Topic 3: Social Contracts and Pension Design

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Topic 3: Social Contracts and Pension Design

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Learning Objectives

At the end of this topic, you should be able to answer these questions:

How is value created through co-operation shared under
- Classical rationality
- Bounded rationality
- Ecological rationality
What are social contracts?
What is the relationship between national pension system design or the five pillars framework of pensions and social contract?
What are the sources of variation in national pension system design?

A harmonious society creates value through cooperation and devises arrangements for how it is shared. Division of labor and the process of specialization in a society creates a growing mutual dependence among its constituent individuals and groups. Humans are social beings; hence this mutual dependence is not just economic but also psychological and social. The value that is created through our co-operative relationships is greater than the arithmetic sum of the value created through our individual efforts. The enhanced value created through co-operation requires the setting up of rules of sharing that is considered ‘fair’ by the co-operating groups. The perception of ‘fairness’ is a prerequisite for the sustainability of co-operating relationships in a society. Plato, in his book The Republic, noted that concepts of justice and injustice emerge when we enter into this arrangement of mutual interdependence. Social justice requires “giving every man his due.” However, determining what ‘every man’s due’, poses a challenge in operationalizing and implementation.

Social Contracts

A social contract is an implicit contract between members of a society that lays down the terms of co-operation and ‘fair’ sharing of the value created. In the next few paragraphs we will examine how the different interpretations of rationality allocate the ‘fair’ share of value created through co-operation.

Classical & Bounded Rationality

In the topic on intertemporal choice we learnt about three interpretations of human rationality. Classical & Bounded rationality with their focus on pursuit of self-interest and ecological rationality as the other view with its focus on collective survival or well being are two perspectives of decision-making behavior. Both these perspectives can be applied to the sharing of value created through cooperation in social contracts. Li and Tracer (2017), in their comprehensive survey of the literature on decision-making behavior, makes a distinction between “selfishness axiom” which underpins classical and bounded rationality and pro social decision behavior that forms the basis of ecological rationality .

Proponents of the selfishness axiom take an individualistic perspective on survival and argue that in the quest for survival and reproductive success “individuals are expected to behave in their own selfish interests” (Krebs & Davis, 1981, p.22). Similar sentiments are expressed by Richard Dawkins (1976) in his book, the Selfish Gene. With its focus on the maximization of self-interest, the selfishness axiom considers sharing of value created as a default outcome realized by the universal pursuit of self-interest. The selfishness axiom is central to classical and bounded rationality. Classical rationality has a very specific view of the social environment. The social environment is seen as the aggregated outcome of independent rational actors’ decisions aimed at the maximization of self-interest. The actors have complete information and the capacity to act unencumbered by the social environment and relationships (Dixon & Hyde, 2003). The social good is achieved by the realization of self-interest of individual decision makers. Sharing of value created is achieved by the terms of exchange (prices) agreed upon between the contracting parties. As Adam Smith (1776) wrote quite vividly:

It is not from the benevolence of the butcher, the brewer, or the baker that we expect our dinner, but from their regard to their own interest. We address ourselves, not to their humanity but to their self-love, and never talk to them of our own necessities but of their advantages (Smith, 1776)

Remarkably, some 17 years before he wrote The Wealth of Nations, none other than Adam Smith recognized, in The Theory of Moral Sentiments, the essentialness of fairness, equity, and justice to the maintenance of the social order: “All men…abhor fraud, perfidy, and injustice and delight to see them punished…few men have reflected upon the necessity of justice to the existence of society”

Bounded rationality does not disagree with the goal of the pursuit of self-interest and exchange value (price) as the basis of the sharing of value created. What bounded rationality seeks is the recognition of our limited computational and information assimilation capabilities and the role of emotions in the pursuit of self-interest. Analytically, the basis of co-operation or social contracts and the sharing of value created in both classical and bounded rationality is the same.

The view that the social good is the outcome of pursuit of individual self-interest is difficult to incorporate in intertemporal decisions like pensions. Given the focus of classical and bounded rationality on the pursuit of self-interest the long term in these interpretations of rationality will be the lifetime of the individual. As we learnt in the previous topic, intertemporal decisions on the other hand have multi-generational horizons and the outcomes are not completely specified in the present. Intertemporal decisions are distinct from long term decisions. In long term decisions the outcomes and the probability that can be attached are known. In intertemporal decisions the outcomes are yet to be fully identified as they are dependent on future scenarios; stakeholders are yet to be born or the existing relationships do not give them a say in the decision. Examples of the latter could be rooted in economic, age or gender based inequities, and hence unable to bargain or negotiate their self-interest. Thus the full implications of an uncertainty are not just the case of an externality or the failure to capture a social good but the case of a social good that is poorly identified and with stakeholders who will bear the cost of the decisions not able to bargain their self-interest.

Ecological Rationality

In ecological rationality, sharing of value created through co-operative behavior is motivated by what has been called ‘prosocial behavior’. Prosocial behavior is behavior or decisions taken to benefit society as a whole. It is not altruism. Such behavior may be motivated by empathy and by concern about the welfare and rights of others as well as for egoistic or practical concerns, such as one’s social status or reputation, hope for direct or indirect reciprocity, or adherence to one’s perceived system of fairness (Eisenberg, Fabes, & Spinrad, 2007). The prosocial perspective of human decision-making behavior is based on studies drawn from several distinct research domains and different disciplines such as anthropology, neurological sciences, human genetics, evolutionary psychology, and experimental and behavioral economics. What is distinctive about these theories and models of human nature is that they are based on evidence gathered either through experiments or direct observation of the neural processes in the brain using three-dimensional imaging techniques. The table below is a summary of the findings of some of the disciplines that have analyzed and gathered evidence on prosocial behavior in their study of the the science of human decisions and nature.

Table 5
Summary of Findings on the Science of Human Nature From Different Disciplines

DISCIPLINE	PRINCIPAL FINDINGS ON HUMAN NATURE
Anthropology	Widespread cooperation, collective decision making, political coalitions, resistance to power and dominance, formal rights and obligations (rules and laws), governance processes, social sanctions, and reciprocity and a sense of fairness or equity (Brown, 1991) based on Human Relations Area Files
Neurosciences	The human brain has a moral sense; wired to behave ethically (Gazzaniga, 2005 ; Greene, 2007)
Human Genetics	Evidence for altruism; nurturance & empathy with significant variations
Evolutionary Psychology	Evidence on social exchange or reciprocity and fairness, not only in adults but in children
Experimental & Behavioral Economics	Strong reciprocity as an explanation of ‘fairness’ and altruistic behavior

Note. Adapted from Corning (2015).

Taking a collective perspective on evolutionary success and survival, several lines of research suggest that pro-social behavior evolved in the ecological context of the pressure to stabilize cooperative groups, which in turn were critical to our evolution into humans (Yoder & Decety, 2018). Thus pro-social behavior is central to our survival. Further experimental research over the ensuing 25 years has confirmed that only in a minority of cases do humans act as self-interested maximizers of personal gain. Recent studies into the neural basis for pro-social behaviors, show that generosity or fair-minded play in games, and punishment behavior, activates reward centers in the brain (Buckholtz & Marois, 2012; Fehr & Camerer, 2007).

The science of human nature shows that a more nuanced interpretation of human rationality is one that is guided by considerations of social justice and fairness. However, fairness as a motivation of human decisions is restricted by the group level or parochial altruism, individual, and biological traits. We are just by nature, but our sense of fairness has a parochial attribute as it does not transcend group identity. Our fairness is “malleable” as our specific choices are shaped by the immediate context, personal experiences, and self-interest, and experience. We will often rationalize our rejection of what is fair to others. Our fairness is also conditioned by biological traits, and may show individual variation. Thus, we have an emerging vision of rationality as ecological that is conditioned by individual/group self-interests and limitations in cognitive and computational capabilities (Corning, 2015).

The evidence on prosocial behavior establish the significance of cooperation and the central role of fairness, equity and justice for decision making. The next step is to examine how the rewards of cooperative behavior can be allocated to ensure a sustainable social contract.

‘Fair’ Share of Value

Using insights from the science of human nature and ecological rationality Corning (2011) proposes the concept of a biosocial contract, that provides a substantive and implementable construct of what is ‘fair’. A biosocial contract is about the rights and duties of all the stakeholders in society, both among themselves and in relation to the “state.” It is about defining what constitutes a “fair society.” It is a normative theory, but it is built on an empirical foundation.

The biosocial contract is made up of three normative components, also called the fairness precepts:

- Equality – the distribution to each according to their basic needs;
- Equity – surpluses beyond the provisioning of our basic needs must be distributed according to merit; and
- Reciprocity – each of us is engaged in the co-operative venture to the collective survival enterprise contributes proportionately according to our abilities.

SOCIAL CONTRACTS

Corning’s identification of social contract and its importance in the design of national pension systems is also mirrored in work by other social scientists and publications by organizations like the International Labour Organization (ILO)and Quebec’s Report on Retirement System

The work of Hyde and Shand (2003) on pensions design, though unrelated, is analogous to Corning’s biosocial contract . Though they do not specifically discuss the concept of social contract in their work, Corning’s first two fairness precepts, “equality” and “equity” are supported by Hyde and Shand pension design principles of “need,” “desert,” and “reciprocity.”

Hyde and Shand’s (2003) first principle, need, is described as a minimum safety net and resonates with Corning’s fairness precept of equality, which is the collective obligation to provide for the basic needs of all people (Corning, 2015). The principle of need in pension design suggests redistributive income transfers to address financial impoverishment.

The second principle, which they call desert (related to the word deserving) suggests that workers should be rewarded financially in accordance with performance at work. This principle justifies earning differentials, and by extension, unequal transfers from occupational pensions would reflect these. Consequently, some would have larger pension payouts than others. Corning (2011) argues that the equity attribute of the fairness requirement of social contracts justifies financial rewards reflecting individual differences in talent, performance and achievements.

Finally, reciprocity, the third component of the biosocial contract, highlights the importance of mutuality in obligations and benefits for the fair distribution of the enhanced value created through cooperation. Hyde and Shand’s characterize this as “citizenship,” based on the characteristics that people share and demonstrates the importance of universal rights and obligations. Reciprocity is critical in balancing relationships with each other.

The ILO in a multi country report entitled, ‘The political economy of pension reforms in times of global crisis: State unilateralism or social dialogue?‘ emphasises the importance of negotiating the social contract in pension reform, as in any other policy reform. The report asserts processes have been hasty and proper consultations with the social partners and other stakeholders have been deficient and this raises significant questions as to the sustainability of the reforms.

The Quebec Report entitled,’Innovating for a Sustainable Retirement System, A Social Contract to Strengthen the Retirement Security of all Quebec Workers’, also highlights the importance of social contracts in the pension reform process.

Equality

The central tenet of equality is that basic needs required for the survival and reproduction of human society should be made available to all. “Goods and services must be distributed to each of us according to our basic needs (in this, there must be equality)”. Equality involves a “collective obligation to provide for the common needs of all our people” and “it does not entail a wholesale redistribution of wealth (Corning, 2011, p.11). Corning identifies 14 primary needs: thermo-regulation; waste elimination; nutrition; water; mobility; sleep; respiration; physical safety; physical health; mental health; communications (information); social relationships; reproduction; and nurturance of offspring (Corning, 2011). The basic needs specifications may differ between countries, societies and communities.

EXPLORE

The Basic Needs Index

An example of the basic needs index supported by the Indiana University that are used in practice by organizations like the Salvation Army . The UN has a Multidimensional Poverty Index (MPI).

We may not agree about the means to deliver these basic needs; nevertheless, the collective survival imperative compels us to have empathy for all members of society. Basic needs do not necessarily have to be met by the state (government), in fact most are met by groups, like family and the private sector. Of course, families are not equally resourced and external support may be required, typically from charity or state funded programs. The key point is that societies must accept the mutual obligation to ensure that basic needs are met. The means for meeting basic needs are informed by many factors including political ideology, cultural values and beliefs.

The first precept, equality as a component of the biosocial contract, is the easiest to operationalize. It refers to “the basic needs” guarantee. An empirical application of the equality component in the social contract is provided by the basic needs index.

Equity

The second component of social contract is equity. The base unit of all societies are individuals who thrive by being connected to others. We need each other to be successful in the collective survival enterprise, however, human skills, talents, intellectual capacity, and other human abilities vary greatly. Cooperation is necessary for the collective survival enterprise, however, competition brings out unique individual skills and abilities that add tremendous value to society. Rewards for human talent incentivize their continued development. The equity precept is based on the principle of reward for effort. In general, it implies that the rewards a person receives should be proportionate to effort, investment, or contribution. Equity is based on the deep psychology of fairness, that is our strong desire to be recognized honored and rewarded for our Individual efforts and achievements. The equity component of the biosocial contract is about how to fairly distribute the economic surpluses of a society—the excess beyond what is required to provide for our basic needs. If merit is deserved, inequality in wealth is accepted as part of the social contract. Perhaps this is because we aspire to be someone who achieves and gets rewarded for genuine effort.

In Canada, for example, there are many different types of pension plans that deliver a wide range of benefits and post-work income. Defined benefit, defined contribution and government-based plans like social security and Canada Pension Plan require both employee and employer to contribute and the retirement benefits are higher than taxpayer funding programs like Old Age Security. The income difference between occupational based and taxpayer supported plans is considered fair since the higher income is based on the merits of many years of contribution by the employee.

Reciprocity

Reciprocity is a corollary of equality and equity. It is considered an entrenched social norm. Colloquially known as “tit for tat,” reciprocity can be either positive or negative. Positive reciprocity occurs when someone does something positive and another reciprocates by doing something positive back. For example, I give you a gift and you give me a gift back. Negative reciprocity involves getting even or getting back at someone; positive reciprocity is like a virtuous circle as opposed to the vicious circle of negative reciprocity. The golden rule of “do onto others as you would want others to do onto you” reflects the importance of reciprocity in supporting the social contract. People consider it unfair when expected reciprocity fails to occur. Without reciprocity, the precepts of equality and equity would be meaningless. Interestingly, reciprocity does not have to be symmetrical, and in fact is mostly asymmetrical, with one party having more power than another. (Rawolle, 2013). Thus, a social contract does not have to entail exchanges of equal value to be perceived as a fair exchange.

An excellent example of negative reciprocity was outlined in an article about pension retrenchment in the Netherlands. It shows a direct relationship between the retrenchment of pension rights in the form of withdrawal of tax benefits on pension contributions to one group of workers, as being perceived as unfair, and resulting in a reduction in job motivation (Montizaan, Cörvers, De Grip, & Dohmen, 2012). In pension design, reciprocity establishes expectations and obligations. Pay in and pay out pension plans are based on a shared contribution of employer and employee. When one of the parties, usually the employer, reneges on contributing their share, loss or reduction of pension payout, it is perceived as unfair and threatens the integrity of the social contract. A recent example of this is the denial or reduction of benefits and pensions to employees as a consequence of the Sears Bankruptcy (Mason, 2018). Sears employees had asserted that they accepted lower wages or reduced their bargaining expectations because of the anticipated and expected benefits of pension payouts. When the employers reneged on these expectations this had implications for the wider pension system as it weakens the reciprocity component of the social contract and threatens the broader sustainability of the ‘five pillars’ of a national pension system.

The Extent of Prosocial Behavior – Individualism & Collectivism

In the sharing of value social, political, and cultural norms, the society or country’s perception of individualism and collectivism will have influence on the determination of the emphasis on equality; equity and reciprocity in pension system design. Individualism and Collectivism will explain the emphasis each country places on the pillars of pensions as identified in the World bank’s typology of pensions around the world.

The perennial contradictions between individualism and collectivism shapes political, social and economic politics and policies. Individualism, can be described as a belief system that values the freedoms and rights of individuals above those of the group or society. Collectivism is a belief system that values the collective, group or society over those of the individual. The seeming incompatibility between these two perspectives defines the core political divide between freedom and equality. Those who value individualism support conservative and libertarian political parties and promote individual freedom. The individualists promote private sector solutions and less government involvement.

In contrast, collectivists back socialist and progressive political parties that fight for equality. These communitarians see a greater role of government in providing social goods and services. Therefore, in economic affairs, capitalism is more highly supported in societies and cultures with an individualistic leaning, while socialism is favored by cultures that lean towards collectivism. The main conflict lies in how goods and services are produced (private vs state enterprise), and how the wealth generated is distributed (through wages and investment returns vs. welfare and basic annual income).

Societies appear to have a default position of being either individualistic or collectivist. Individualism or collectivism, is deeply entrenched in the social and political culture, and is a key element of the implicit social contract. The country’s constitution, institutions, policies, political parties, ideologies, and political discourse contribute and shape the social and political culture.

Cultures lean towards either individualism or collectivism. The collectivist mindset generates socially constructed values and beliefs that include equity and distributional justice, social solidarity, integration and inclusion. In contrast, individualism values individual responsibility and contractual rights. Both collectivists and individualist see some value in some form of social contract; they disagree on the extent and depth of collective action to solve social and economic challenges. Collectivists tend to see more value in social contracts whereas individualists see social contracts restraining individual freedom. Cultural preference towards either individualism or collectivism influence the interpretation of the equality, equity and reciprocity components of the biosocial contract. For example, the social culture of United States is considered to be individualistic and based on the belief government cannot and should not be active in the lives of their citizens. The health care battle in the United States can be considered a case study of the clash between culture and politics. Within the United States, despite mountains of data showing otherwise, a widespread belief exists that their health care is the best in the world. Even when individuals do recognize the deplorable state of many social health metrics, there persists a stubborn, Lockean refusal to entertain the idea that more government may be the solution” (Meslin, Carroll, Schwartz, & Kennedy, 2014). In contrast, Canada is considered to have a slightly more collectivist social culture than the United States. While heath care in the US is contentious and politically charged, the matter of public funding and universal access to basic health care in Canada has been settled at least for the time being.

The normative principles of Equality, Equity & Reciprocity can form the basis of a response to calls for changes in pension systems around the world triggered by the growing challenges of longevity, technology and globalization. All pension systems will have pillars that share these tenets and principles. However, the emphasis on the different pillars in a national pension system on the tenets of equality; equity and reciprocity will depend on social and cultural norms that interpret values and beliefs like individualism and collectivism. The social and cultural norms will be instrumental in determining the emphasis or the relative weight of the three tenets or normative principles of social contract in a national pension system.

Negotiating Pension System Changes

Social contracts implicit in pension systems, can be negotiated at three levels (Rawolle, 2013). The first level, the societal level, is a broad social contract that impacts the relationship between a government and its citizens. This is the level where the fairness precepts apply. From time to time, the commitments and obligations of the social contract are made explicit, usually in momentous policy declarations in times of national crises. For example, both Franklin D. Roosevelt’s New Deal in the USA and R.B. Bennett’s New Deal in Canada were both announced in the depths of the Great Depression in the 1930s. US President L.B. Johnson’s War on Poverty in the 1960s is another example.

There is growing interest in expanding social contracts to include social rights. As noted earlier, the language of national constitutions come close to describing the terms of the social contract. In 1944, Franklin D. Roosevelt challenged the US congress to pass legislation to provide social rights like medical care, a decent home and adequate protection from the economic fears of old age. Grand pronouncements like these build on the original social contract, giving them legitimacy and the support needed to mobilize members of society. These programs focus mainly on economic rights and not on social rights. Classical social contract theories and ideologies that were influenced by them, focused on political, economic, civil and property rights. Social rights, like the right to a minimum income, education, housing and health care, are noticeably absent in these theories and ideologies and are not usually given constitutional protection. Social rights are at the core of social contracts.

At the second level, social contracts focus on social, economic, or political institutions like health, family, retirement, social justice and the like. An example would be the social institution of retirement advocating for a social contract supported by organizations like AARP in the United States or CARP in Canada. Other institutions and non-governmental organizations can also be recruited to help build the social contract.

The third level of the social contract is focused on managing the relationship characterized by fundamental asymmetries of power and knowledge. An example of this would be the social contract between a teacher and their students. It refers to specific contract-like mechanisms that set expectations and relations between people in regulated service provisions (Rawolle, 2013). In the field of pensions, this would include dyads like financial planners and those seeking advice on their pension planning. This kind of social contact would make explicit the expectations and commitments of both parties.

In summary, negotiating pension system changes at the first level of the social contract, is a very large task and involves many people within society. At the second level, it necessitates a mobilization of allies and partners connected to a social, economic and political institution. This would take time, resources, and commitment by those involved. Third level efforts would be more specific to the kind of asymmetrical relationship requiring a contract-like mechanism to encourage the parties in the contract to apply the fairness precepts. Given the substantial amount of effort involved in creating an explicit social contract, beginning the process by prototyping and testing the contract-like language at the third level to explore asymmetrical relationships would be a good starting point.

The process of negotiating social contracts is not a legal process guided by those in the legal profession. Rather, it is based on contractual or social morality. Social morality is defined as “the basic framework for a cooperative and mutually beneficial social life” and “provides rules that we are required to act upon and which provide the basis for authoritative demands of one person addressed to another” (Vallier, 2011). These are the publicly recognized rules of conduct that determine how we should treat others and the conditions under which others can hold us accountable or blame us for violating them. When negotiating a contract-like relationship, the principles of informed consent between/among the parties, points of renegotiation at specific times and reciprocal accountability will guide the negotiation process (Rawolle, 2013).

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