FROM TAIL-WIND TO HEAD-WIND
4.5 E ASY FIXES ?
In the debate on the consequences of the ageing of society, it is often claimed that there are some easy solutions. Let us consider a few of these.
Many people want to retire early – but should be encouraged to prolong their work- ing careers
More children. Since the problem is the increasing share of old
people in society, it is intuitively plausible that more children would be a straightforward solution. However, there are two reasons why this will not solve the problem. First, to eliminate the baby-boom effect, fertility should have increased years back, cf. figure 4.5; it is too late to rectify this problem now. Second, the newborns will also benefit from increased longevity, and hence in a lifetime perspec- tive they will not be net contributors if current retirement ages remain unchanged. If the current system is not robust with respect to increasing longevity, it does not help to increase the number of newborns who will also enjoy increasing longevity. This is not to deny that there are both economic and non-economic reasons why more children and higher population growth are important for the society. However, higher fertility is not a solution to the financial problems arising from ageing.
Immigration. If it is too late to solve the problem by increasing
fertility, could it not be rectified swiftly by immigration? It is correct that immigration of people in their 20s and 30s would contribute to flattening the rise in the dependency ratio. However, this will solve the economic problems only if the immigrants obtain a high labour-market attachment; to put it a bit bluntly, we are not look- ing for young people per se, but for workers who can contribute to financing our welfare system by paying taxes (rather than receiving benefits). It is not obvious that a country like Finland can induce immigration satisfying the latter condition on a very large scale. The potential for solving the problem via immigration may also been seen in light of the fact that in a medium-term perspective there is no “population surplus” in Eastern Europe; these countries are among the significantly ageing countries, and therefore large migration flows from these regions should arguably not be expected, cf. Carone (2005). The conclusion is again that more immigration may be desirable for various reasons but is not realistically to be perceived as a solution to the public finance problem at hand.
The others have a bigger problem. It is often argued that our
demographic problems are not that bad since other countries, like those in Southern Europe, are facing even larger demographic shifts. This is a strange argument: why would problems faced by other countries contribute to solving the problems faced by the
More children are desirable – but will not solve the public fi nance problem
More immigration may well be desirable – but will not solve the public fi nance problem
Demographics: from tail-wind to head-wind
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Finnish welfare state? Actually the opposite may very well be the case. If countries with large demographic problems are late in reforming their systems, they may be a source of financial and eco- nomic instability with negative repercussions on other countries. If anything, it is better to have trading partners that either have smaller problems or are front-runners in reforms.Growth. If the problem is that we have to support more old
people, could the problem not be solved by a growth-oriented economic policy? In this way the pie would become larger, and perhaps we could then ensure the financial viability of the welfare system. Upon reflection, this turns out to be less obvious than it sounds. True enough, more growth will imply higher wages and incomes and thus also more tax revenues. This will indeed give more leeway in the public budget. However, the expenditure side will also be affected.
The public sector has basically two types of expenditures: wages paid to employees hired for the supply of various welfare services and transfers of one kind or another. Consider the follow- ing benchmark case in which we assume an unchanged supply of welfare services and an unchanged distribution profile in society. Under these two provisos, public expenditures will tend to grow by the growth rate of the pie.
To see this, note that public sector wages will have to increase by the same rate as wages in the private sector in order to main- tain (in the medium term) the public-sector work force. Hence, this expenditure component increases by the same growth rate. Similarly, if recipients of transfers are going to gain from growth to the same extent as other groups in society, transfer expenditure will also grow at the same rate. Thus, more growth in the private sector will (roughly) raise the growth rate of public revenues and expenditures by equal magnitudes. It will not create any leeway in the public budget – under the assumption of unchanged service supply and distribution. Nothing is, of course, precluding a change in either of these two conditions. The point is that growth per se will not contribute to solving the financial problems unless policy makers decide or accept a decline in public-sector wages and/or transfers relative to private-sector wages.
Economic growth is important – but will not solve the public fi nance problem
Actually higher growth may make the financial problems of the welfare state worse. We return to discuss this paradoxical effect in detail in the next chapter.
There are thus no easy fixes to the financial problems driven by the demographic changes. This leaves basically three options: increase taxes, cut expenditures or increase employment. The option of increasing taxes is not only conditional on political sup- port for such increases, but it also raises question about how tax increases would affect economic performance. The tax burden is already high and it is not clear that it is advisable to increase tax rates further. Expenditure cuts imply a retrenchment of the welfare state, and hence the sustainability problem of the welfare state is solved by making it shrink. This meets with political opposition and it would not qualify as a strategy for adjusting the welfare state to the new challenges – unless it is based more on increased efficiency than reduced entitlements. A further option could be to reduce benefit dependency and increase employment. Since a significant part of the problem is driven by increased longevity, it is natural to focus on measures to ensure that the effective or average retirement age increases.