Abstract
European social models have many advantages and some disadvantages—both have been widely discussed. However, disputes on whether the European welfare state is a good or bad idea have become less relevant since the demographic dividend that used to fuel the institutions of the welfare state has disappeared. Having fewer resources, Europeans must spend less. In order to adjust to the new situation it is crucial to rethink the essence of social goals, to explain conclusions to the public, and to then neutralise certain elements of social models in order to withdraw them from political bargaining and downsize them. All this is necessary in order to save the social models, which have become overused. Not having the demographic dividend available, politicians have had to increase the burden put on production factors, reducing net remunerations. European social models still have a lot of potential for the future. If they focus on the key social goals and are of a reasonable scale then they will once again contribute to higher productivity and competitiveness among European economies.
Introduction
The current difficult situation in Europe is commonly perceived as a crisis, part of the worldwide financial and economic one. In fact the situation is worse. A crisis has an optimistic component—it eventually ends. However, the recent crisis has also triggered a downward shift in welfare, from which it will probably not recover. This shift stems from the eventual loss of the illusion that twentieth-century institutions can remain unchanged now that the demographic dividend that fuelled them has disappeared.
The dividend used to be generated within a financial pyramid as each subsequent generation of the population was significantly larger than the previous one. As in a Ponzi scheme, it was easy to generate income ‘from nothing’. 1 Running large deficits, both explicit and implicit, did not lead to any substantial economic or social problems, and paying debts back was easy since repayment was spread over a constantly increasing number of tax/contribution payers. This was the basis for financing European social models, in other words, the welfare state.
Today few people remember Ponzi but many remember Madoff.
A Ponzi scheme is illegal if it is run by a private person or firm—and there are good reasons for this. However, government-run institutions designed in a similar way are completely legal. Yet, the same reasons for caution also apply to them. We are now living at a time when government-run financial pyramids have not yet collapsed in cash terms but have already collapsed in actuarial terms. In order to keep them alive, benefits need to be reduced or the cost of participation (contributions/taxes) needs to be increased. This applies not only to pension systems but to the whole of public finance. 2
Pension systems are most exposed to the collapse of the Ponzi scheme.
This is the familiar landscape of the world (but mostly Europe) now that the demographic ‘Santa Claus’ has passed away. Santa kindly used to pay the bills of our social welfare systems, but since his demise we must pay the bills ourselves. There are not and will not be enough resources to do this, which means that the great idea of the European social model is exposed to huge risk. The European economies and their competitiveness are also exposed to risk, since to develop they need well-remunerated workers and innovative technologies. Both require proper financing, which is impossible since the resources are locked in an attempt to hide the loss of the demographic dividend.
Remuneration of production factors versus financing transfers
There are many controversies surrounding the idea of the welfare state. 3 However, they mostly refer to the past when the demographic dividend was still at the disposal of European governments. 4 Nowadays, irrespective of whether the idea was right or wrong in the past, societies do not have the resources to maintain the welfare state in its twentieth-century form. In the past the cost of servicing the growing aggregated debt was spread among the growing population of active citizens (workers and entrepreneurs). However, today the cost of servicing the still-growing debt is spread among a shrinking population of active contributors. 5 A new approach is needed. 6
There is a long list of pros and cons regarding the concept of the welfare state—see Atkinson (1999), Barr (2001), Lindbeck et al. (1994) and Ringen (2009).
For a broad picture of the good ideas and their implementation in the twentieth century, see Jude (2012).
An analysis of the availability of resources for financing the welfare state goes beyond the scope of this paper. See, for instance, European Commission (2009).
For a discussion of new challenges, see Esping-Andersen (2002).
We all have to live on the current gross domestic product (GDP), so the essence of the problem is how to divide its value between various goals. 7 The two main goals are remunerations and transfers (in both cases in a broad sense), thus the real choice we face is how to divide the GDP between these two items. It is a difficult task.
I use the term GDP throughout this article, despite the fact that it is often criticised. In this context its criticisms are irrelevant as it is used to mean any measure of the outcome of a working society.
On one hand we have a socially devastating extreme, that is, no transfers at all. This is hard to imagine. On the other is pure communism (people working without any remuneration but being given everything for free according to set rules). The latter extreme would be as socially devastating as the former. Thus we have to seek an optimum balance between Scylla and Charybdis. In public debate there is a hidden contest about which extreme would be less devastating to society. 8
One of the extremes is often advanced as ‘evil’, giving the proponents of the other the chance to promote their views.
There is no analytical method we could apply that would be unquestionable and commonly accepted. In practice we can apply methods of public choice, but unfortunately any outcome of public choice is constantly affected by demographic developments. Whatever is decided today will cease to be close to the social optimum tomorrow because of the changing proportions of those who work and should be remunerated, and those who do not work and receive transfers. This is complicated even further if we take into account that in many cases those who are active as workers are also transfer recipients. In fact, societies are trapped in the constant demographic bias of a public decision taken many decades ago. For various—mostly political—reasons, instead of a constant adjustment following societal and population developments, we can observe an almost entirely frozen outcome as the result of very ‘ancient’ decisions.
One could say that the rich should pay for transfers to the poor, and it is easy to agree with this. However, this does not solve the problem that we have, namely the loss of the demographic dividend. As an entire society, the rich, the poor and those in between, we have fewer resources than we would have had if the population structure in terms of age had remained similar to that observed many decades ago. 9 The ‘golden age’ of welfare without work is over.
Issues related to fair distribution of welfare go beyond the scope of this paper.
On top of the above, it is worth noting that traditional oppositions, such as the rich versus the poor or capital versus labour, have been supplemented with a new one, namely the economically active versus the recipients of benefits. This opposition has recently become significant. The economically active are now becoming increasingly underpaid due to the need to fund transfers.
Rethinking goals, changing methods
Europe has a great heritage of social models supporting both economic growth and social development (Barr 1992). At the same time, Europe cannot afford to finance these models on their current scale. The cost of running the institutions is already very high and is projected to increase substantially in the decades to come (European Commission 2009, 2012); these costs must be borne by the working generation. By generating positive outcomes the institutions also generate increasing costs, thus reducing the competitiveness of European economies. Inevitably increasing costs will strengthen the latter and undermine the former.
It looks as if there are just two options. The first one is to simply ‘keep the values’ and try to hide the costs. The longer this option dominates in Europe the higher the cost of the eventual collapse. In the mean time, the competitiveness of European economies will incrementally decrease vis-a-vis the rest of the world. The second option is to ‘give up the values’ and try to become as efficient as the new powers. Is this possible? Maybe. Will it be a success? I rather doubt it.
Are we caught in a trap between these two undesirable options? Hopefully not. One solution is to rethink the real meaning of the values. For instance, retiring workers in their sixties and paying them benefits financed by the younger generation—is this really a social goal that corresponds with the values behind the European social models? The value is to support the very old, which—given current and projected longevity and health—corresponds to helping people in their late seventies and eighties. If Europeans are able to take this into account and adjust regulations within the pension systems then huge resources will be unlocked. This funding will then become available for the greater remuneration of labour and/or for investment in fields such as education, research and development, poverty alleviation and so on. The retirement age adjustment is only one example of possible changes to the institutional infrastructure. 10 A full analysis of the possibilities goes beyond the scope of this paper. In principle we can say (travestying Talleyrand) that a lot must change in order to preserve the European social models.
For more discussion on the retirement age and the need to increase it, see Guillemard (2005).
This is easy to say, but difficult to implement. However, it is worth trying. The social models developed in Europe have a lot of potential for the future. They are the great idea; the pipe work has simply become slimed and blocked through overuse. Europe can preserve its social model and become competitive again if (a) the scale of the burden it generates for the working part of societies is reduced, and (b) the real meaning and relative importance of its goals is rethought. When these two goals are achieved then the social models will again increase the strength of European economies rather than create a burden.
Redistribution via the budget is already carried out on a large scale. It will be even larger when societies have to repay debts that are currently still hidden and not presented in official statistics. The real problem is not just the current scale of redistribution, but its tendency to increase. While spending more on transfers we have no choice but to reduce remunerations in terms of GDP. By doing this the interests of the working population are neglected. Their remuneration is not only an incentive to work but also a social goal.
In order to preserve social models and become competitive again, Europe has a number of reform options. The largest single item on the list of expenditure via the state budget is old-age pensions. People in their sixties are now no longer old, yet they receive benefits, while new entrants to the labour market are underpaid or cannot even find a job (Góra 2008).
It is worth noting here that the ‘Occupy’ protestors who appeared in many places in 2011 are a part of the story. At first glance they are protesting against the ruthless behaviour of the financial markets and governments, whom they blame for their situation. The young protestors are unable to enjoy such good opportunities at the beginning of their adult lives as their parents had. Jobs—if available—are not well paid, usually only temporary and do not offer even basic social protection. Moreover, there is little hope that the situation will improve soon. Why is this? The demographic dividend has vanished and the whole of society is less affluent. However, older workers cannot have their various social privileges taken away for legal and political reasons. The situation of this social group, which is already rooted in social institutions, is virtually unchanged. It is the young that are weak; they have simply not been given the privileges. Even if they do not know it, the young are protesting against the loss of the demographic dividend and the unfair distribution of the cost derived from this loss. The downward shift of welfare should be generationally more just. A downsizing of the scale of social models is needed in order to offer the young an acceptable standard of life. The welfare of the young should be treated as seriously as the welfare of older generations.
The politics behind the problem and the possible options
Politics is inevitably involved in providing people with welfare. Politicians win elections if they are credible in promising welfare improvements. Unfortunately, responsible politicians should today tell people the truth, that is, they should state that it is most probable that the amount of traditionally understood welfare will shrink in the future. However, after such a statement—given their ‘terms of reference'—they would almost certainly be sacked immediately and, at the very least, their ratings in opinion polls would fall substantially. 11
Note, for instance, the case of the Swedish prime minister, who said that the retirement age in Sweden should be increased to 75 years.
The problem with political ‘terms of reference’ is that they address a relatively short time span, namely a couple of years, while the horizon that matters for people is a couple of decades. Even optimal decisions taken within the political time span do not necessarily correspond to the social optimum, which requires politicians to take into account not only today but also tomorrow. Democracy remains the best of the available political systems but does not solve this ‘time inconsistency’ problem, which is particularly challenging now, after the change in the welfare growth trend following the loss of the demographic dividend.
Public education can help a lot in reducing the problem. While leaving this issue to another study, it is worth noting here two hints that might help. The first is to stop using the terms ‘state’ and ‘budget’ when referring to financing social goals in public debate. These terms are commonly used as useful shortcuts. Unfortunately, their use confuses public perception, resulting in them often being understood as an incarnation of Santa Claus. While the state cannot finance anything via its institutions, it can enable society to produce public goods. It can organise and supervise the financing of goals by the active population, as, in fact, we already know. However, when it comes to formulating views on social issues we often forget such obvious things. Consequently, the public is generally against reducing the generosity of social systems, even if such reductions are focused on expenditure on policies that are not crucial to fulfilling any social goals.
Given politicians’ terms of reference in democratic countries, it looks as if once we increase expenditure we cannot reduce it unless there is a real financial disaster. In the case of social models this increase was partially unintentional, but the damage was done automatically as a result of the ageing population. This, however, does not change the essence of the problem.
A mechanism that goes beyond politics is needed to bring back some control over the division of GDP between remunerations and financing transfers. The time inconsistency makes the existing democratic procedures ineffective. The mechanism was sufficient when the population was growing, but it is insufficient now that this trend has changed. The goal is to extend the democratic mechanism in a way that will allow long-term and possibly undesirable developments to be taken into account. The ability to choose such extensions is on the way. For instance, the Stability and Growth Pact (SGP), some early steps towards fiscal integration in Europe, and the increasingly discussed idea of establishing fiscal boards at the national level will bring long-term issues into political systems.
There is also another option, namely an automatic adjustment instead of a discretional one. This would lead to the neutralisation of the elements of social models that do not contribute to social goals. European societies spend a lot on pensions paid to the not-yet-old while old-age care is commonly underfinanced. A possibly fruitful solution to this problem could be the reform of pension systems along the lines of the Swedish and Polish systems, which are based on the full individualisation of participation and the iron rule that the present value of benefits is equal to the present value of contributions. Such a system plays the role of an automatic stabiliser, 12 leading to the ‘neutralisation’ of the mandatory pension system and leaving redistribution and help for the very old to tax-based systems. This could really unlock the huge resources bound up in pension systems without any loss to our ability to reach social goals. Neutralisation is possible only in selected areas, such as the old-age pension system. However, as that system is the largest, it matters most for public finance.
This should not be confused with the privatisation of the systems. For a detailed discussion of the approach, see Góra (2003).
Conclusions: rethink, explain, neutralise and downsize to save
The European Union is still a project in progress. Much has already been achieved, but the final shape of the Union has not yet even been designed. Further development of the project will continue in tough times. We face a mixture of various global problems and population ageing. The latter is very advanced in Europe, which makes the situation of the Union difficult vis-à-vis the rest of the world. If we just try to protect what we have already achieved, without continuing the intellectual, organisational and political efforts to design and create a truly advanced Union, then many or all of the achievements will be lost.
If we try to preserve the social models in Europe in their current shape we expose the goals of these models to the risk of being totally given up when the accumulated debt exceeds a certain level. Furthermore, this level cannot be precisely predicted. It is certain, however, that there must be a real limit to the spending of non-existent resources. This is perfectly understood with respect to the explicitly accounted for amounts. The aim of the SGP is to prevent the Union from reaching this limit. However, social institutions are commonly financed in a way that is not explicitly accounted for. In such cases the current version of the SGP cannot provide much help. Should European accounting standards be modernised? Should the SGP be extended in order to cover the finances of social models’ institutions? Yes, they probably should. 13
Further discussion of these issues can be found in Góra (2011).
Population ageing is one of the most often used expressions in public debate. Not only experts but a growing part of the public understands that the ageing population is the factor most strongly affecting our social life. Rationally we know we need new ideas and methods, but intuitively we are still dreaming about restoring the ‘good old times’ when welfare was a form of gift from ‘the state’ rather than the result of our own hard work. The public discussion is still looking to the past.
The theoretical background for our view of the welfare state was developed at a time when a large demographic dividend was available. This means that we need to have a thorough rethink of our social system. We still have the same goals, but many of the methods used to achieve them now need to be exchanged for newly designed ones.
In addition to a change of methods, we should also rethink the terms of reference for politicians in democratic states. The time inconsistency built into their terms of reference was much less distortive in the past. Nowadays time inconsistency makes taking the steps needed to reform European societies very difficult.
The longer Europeans postpone the acknowledgement of the truth, the more socially costly will be the eventual collapse of the illusion that welfare state institutions can be run on nothing. Europe is less affluent than we tend to perceive it as. Welfare is not given forever. There is no choice but to work for welfare in the future. The basis of the great European heritage and the establishment of forward-looking social institutions designed with the loss of the demographic dividend in mind will help with the acceptance and implementation of this.