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Cover story
In 2014, two major negotiations will be closely intertwined
in their respective agendas: a) the revision
of the European Monetary Union (EMU) already
started with a number of piecemeal changes to
the 20-year-old Maastricht Treaty; and b) the beginning,
hopefully, of the international operational discussions
on the establishment of a Transatlantic Partnership
and the drafting of a pertinent Agreement.
Each of them will have an impact on the European
welfare statemodel, which is now based on a high level
of taxation to finance, by and large, an extended income
support system. Fifteen years ago, a well-known
Italian economist Pier Luigi Ciocca (then Deputy Director
General of the Bank of Italy) raised a very pertinent
question in the foreword of the collective book
Disoccupazione di Fine Secolo concerning whether
Europe could remain competitive in the world area
with a tax pressure equivalent to 42%of GDP when in
North America, Japan and Australia, the tax pressure
is around a third of GDP and in the new emerging
countries is about one forth. In the last decade and a
half, the situation has not improved; i.e. in Italy today
the tax pressure approaches 48% of GDP. European
competitiveness has dramatically slowed down in all
European countries that have not implemented drastic
reforms. An updating and a revision of the Maastricht
Treaty is required if the eurozone wants to wake
up froma long hibernation and become dynamic. In
a future Transatlantic Partnership, there is no roomfor
major differences in tax pressure and welfare cost.
Italy may have an important role in both negotiations
because in the second semester of 2014, it chairs
the European Union (EU) Council and associated
bodies.
No doubt, as recently purported in a joint paper by
InciOtker Robe (IMF) and AncaMaria Podpiera (World
Bank), The Social Impact of Financial Crises – Evidence
fromtheGlobal Financial Crises, the financial crisis that
has hit theworld economy since 2008 has transformed
the lives of many individuals and families, even in advanced
countries, and especially in Europewheremillions
of people fell, or are at risk of falling, into poverty
and exclusion. Formost regions and income groups
in developing countries, progress to meet the Millennium
Development Goals by 2015 has slowed and income
distribution hasworsened for a number of countries.
Countries hardest hit by the crisis lostmore than
a decade of economic time. As the efforts to strengthen
the financial systems and improve the resilience of
the global financial systemcontinue around theworld,
the challenge for policy makers is to incorporate the
lessons from the failures to take into consideration
the complex linkages between financial, fiscal, real,
and social risks and ensure effective riskmanagement
at all levels of society. The recent experience underscores
the importance of systematic, proactive, and
integrated risk management by individuals, societies,
and governments to prepare for adverse consequences
of financial shocks;mainstreaming proactive riskmanagement
into the growth and development agendas; establishing
contingency planningmechanisms to avoid
unintended economic and social consequences of crisis
management policies and building a better capacity
to analyze complex linkages and feedback loops
between financial, sovereign, real and social risks;
maintaining fiscal room; and creating well-designed
social protection policies that target the vulnerable,
while ensuring fiscal sustainability.
However, at the origin of the Fiscal Crisis of the State
– to borrow the title of a James O’Connor’s very popular
book in the 1980s, there is no lack of care in management
of public finance and little resistance to pressure
groups claiming shares of public funds.The European
fiscal crisis of the state hasmuch deeper roots:
Since 1830 (when, according to Angus Madison’s
life-long painstaking statistical work, India and China
had 43% of world GDP), Europe and North America
grewat a very sustained rate,while the rest ofworld continued
to stagnate around mere substance level (as it
had done formillennia) because the key to technological
progress inmechanics, electricity and other forms
of powerwas in the hands of a group of very fewcountries.
This changed during the 1990s, when due the Information
Technology and the improved level of education
in emerging countries themonopolywas broken.
In parallel, since 1830 or thereabout, political power
and colonialismimplied a real annual transfer of resources
estimated by the late economist Enzo Grilli
(who worked both for the IMF and theWorld Bank) at
some $20-$30 billion per annum. The transfer was
made almost entirely through terms of trade favorable
to North America and Europe.
These two determinants fueled growth and allowed
income redistribution within North America and Europe
(as well Australia, Japan and New Zealand). But
they have been a phenomenon that after nearly two
centuries has lost its steam and lately has vanished.
Thus, amajorworld economy structural adjustment is
taking place since the mid-1990s. It entails the world
structure of production, income, investment, and savings.
North America and the countries of the antipodes
have shown great ability in adjusting to the new context.
Within the European Union, and more significantlywithin
the eurozone, countries have shown very
different capabilities when it comes to making the
necessary changes, even because their welfare states
had evolved in very differing ways in the last two centuries.
When Europe and North America (and a few other
countries) had the monopoly of technical progress
and consequently high growth rates, welfare systems
provided insurance against risks of becoming unemployed,
disabled, poor, old and the like. Philosophically
these welfare systems rested on social welfare theory,
a consequence-based (or consequentialist) approach
geared toward formulating and implementing corrective
actions tomitigatemarket failures and other societal
imperfections.
Each pension and welfare system is the result of a
delicate balance of economic, social, and political power.
Worldwide, pension systems are broadly classified
as based on defined contributions or defined benefits,
funded or unfunded, and actuarial or non-actuarial. A
more specific taxonomy is used to depict the principal
features ofWestern European pension andwelfare systems
as they were originally designed.
In terms of eligibility there are universal systems
where, subject to certain criteria, all citizens (or residents)
of a country are entitled to basic welfare and
pension coverage, often based on a flat rate element
complemented by an earnings-related component,
and particularistic, occupation-based systems where
welfare and pension mechanisms are tied to the recipient’s
status, normally their occupation.
Variations on
the welfare state
Europe has no choice but to change its welfare model.
A look at the variety of models already in place and the
factors that will change in the future can allow
governments to adapt according to their citizens’ needs.
An illustration made
with a gurine set up
on a salary slip to
illustrate the French
CSG (Contribution
Sociale Generalisée)
tax.
JOEL SAGET/AFP/GETTY IMAGES
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e year of Europe
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Cover story
In terms of financing there are systems financed almost
entirely by general taxation and there are those financed
mostly by contributions from workers (as future
retirees) and their employers. More important,
somewelfare and systems are based on pay-as-you-go
mechanisms where current benefits are paid out of
current revenues (contributions) and the general exchequer,
while others rely on fundedmechanisms that
pay benefits using proceeds fromcapital accumulation.
In terms of administration, some systems are centrally
run by the public service and some are highly decentralized
to other public or semi-public institutions,
often operated as autonomous agencies under boards
and management committees representing workers
and employers.
MostWestern European welfare and pension systems
have evolved intomixed systemswith varying elements
of all these features and of defined contributions
and defined benefits, funded and unfunded, and
actuarial and non-actuarial components. Pension reforms
in Sweden and Italy showhowa universal system
(Sweden) and a particularistic, occupation-based system
(Italy) have evolved into mixed systems and
changed, nearly in parallel, their pay-as-you-go defined
benefit pillars into partly funded actuarial and defined
contribution pillars. Significant institutional differences
across countries will likely remain important
for the foreseeable future, but gradual reforms towards
NDC (Notional Defined Contribution) couple with a
funded pillar could go a long way towards reducing
these differences and even pave the road towards an EU
pension systemwith a growing private leg (based on individual
pension savings plans). The NDC system has
been pioneered in Italy and Sweden: pension payments
are based not on salary received in the last few
years ofwork or throughout theworking life, but on the
workers and employers contributions to the pension
system, updated on the basis of formula related to
GDP and cost of living growth (this way is called ‘notional’).
In almost all countries of the EU, the bulk of the
welfare expenditure concerns the pension systems.
Many systems were conceived when “the risk” of becoming
oldwas quite small because life expectancywas
short; thus, pensions were thought to be an insurance
against such a risk for the few that reached old age, to
be paid by the many who never became old. Over the
next fewdecades the EUin general andWestern Europe
in particularwill face a significant acceleration in ageing
due to the “baby boom” generation reaching retirement
age, continued increases in life expectancy,
and decreases in fertility, especially since the early
1970s. Together the large cohort reaching retirement
age and rising life expectancy will cause a doubling of
Western Europe’s old-age dependency ratio (defined
here as the number of people 65 and older as a percentage
of those 15–64). In 2000 this ratiowas just over
25%; by 2050 it will be more than 50%. Even if the average
fertility rate were to gradually increase, it would
not be sufficient to counter a projected reduction in the
EU population starting around 2020. As a result, public
spending on pensions is projected to increase considerably.
Until a fewyears ago only demographers and economists
were seriously concerned by these developments.
But now public perception of their implications
for pension systems arewidening and deepening
in the civil society as a whole as well as among politicians.
Because most existing systems are public “payas-
you-go” schemes (i.e. the current working generation
pay the checks for the retirees), amajority ofWestern
Europeans are taking pessimistic views of their future
public pension entitlements and of the difficulties
they will have in living on foreseeable retirement incomes.
An obvious policy response to rising life expectancy
would be to raise the retirement age which typically
stands at 65 inWestern European countries. But few
people stay in the labormarket until the statutory age,
with most retiring between the ages of 56 and 60. On
average,Western Europeans spend 20 years in retirement,
up from13 years in the 1960s. Another obvious
response to rising life expectancywould be to develop
fully funded pension pillars, private or public. But the
heavy burden of employer and employee contributions
to “pay-as-you-go” schemes leaves little room
for the savings required for
funding, especially during the
transition phase. Also the NDC
systems are “pay-as-you-go” for
several years to come, but they
have an “automatic pilot” in
their design whereby in a couple
of decades pension payments
ought to be in line with
contributions.
Over the past 15 years,many
Western European countries
have embarked on pension reforms,
and the related challenges
have led to a lively debate.
Recently a few governments
– most importantly the
German and the British governments
– have indicated the
intention of proposing to Parliament
a gradual increase of
the statutory pension age from
65 to 67 years of age. Italy has
introduced a system whereby
the pension agewill be periodically adjusted to changes
in general life expectancy of the population.
A common but rarely studied philosophical trend
underlies the shift fromthe socialwelfare theory to the
contractual approach in pensions and other aspects of
welfare.Whereas the socialwelfare theory approach focuses
on outcomes – the consequences of policies and
programs – the contractual approach seeks to get “institutions
right” through appropriate procedures
where, given ethical constraints, rights protection, and
fair rules of the game, individuals are free to pursue
their own ends. In pension andwelfare policies this implies
an emphasis on greater freedomof choice about
contribution levels and future benefits, retirement age,
risk diversification between two ormore pillars, and the
coverage ratio of retirement benefits relative to income
in the last fewyears ofworking life.This also entails
more extended private participation by individuals,
families and corporations in providing welfare
through private efforts (i.e. participation in private
pension plans and complementary health programs as
well as unemployment insurance). In Italy, there are
some 700 different pension funds; there is a clear need
for concentration andmerger to reach a number similar
to those in other EUcountries (rarelymore than 50
per country) so as to provide for larger, stronger and
more diversified protection. Also, inNovember 2013 the
Italian Economic Club awarded to the formerMinister
of Labor and Social Affairs a special prize for the best
economic idea in many years: the introduction of a
compulsory unemployment insurance because the
country did not have one and unemployment allowances
were very low and last only a few months. In
the field of health, in all EU countries is, albeit to different
degrees, the key issue is how to improve efficiency
and how to shift from curative to preventative
care; it is appalling that nearly two-thirds of health research
and development expenditures concerns diseases
related to the last six months of life.
The EU is generally criticized for not moving forward
fast enough in the welfare systems. If this applies
to the attempts to harmonize long established systems,
such a strategy would be wrong because, as
shown above, the differences mirror a very profound
historical path; societies are as “path dependent” as individuals.
Amore promising routewould be to try to attempt
to learn fromeach other: the NDC pension system
is a good example because it was initiated, separately,
by two very different countries (Italy and Sweden)
and nowis applied, in various versions and at different
stages, by a dozen EUcountries.Many EUcountries
have to learn fromlabor market reforms applied
in Austria and Germany.Overall harmonization, however,
would be beneficial in two areas: a) general financial
constraints and b) the avoidance of discrimination
(i.e. by gender, sexual orientation).
The road to change the EU welfare model (and its
diverse systems) is likely to be long and hard. But it can
be successful if the EU follows a strategy along the
lines summarized above.
Elderly visitors are
dancing a senior
citizens convention in
Hamburg, Germany.
Universalistic High General taxation Central Government
Universalistic
Low but can
be increased
Taxation and
contribution
Occupational High
Payroll
contribution
Intermediate
bodies
Corporatist
High only for
certain categories
Taxation and
contribution
Intermediate
bodies
Source: G.Pennisi - Longitude
Central Government
SCANDINAVIAN
COUNTRIES
IRELAND
U.K.
BENELUX
FRANCE
GERMANY
ITALY
PORTUGAL
SPAIN
ELIGIBILITY BENEFITS FINANCING ADMINISTRATION
JOERN POLLEX/GETTY IMAGES
FOUR PATTERNS OF WELFARE AND PENSION SYSTEMS
IN EUROPE
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! is a professor at Università Europea di Roma.
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