VARIATIONS ON THE WELFARE STATE in Longitude gennaio

VARIATIONS ON THE WELFARE STATE

Giuseppe Pennisi

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 piece meal changes to the twenty years 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 of the European welfare state model, 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 (BollatiBoringhieri, 1997) if 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 un 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 now 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 euro area wants to wake up from a long lethargy and become dynamic. In a future Transatlantic Partnership, there is no room for 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 Inci Otker Robe (IMF) and Anca Maria Podpiera (World Bank) – The Social Impact of Financial Crises- Evidence from the Global Financial Crises , World Bank Policy Research Working Paper No. 6703-  the financial crisis that has hit the world economy since  2008 has transformed the lives of many individuals and families, even in advanced countries, and especially in Europe where millions of people fell, or are at risk of falling, into poverty and exclusion. For most regions and income groups in developing countries, progress to meet the Millennium Development Goals by 2015 has slowed and income distribution has worsened for a number of countries. Countries hardest hit by the crisis lost more than a decade of economic time. As the efforts to strengthen the financial systems and improve the resilience of the global financial system continue around the world, 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 risk management 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 risk management into the growth and development agendas; establishing contingency planning mechanisms 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 book very popular in the nineteen eighties- , there is not the lack of care in management of public finance and the little resistance to pressure groups claiming shares of public funds. The European fiscal crisis of the State has much deeper roots:

a)     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 grew at very sustained rate, whilst the rest of world continued to stagnate around mere substance level  (as it had done for millennia) because the key to technological progress in mechanics, electricity and other forms of power was in the hands of a very few group of countries. This changed during the nineteen nineties when due the Information Technology and the improved level of education in emerging countries, the monopoly was broken.

b)    In parallel, since 1830 or thereabout, political power and colonialism implied a real annual transfer of resources estimated by the late economist Enzo Grilli (who worked both for the IMF and the World Bank) of some $ 20-30 billion p.a. . The transfer was made almost entirely through terms of trade favorable to North America and Europe, as I documented in a book published way back in 1967.

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 century has lost its steam and more lately has vanished. Thus, a major world economy structural adjustment is taking place since the mid nineteen nineties. It entails the world structure of production, income, investment, 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 significantly within the euro zone, countries have shown very different capabilities to make the necessary changes, even because they welfare states had evolved in very differing ways in the last two centuries.

When Europe and North America (and a few other counties) 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 to mitigate market 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 of Western European pension and welfare 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 recipients’ status, normally their occupation.

·        In terms of financing there are systems financed almost entirely by general taxation and there are those financed mostly by contribution from workers (as future retirees) and their employers. More important, some welfare 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 funded mechanisms that pay benefits using proceeds from capital 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..

FOUR PATTERNS OF WELFARE AND PENSION SYSTEMS IN EUROPE

Eligibility	Benefits	Financing	Administration
Scandinavian Countries
Universalistic	High	General taxation	Central Government
Ireland, United Kingdom
Universalistic	Low (but can be increased)	Taxation and contribution	Central Government
Benelux, France, Germany, Italy
Occupational	High	Payroll contribution	Intermediate bodies
Portugal and Spain
Corporatist	High (only for certain categories)	Taxation and contribution	Intermediate bodies

    Most Western European welfare and pension systems have evolved into mixed systems with varying elements of all these features and of defined contribution and defined benefit, funded and unfunded, and actuarial and non-actuarial components. Pension reforms in Sweden and Italy show how a 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 NdcNDC  (Notional Defined Contribution) couple with a funded pillar could go a long way towards reducing these differences and even pave the road towards a EU pension system with 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 of work or throughout the working 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 is way it called ‘notional’)

In almost all countries of the EU, the bulk of the welfare expenditure concern the pension systems. Many systems where conceived when ‘the risk’ of becoming old were quite small because life expectancy was short; thus, pensions were thought as 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 few decades the EU in general and Western Europe in particular will 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 nineteen seventies . 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 ratio was just over 25 percent; by 2050 it will be more than 50 percent. 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 few years ago only demographers and economists were seriously concerned by these developments. But now public perceptions of their implications for pension systems are widening and deepening in the civil society as a whole as well as among politicians.. Because most existing systems are public ‘pay- as -you –go’ schemes (i.e the current working generation pay the checks for the retirees), a majority of Western 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 in Western European countries. But few people stay in the labor market until the statutory age, with most retiring between the ages of 56 and 60. On average, Western Europeans spend twenty years in retirement, up from thirteen years in the 1960s. Another obvious response to rising life expectancy would 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 fifteen years,  many Western European countries have embarked on pension reform, and the related challenges have led to lively debate. Recently a few Ggovernments – 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 age will be periodically adjusted to changes in general life expectancy of the population.

A common but rarely studied philosophical trend underlies the shift from the social welfare theory to the contractual approach in pensions and other aspects of  welfare.  Whereas the social welfare 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, individual are free to pursue their own ends. In pension and welfare policies this implies an emphasis on greater freedom of choice about contribution levels and future benefits, retirement age, risk diversification between two or more pillars, and the coverage ratio of retirement benefits relative to income in the last few years of working life. This also entail s more extended private participation by individuals, families and corporations in providing welfare through private efforts (ei participation to private pension plans and to complementary health programs as well as to unemployment insurance). In Italy, there are some 700 different pension funds; there a clear need for concentration and merger to reach a number similar to those in other EU countries (rarely more than 50 per country) so as to provide for larger, stronger and more diversified protection. Also recently, in November 2013, the Italian Economic Club (Club dell’Economia) awarded to the former Minister of Labour 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, how to improve efficiency and how to shift from curative to preventing care: it is appalling that nearly two third 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 beating the wrong bush because, as shown above, the differences mirror very profound historical path; society are as ‘path dependent’ as individuals . A more promising route would be to try to attempt to  learn from each other: the NDC pension system is a good example because it was initiated, separately , by two very different countries (Italy and Sweden) and now is applied , in various versions and at different stages, by a dozen EU countries. Many EU countries have to learn from labour market reforms applied in Austria and Germany. Overall harmonization, however, would be beneficial in two areas: i) general financial constraints and ii) the avoidance of discrimination (i.e by gender, sexual orientation).

The road to change the UE welfare model (and its diverse systems) is likely to be long and hard. But it is likely to be successful if the EU follows a strategy along the lines summarized above.