covenant and the
European Social Charter have vague and abstract formulations, and it is often unclear
how they are related to national legislation. The manner in which Article 22, Article 9
and Article 13, are formulated is vague or non-justiciable. These articles must also be
regarded as stating minimum standards. They are therefore not well suited for a
protection of welfare rights such as the right to supplementary pension.
The status afforded to the three already incorporated conventions is that they have
precedence over ordinary legislation, but rank lower than constitutional law. One may
say that these documents are provided a “semi-constitutional” status. This is not a very
strong position, and many have argued that it is not strong enough to grant human
rights proper legal protection (Smith 1994 66). 65 In the preparations leading up to a
65 For a thorough discussion of the interpretation of Article 110c and the relation to conventions on economic, social and cultural rights, see (Vislie 1999:55-102)
160
The Case of Norway
new act of legislation on human rights, reference was made to the preferred position
principle, and emphasis put on the priority of civil and political rights over economic,
social and cultural rights (Ot.prp.3 1998-99 71), (NOU1993:18 85))66. The protection
under Article 110c will, according to the preferred position principle, depend on the
category of right in question and stronger judicial review is likely to be afforded to
classic civil and political rights. Also note that, even if Article 110c presumably can
establish a certain protection for public pension rights, this protection is only indirect
and not visible in any of the formulations in the Constitution (Holgersen 1995 357).
The Norwegian Constitution does not have a consistent set of articles protecting
individual rights, and the new law regulating human rights does not change this.
Political and civil rights are expressed in Chapter E of the Constitution, especially
Articles 96, 97, 100 and 105. These articles are also understood as the unwritten rule
of Judicial Review (Vislie 1999 40). We have seen that Article 97 (retroactive effect)
and Article 105 (right to property) are relevant to the protection of pension rights.
None of these articles, however, gives explicit protection to a right to a minimum
subsistence. The inclusion of a specific article (under Chapter E) granting a
constitutional right to basic subsistence should, therefore, be considered.
7.3. Four Proposals for a Pension Reform
The expected increase in pension expenditures from 2020-2050 represents a real
challenge for the national economy. It is generally argued that the using the
Government Petroleum Fund money will rescue future generations of workers from an
increased tax-burden. However, this argument is questionable for at least two reasons.
First, higher levels of economic growth are likely to make the following generations
better off. This may actually defend an increase in the tax burden from the perspective
66 In the law proposal (Ot.prp.3 1998-99:71) there is a reference to the Kløfta verdict where the preferred principle was first stated in Norwegian law: " Det vil være større grunn til å legge vekt på konvensjonsvernet når det er tale om vern av enkeltmenneskets personlige frihet eller sikkerhet, enn når det er tale om vern av økonomiske rettigheter. Dette vil være i tråd med tilsvarende sondering når det gjelder betydningen av grunnlovsvernet, jfr Høyesteretts uttalelse i RT.1976 side 1 (på side 5-6)". A similar passage is to be found in the Committee Report (NOU1993:18:85):" Dersom tilsvarende prinsipper vil bli anvendt i forhold til
161
of intergenerational equity. Second, the Government Petroleum Fund should be used
in a manner that benefits all future generations. It is not obvious, therefore, that this
money should be used to finance the pensions of a particular generation of pensioners.
If the money from the oil wealth is to be used to cover pension expenditures at all, it
should be used to finance a reform of the pension scheme that would make it more
sustainable. The case of Norway illustrates how, in a pay-as-you-go pension system,
pension rights are not fully secured, either financially (through saving/funding) or
legally through a system of constitutionally entrenched pension rights. More
sustainable means less vulnerable to fluctuations in the dependency burden and better
protection of the real value of pension entitlements. A general earmarking in order to
preserve the existing pay-as-you-go system does not satisfy these requirements.
A reform should be considered that separates the two basic elements in the current
pension scheme: the basic pension and the supplementary pension. The basic pension
should be secured by means of a constitutional guarantee.
The real value of the supplementary pension has been severely reduced since 1967.
This makes supplementary pension from the National Insurance Scheme both
unreliable and unpredictable. We have also seen that there is no “quick” fix solution to
this problem. Constitutional entrenchment of these rights is not a good solution. For
the sake of the freedom of choice of future generations of voters, constitutional rights
should be restricted to those rights that are necessary pre-conditions for democracy.
General funding is not likely to be effective with regard to securing the financing of
these rights. Earmarking the petroleum money to pay off pensions may have a certain
protective effect, but cannot be defended without depriving future generations of their
rights to share in these non-renewable resources.
konvensjonene, er det grunn til å tro at domstolene vil være mer innstilt på å sette til side bestemmelser til vern om den personlige frihet og rettssikkerhet, enn f.eks til vern om økonomiske rettigheter".
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The Case of Norway
A reasonable implication would be a reform that changes the pay-as-you-go financing
of supplementary pensions, and redefines the nature of these rights. (The obligation to
pay for already accumulated pension rights must be honoured, however.)
If we now try to draw the treads together, the following elements should be considered
in a reform of the National Insurance Scheme:
5. Allow for increased taxation of future generations of workers
6. Government provision of intergenerational risk-insurance
7. No general earmarking of the Government Petroleum Fund for pensions
8. Constitutional entrenchment of a right to basic pension
163
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