A Crisis in the Making; N. Elliott

Comprehensive welfare states have be come standard across Western Europe since 1945, providing-variously- unemploy ment benefits, sick pay, disability benefits, maternity benefits, child care, health care, and pensions. In the early stages it appeared Mr. Elliott is a financial journalist in London, England. affordable to extend these benefits, paid for by young taxpaying populations. However, there was always a fine line. Sweden illustrates the economic conse quences of unrestrained welfarism. From 1960 to 1990, as an extensive welfare state was erected, government spending grew from 31 percent of Gross National Product to 60 percent. But the increase in taxes required to pay for this blunted incentives disastrously. For instance, because of higher taxes, real after-tax wages for Swed ish industrial workers fell 0.6 percent from 1980to 1987despite a 72 percent increase in gross wages.2 As a result, Sweden has tumbled from being the third wealthiest in 1970 to 12th place among rich countries, reflecting an average growth of only 1.1 percent in the past 20 years. The government of Carl Bildt was elected in 1991 with a program of welfare reform to restore the economy.

Pensions and Aging The largest spending increases in welfare states have been on pensions, and without reform the future costs are potentially ex plosive. Only about a quarter of the increase in pension spending among Organization for Economic CoOperation and Development (OECD) countries between 1960 and 1984 was due to aging populations; the rest re sulted from widened entitlements and larger 505 506 THE FREEMAN • SEPTEMBER 1994 benefits. 3 Because such a major aging isnow underway, this largess will have to be re versed. Greater longevity means that by the mid dle of the next century there will be 190 million over-65s in the OEeD, up from 61 million in 1960.The disparity this will cause between earners and pensioners is high lighted by the age-dependency ratio, which shows the number of over-65s in proportion to 15-64 year-olds. This is set to rise from 19 percent in 1990to 28 percent by 2020and 37 percent by 2040.4 To give some individual examples, the over-60s made up 11.75percent of the Brit ish population in 1961,but that's expected to rise to 22.44 percent by 2011 and 26 percent in 2026. At the same time, the proportion of 15-64 year-olds-roughly speaking those of working age-is forecast to drop from 65.3 percent in 1990 to 62.3 percent by 2026.5 Similarly, in Germany the proportion of 15-64 year-olds is forecast to fall from 69 percent of the population in 1990 to 67 percent in 2011 and to 64.5 percent in 2023, while the portion of over-65s is projected to increase from 14.94 percent in 1990 to 20 percent in 2011 and 23 percent in 2023.6 The fiscal stress of this aging will be exacerbated by some pension schemes reaching maturity-paying out the maxi mum benefits-around the time that the number of pensioners peaks. When pension funds are first established there are many contributors and few claimants, but as time goes on there are fewer payers and more recipients. For example, Britain's State Earnings Related Pension Scheme (SERPS) will mature in 2020.

Many government schemes are unfunded; they are simple transfers from the young to the old. Whereas funded schemes can be managed with a view to future liabilities, unfunded schemes are laid bare to the rav ages of demographic swings. Also, older people make greater demands on health care, which adds to government spending where the system is publicly op erated. For example, the over-75s cost Brit ain's National Health Service nine times as much each year as 16-64 year-olds.7 The Necessityof Reform There is a crisis in the making across Europe, to which most governments are now alert. The extent of their reforms now consisting principally of reducing govern ment entitlements and encouraging private provision-will be a key determinant of economic growth in years to come. Several countries have raised the age at which government pensions are paid. The British government recently announced that the pensionable age for women, currently 60 years, will be raised to 65, equal to that of men. The Italian government plans to raise the pensionable age from 60 years to 65.

Bildt's government in Sweden intends to raise it from the current 60 years to 61. In France the government plans to lengthen the period over which contributions must be made to qualify for a full pension. Outside Europe, Japan's pension age for women will be raised in the year 2000 from the present 60 years to 65, equal to that of men. The u.S. government took a similar step in 1983, scheduling a gradual increase in the pension age, from 65 to 67 years, beginning in the year 2003. Another move has been to encourage opting-out of government pensions into pri vate plans. The British government did this with SERPS in 1988, prompting 4.5 million to exit the government scheme. This shrink agein membershipof the government scheme should greatly curb any increased costs to the taxpayer arising from its maturing. The most significant reform is to update pensions with prices rather than incomes, as earnings typically outpace prices over time.

The U.K. did this in 1980,and France did so in 1984. A British government actuarial report estimates that tax rates would have to be eight percentage points higher by 2030 if pensions had continued to be linked to earnings rather than prices. 8 Differences in welfare burdens and in the rigor of reforms among the countries of Europe are already being reflected in their respective economies. Despite the demo graphic trends described above, Britain is in a relatively good position; her reforms will A CRISIS IN THE MAKING: EUROPE'S WELFARE BURDEN 507 contain future costs. Also because much of the aging of her population has already occurred, the size of the emergent mismatch won't be as great as in other countries. The age dependency ratio is set to rise by 31 percent in Britain by 2040, as compared with 66 percent in the United States and 73 percent in Germany.9 By contrast, Germany's welfare costs are potentially explosive, with the admittance of new claimants from the former East Germany, placing further strains on a sys tem that was already bloated.

German government pensions are linked to earnings and the retirement age-58 years-is relatively low. Proposals to re form a sprawling system of welfare benefits are already meeting with vociferous protest: 100,000 building workers recently con verged on Bonn to object to plans to curb payments for being left idle by bad weather. The government may raise the pensionable age, but at the same time it is planning to extend government nursing care. Welfare costs are recouped in Germany through taxes on employers and employee earnings, not through general taxation as in Britain. As a result of higher welfare spend ing, these costs are expected to reach 40.2 percent of wages next year, up from 26.5 percent in 1970.10 With such a burden it's not surprising that 36 percent of western German industries are planning to relocate investment abroad in the next three years. 11 In the short term a welfare state may be an affordable luxury for a wealthy and pros pering country, but in some European coun tries wealth and growth have been dissi pated by the taxation needed to pay for it.

Maintaining a welfare state is not simply a question of producing the wealth and then redistributing it, because the process of redistribution itself hinders wealth creation. The extent to which this point is understood will determine whether or not Europe re mains a rich continent. It's an open question whether welfare reform will be far-reaching enough to restore economic incentives. Oth erwise some European countries risk be coming economic backwaters. D 1. See S. G. Warburg Securities, Weekly International Bond Market Review, November 25, 1993. 2. Peter Stein, "Sweden: From Capitalist Success to Welfare-State Sclerosis," Policy Analysis, Cato Institute, September to, 1991. 3. Organization of CoOperation and Development, "Reforming Public Pensions," OECD, Paris, 1988. 4. Financial Times, October 25, 1993. 5. Office of Population and Census Studies. 6. Federal Statistics Office. 7. Paul Johnson and Jane Falkingham, Aging and Eco nomic Welfare (London: Sage Publications Ltd., 1992),p. 133.

8. Cited in Johnson and Falkingham, op. cit., p. 142. 9. The Sunday Telegraph, November 28, 1993. 10. Financial Times, November 19, 1993. 11. Cited in Gerard Lyons, The Outlook/or the European Economies and Financial Markets in 1994,DKB International, November 1993. A Classic Reprint from FEE ... Essentials of Economics by Faustino Ballve S ubtitled A BriefSurvey of Principlesand Policies,Dr. Ballve's Essentialsof Economics is a concise, authoritative primer of economics written in language easily under standable by the intelligent layman. Dr. Ballve, a native of Spain, emigrated to Mexico in 1943, where he wrote Diez lec ciones de economia,which was subsequently translated into French as L' EconomieVivante. The English-language edition, translated by Arthur Goddard and published by Van Nostrand in 1963, was reprinted by The Foundation for Economic Education in 1969. In reviewing Essentialsfor The Freeman,John Chamberlain advised readers: "If you want instant enlightenment, Henry Hazlitt's Economicsin One Lessonis still the desired text. If you want enlightenment in great depth, there is Mises' Human Action. But if you are looking for something in the I in-between' catego~ Essentialsof Economicsis your meat."

109 pages, $9.95 paperback THEFREEMAN IDEASON UBERlY Are Women Exploited By the Free Market? by John Chodes T he recently enacted Federal CivilRights Bill once again tossed out one of the political hot potatoes of the 1990s:the issue of "equal pay for equal work." Many of the Congressmen who voted for this legislation believe that America's free market economy has always exploited women. They say that the only way for women to earn the same amount as men for the same or similarjob is to enforce more far-reaching regulations to equalize wages. A careful study of American economic history shows that such measures are not warranted. Beginning with the early 1800s, when wages and working conditions were completely uncontrolled, the free market was the one force that liberated women, via economic independence and merit wage parity. Women, the First Wage Earners For the first fifty years of the American Industrial Revolution (1800-1850), women were the major factor in the workplace.