[Futurework] 099. The looming dilemma of the welfare state

[Keith Hudson]

Now that larger numbers of people are living into old age, developed countries are facing horrendous problems of paying for their pensions and health care in the coming years. Whereas 30 or 40 years ago, when many European countries instituted state schemes that were paid for by those at work, there were anything between eight and ten workers for every old age pensioner. Today, the ratio is four, and by 2035 the ratio will be two. Clearly, there is a financial, as well as a population, dilemma looming. There is no way that ordinary workers in the coming years will be able to afford the standard of life that they expect and to afford to raise enough children to replace themselves (2.2 children per family) and to pay for the pensions and health care of the growing numbers of the old. Similar circumstances affect Japan, America and the other white developed countries, formerly of the British Empire.

The Chinese, being intelligent people, are aware of the inevitable catastrophe that faces us and are intent on not falling into the same trap while they still have time to avoid it. They are now reducing state social security. They are insisting that those who are now working save enough for their own old age. The Chinese people, normally high savers, are being enouraged -- if not forced -- to save at an even higher rate instead of being tempted to spend their way into high levels of debt as consumers do now in western nations in the expectation that the state will look after them when they get too old to earn an income. Furthermore, the Chinese Poliburo is also insisting that pension funds invest the premiums they receive in far higher quality investments than pension funds in the west have done hitherto -- those that have cost British pensioners at least £20 billion in bad investments in speculative equities in the last ten years.

A recent OECD report suggests that western governments will have to think hard about this problem. (One of the few politicians in England who did so, Frank Field, got sacked by Tony Blair for doing so.)  In the immediate future, governments will have to start to encourage -- if not force -- many more people to enter the work force -- that is, those who are of working age but decline to make themselves available for employment. This growing segment of the population is in addition to those who are unemployed but are willing to work and help pay for welfare benefits and pensions for the old.

Keith Hudson

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WORKING CAPITAL

A manifesto to raise employment

As developed economies emerged from their last deep recession in the early 1990s, there was high anxiety about high unemployment. Thus in 1994 the OECD set out a programme of labour-market reforms through which its member governments might cut the jobless count. A decade on, rich economies are recovering from another slowdown and unemployment is on the rise once again. On September 17th, in its annual Employment Outlook, the OECD issued a new manifesto that reflects the anxieties of western governments about jobs. But the aim this time is not just to reduce unemployment but to raise employment.

Eh? What's the difference? Plenty, in fact. To be counted as unemployed, people usually have to be part of the labour force: they must be available to work and actively looking for a job. But there are many other people of working age -- housewives, students, lone parents, disabled people and early retirees -- who neither have work nor seek it. These are termed the "economically inactive". Policies to cut unemployment aim to lower it as a share of the labour force. Policies to raise employment aim to raise the proportion of the whole working-age population with jobs, not just by getting the unemployed into work but also by mobilising the economically inactive.

One reason for setting the new goal is that OECD governments have had some success in bringing down unemployment during the past decade. Generally, jobless rates have fallen; in some countries, notably Ireland, spectacularly. Some of the gains have been lost during the recent global slowdown, but the setback has been less severe than in previous downturns. Much of the long-term improvement will therefore prove sustainable, argues the OECD.

However, the emphasis on raising the employment rate also reflects new concerns, especially in Europe. A particular worry in the early 1990s was that too many young people were unemployed -- ie, looking for work but unable to find it. Now, governments are concerned that there are too few young people in the labour market overall. In the European Union, there are now four people of working age for every person aged 65 or over. By 2035, this ratio will have fallen almost to two-to-one. As it falls, the burden on workers of tax-financed pension schemes will rise and public budgets will come under ever greater stress. One remedy is to raise the employment rate and so increase the number of people contributing to public pension schemes.

The rationale for cutting unemployment is straightforward. If people who want to work cannot find jobs, then potential labour resources are being wasted and taxpayers are having to support the involuntarily idle. The rationale for raising employment is less obvious. There are good reasons why students, for example, are not employed. If people choose not to work and can support themselves, what business is it of the state -- however cash-strapped -- to try to push them into work?

One answer is that inactivity costs taxpayers money, over and above what they must pay to support the unemployed. Besides unemployment payments, there is a wide range of other benefits, including support for early retirement, disability and lone parenthood. In the EU, there is now one person of working age receiving a benefit for every three people in employment. In America and Japan the figure is one in five. In many countries a majority of people who are neither employed nor in education get some form of income support.

Springing the trap

This benefit culture is not just a burden on the working taxpayer. It also generates incentives for people not to work. In the early 1990s, the talk was of unemployment traps, where high, long-lasting benefits dull the spur to find work. Now the OECD highlights inactivity traps where people outside the labour force face little financial incentive to seek work.

The substantial variation in employment rates between broadly similar economies suggests that in some countries there is plenty of scope for getting more inactive people into work. In Iceland, for instance, 80% of working-age women are employed; in Italy, the figure is a mere 42%. The report estimates that a convergence in working patterns would raise the average employment rate (for women and men) in OECD countries from 65% to 77%. Based on what the economically inactive say about their willingness to work, the increase would be less, to 72%.

It is easier to identify the potential gain than to realise it. The OECD sets out three main policies. The first is to make work pay for the low-skilled. To encourage more of them into the labour market, more use could be made of top-up benefits for those on low wages. Reduced payroll taxes on low-paid jobs would enhance employers' demand for such labour. The second is to remove other barriers to joining the workforce such as the difficulties women find in juggling families and jobs; for example, through subsidising child-care services. The third is to restrict the flow of people on to out-of-work benefits and to encourage those already getting them to look for jobs.

The main question is whether governments will have the courage to implement the more unpopular reforms. By extending in-work benefits, they will offer people a carrot to join the labour force; but as long as people can draw welfare payments when out of work, there will be no accompanying stick. The OECD calls for the removal of incentives to early retirement, but this requires unpopular reforms, not just to pensions but also to other benefits that allow older people to quit the workplace.

Some increase in employment rates will occur anyway as a younger generation of working women replaces an older generation that largely stayed out of the labour force. But most countries will struggle to raise the employment rate without harsh reforms. The OECD'S manifesto sets a daunting challenge.

Economist 20 September 2003
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Keith Hudson, 6 Upper Camden Place, Bath, England, <www.evolutionary-economics.org>