Welfare versus wealth of nations: Governments are anxious to cut the cost of pensions, healthcare and benefit payments
The welfare state, the glue that binds the social fabric of the world's advanced capitalist economies, is coming unstuck. The immediate cause is its increasing cost at a time when budget deficits burden most of the 24 member states of the Organisation for Economic Co-operation and Development. Rising welfare spending has been a significant factor in the average increase in net state borrowing of 3 percentage points of GDP across the OECD between 1989 and 1992. In the longer term, there are fears that the cost of the welfare state could become insupportable as populations age over the next 50 years. While short-term measures may ease the immediate budgetary pressures, more fundamental reforms will be needed if the welfare state is not to undermine the economic performance that has underpinned its enormous expansion since the second world war. Reform of national welfare systems to bring costs under control is now on the political agenda throughout the OECD, as countries struggle to rein in government spending. Total government spending in the OECD countries has risen from 28.1 per cent of GDP in 1960 to 43.8 per cent in 1990. The biggest element in this growth has been the cost of pensions, healthcare, unemployment benefits and family support. Social security payments more than doubled during this period, from 7 per cent of GDP to 15.4 per cent. Health expenditure also doubled, from 3.9 per cent to 7.8 per cent. The largest single budget item in most welfare states is the cost of publicly provided pensions. Expenditure has risen rapidly in recent decades, more than doubling its average share of GDP in OECD countries since 1960. Pensions typically account for about a quarter of the increase in public expenditure over this period. The growth is largely attributable to three factors: The increase in coverage as pension schemes introduced after the second world war mature. The rise in the number of elderly people. Improvements in pension benefits, such as automatic increases to match rising earnings. The maturing of the welfare state is also a significant factor in the doubling of health expenditure since 1960. Countries such as Spain, Ireland and the Netherlands have been extending their public healthcare systems to provide universal coverage. As with pensions, health systems have become more generous in the wake of economic growth - for example, including grafts and transplants that were previously regarded as experimental. The ageing of the population has also contributed to rising costs, though not as much as for pensions. Rising unemployment has added to the cost of the welfare state in both unemployment benefits and general family support for low-income families. But it has also helped to push up the budget for sickness and invalidity benefits, which often offer an escape route into early retirement for older workers. Most OECD countries have recognised the need to curb growth in these main areas of welfare spending during the 1980s, and have introduced policies to tackle the underlying causes. For example, governments have become much less willing to offer improvements in pensions. Moves are afoot in countries such as Germany and Italy to raise the pension age. Automatic indexation of pensions to earnings has been weakened in Germany and ended altogether in the UK for the basic flat-rate pension. Healthcare systems have been reformed to make them more efficient and to bear down on the cost of pharmaceuticals. Although there are considerable differences between national health systems, healthcare reforms in countries such as the UK and the Netherlands are increasingly converging on models that use competition and price incentives to control costs. Many countries have also begun to tighten up on unemployment benefits, with reductions in benefit levels and more rigorous conditions to qualify. Active labour market policies have been introduced to promote a return to employment. Some countries have succeeded in stabilising their welfare costs by measures such as these. But what most concerns those responsible for public finances is the strength of underlying pressures on welfare spending that will push costs upwards in the future. The most important of these is demography. Increases in life expectancy have already increased the number of elderly people collecting pensions. The number of over-65s in the 24 OECD member states rose from 61m in 1960 to more than 100m in 1990. The growth is accelerating, with the number projected to rise to more than 115m in 2000, 131m in 2010 and 156m by 2020. Only halfway through the 21st century will the number of over-65s peak, at about 190m. The strain that this will put on the welfare state can best be seen by relating it to expected trends in the number of people of working age. The standard measure for this is the age dependency ratio, the population over 65 as a percentage of the population aged 15-64. For the OECD as a whole, the age dependency ratio is predicted to rise from about 19 per cent in 1990 to 28 per cent by 2020 and 37 per cent by 2040. Some countries face much greater pressures from the ageing of their populations than others. Germany and Japan, for example, will both have age dependency ratios of 34 per cent by 2020 - one person over the age of 65 for every three people between 15 and 64. By 2040, almost half of Germany's population could be over 65, though the proportion will fall thereafter. Age dependency ratios will climb more slowly in the UK and US, to about 25 per cent in 2020 - four people of working age to support every elderly person. In both countries, ratios will peak at about 33 per cent in 2040. The most immediate impact of these demographic changes will be on pensions, where costs will in any case rise as pension schemes continue to mature. Overall, the OECD estimates that the pension burden could double over the next 50 years. Real economic growth rates of up to 1.5 per cent a year would be needed to pay for pensions alone - and that on the assumption that the pensions do not increase in real terms. In practice, increasing pensions in line with prices might be difficult to sustain if earnings rose faster. The growing gap between pensioners and those still at work that would result could be politically unacceptable. However, raising pensions by more than prices would either require much higher growth rates or higher taxes for those in work to pay the bill. The impact of an ageing population on healthcare costs is less clear-cut. Experts differ on whether increased longevity inevitably means more medical care: while more might be required for the very elderly, less might be needed for younger people as chronic diseases become less common. Additional costs of new drugs and advances in medical technology could be at least as important as demography in pushing up healthcare bills. However, there will be an increase in demand for geriatric care and social services for the elderly.
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