Unemployment has long-term effects on retirement income, research finds

17 February 2017

The credit crisis of 2008 will be felt for years to come. Workers who lost their jobs during the crisis especially will feel the pain throughout their retired life. Younger workers are the hardest hit category, concludes researcher Boele Bonthuis.

In his thesis, Boele Bonthuis reaches some remarkable conclusions about the many implications that unemployment has for wages and pensions. ‘The negative effects of unemployment are usually grossly underestimated, because researchers are not aware enough of the effect that unemployment has on the retirement income of the worker,’ says Bonthuis.

Bonthuis finished his thesis on labour markets and pension systems at the University of Amsterdam (UvA) at the end of 2016. In his research, Bonthuis distinguishes between different generations and concludes ‘that the burden falls heavily on some, but less so on others. Younger generations suffer the most, because they are the first to be laid off after an economic shock. And when they have found a new job, they will find themselves having to pay extra premiums to fund the pension claims of the older generations.’ During his research period, Bonthuis worked as a researcher for the European Central Bank as well as the German Bundesbank.

Economic shock

Bonthuis examined the labour market and pension systems in the four largest countries of the Euro area: Germany, France, Italy and Spain. What these countries have in common is that pensioners are highly dependent on state pensions. A state pension is financed by premiums paid by employees. This system is known as the pay-as-you-go system. The retirement income is mostly related to the number of years worked and the level of the salary. In case of unemployment, the unemployment benefit provided by the state includes the continued accumulation of pension entitlements during a certain time.

The Dutch system differs from the systems in these four countries. The level of the state pension (which is funded on a pay-as-you-go basis) is based entirely on the amount of years the individual has lived in The Netherlands. It is relatively low, because the law requires that employers offer pension schemes affording workers to build up additional pension entitlements. This additional pension is a funded pension, which means that the employee’s pension plan is funded by contributions from the employee. In the other euro countries, workers’ funded pension plans are non-existent or small in scale.

Unemployment hits people in many ways, says Bonthuis. ‘The first, direct effect of unemployment is a fall in spendable income. Secondly, when a jobless person finds a new job, his income will be lower than the income of someone who has worked all the time. Thirdly, employees are confronted with higher pension contributions after an economic shock. Finally, the building up of pension entitlements will be wholly or partially suspended while unemployment lasts.’

Younger and older employees

Bonthuis differentiates between starters who are not able to find a job in the first ten years of their careers and workers who lose their job ten years before they are to  retire. Bonthuis compares the results of his calculations for these two groups with those for the group of workers who work throughout their career.

An economic shock has different implications for different generations. Bonthuis: ‘In terms of the fall in income, it is the older generation who suffer the most. They have a relatively high income so their fall in income is the largest.’

Younger employees are hit as well, but for a different reason: they are to receive a relatively low income when they return into employment. ‘The older generation do not have to suffer this loss, or only for a short period’, says Bonthuis. ‘After this period of unemployment, they will have reached their retirement age.’

Pension contributions fall when employment falls, but pension benefits remain at the same level. The pension fund needs to cover the resulting deficit, which can only be done by raising employees’ pension contributions. ‘This increase falls on current workers and those who successfully reintegrate, because the older generations will retire after a period of unemployment.’

Pension pain

According to Bonthuis, the younger generations will also suffer most with regard to the accumulation of pension entitlements. ‘In the larger countries of the euro area, workers who become unemployed receive unemployment benefits that in  the first few years include the accumulation of pension entitlements. This only applies to those who have worked a certain number of years, in other words: the older workers. The state benefits for unemployed persons who are not able to find a new job will not include any accumulation of pension entitlements.’

All these effects have huge implications for the retirement income. In Italy, the differences are the largest. A person who is not able to find a job in the first ten years of his career will receive a pension that is 26% lower than someone who has worked during his whole career. An Italian who loses his job ten years before his pension age loses 19% on his pension benefits. In Germany these figures are respectively 26% and 23%. In France they are 13% and 0%. In Spain the differences are small, because pensioners receive a full pension even if they have not worked during their whole career.

Inflexible wages

Crises will hit the younger generations even harder than others, as they are the very first who will be laid off or, if at the start of their careers, will find themselves unable to secure a job at all. ‘Companies have to cut their costs during a economic shock one way or another’, says Bonthuis. ‘This can be done by lowering salaries, which keeps most of their employees at work. But lowering salaries is something that happens rarely, because it would arouse opposition from the mighty unions, and would lead to dissatisfaction and insecurity among employees.’

So the only option companies have is to lay people off. According to Bonthuis it is hard and costly to let go of older employees, so it is the younger employees who have to leave first. It is not a coincidence that youth unemployment in Spain and Italy went up to 50% at the peak of the crisis between 2010 and 2013. Bonthuis is of the opinion that it would be fairer to cut wages of all workers during harsh economic times, so more workers could keep their jobs.

Flexible labour market

Another solution for spreading the burden of unemployment more evenly over generations is to work towards a more flexible labour market. Bonthuis: ‘It would be useful to weaken the rights of permanent employees, while strengthening the rights of temporary employees. A solid social safety net, however, would be conditional on carrying out such major reforms.’

The reform of the pension system as a whole could also lead to a more balanced situation: ‘When workers in the four countries of the Eurozone can accumulate more funded pensions, there would be less need to raise premiums after an economic shock.’

More information? Email redactie-feb@uva.nl.

By Bendert Zevenbergen

Published by  Economics and Business