Worldwide Crisis in the Welfare State: What next in the Context of Globalization? Address by Michel Camdessus
IMF News, October 15, 1998
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- Published: October 15, 1998
Context and framing
- Publication: Address by Michel Camdessus, Managing Director of the International Monetary Fund.
- Event: Seminar organized by Observatoire Chrétien des Réalités Economiques, Paris, France, October 15, 1998.
- Internal reference: 98/23. As prepared for delivery. (Delivered in French)
- Core tension identified: coexistence of the welfare state (large public social spending) and globalization (rising cross-border trade and capital mobility), both facing crises of different natures.
Benefits from welfare states
- Definition and scale:
- Welfare states typically have government expenditure at about half of their GDP; in some countries it has risen as high as 60 percent of GDP.
- At the beginning of the twentieth century, public spending in these countries was around 10–15 percent of national income; now in many it is around 50 percent or more.
- Social achievements noted:
- Reduced costs and risks associated with illness, illiteracy, old age, poverty, and unemployment.
- Increased literacy and education levels.
- Reduced infant mortality and longer life expectancy.
- Reduced trauma and despair associated with unemployment.
Costs of the welfare state
- Fiscal and economic costs:
- Taxes and borrowing finance the welfare state; tax burdens have increased enormously over the century.
- Tax levels cited: around 45 percent of GDP in France and in Italy; taxes as high as 50 percent of GDP or even more in some countries.
- Historical reference: Paul Leroy-Beaulieu considered taxes above 12 percent of national income “exorbitant” at the beginning of the century.
- Main revenue sources: personal income taxes, value-added taxes, and social security taxes.
- IMF staff analysis: a particularly heavy share of revenue increase has fallen on labor income, and less skilled, lower paid labor in particular.
- Labor market distortions:
- High social security taxes raise the cost of labor and create a "wedge" between employer labor cost and worker wages, discouraging employment and encouraging capital substitution and hidden-economy activities.
- Unemployment compensation and employment protection may reduce incentives to seek work.
- Employment protection legislation, high social security taxes, and excessively high minimum wages can raise costs of employment.
- Public debt:
- Example: public debt has risen over the decades to almost 60 percent of GDP in France; in some countries debt has exceeded 100 percent of GDP.
- High debt diverts resources to servicing and complicates monetary policy.
- Social segmentation:
- Two-tier outcome in some welfare states: "insiders" with generous job-related benefits and "outsiders" excluded from the labor force with few opportunities to re-enter.
- High youth unemployment and social alienation among younger people are highlighted.
Future trends and pressures
- Two irresistible forces:
- Demographic change: aging populations raise pension and health care costs.
- Life expectancy: at the beginning of the twentieth century about 50; in just 100 years it has risen to about 70-75 (even higher in Japan).
- Longer retirement increases years in retirement relative to working years; pay-as-you-go pension schemes imply more pensioners supported by fewer workers.
- Globalization: lower trade barriers and increased capital mobility create competitive pressures and "tax competition."
- Globalization reduces capacity to sustain benefit and tax levels superior to competing countries unless productivity differences justify them.
- Tax competition example: in France and Italy, the level of taxation is now about 12–13 percentage points of GDP above that in the United States and Japan.
- Fiscal sustainability concern:
- Anticipated rising pension and health costs make current tax and entitlement structures difficult to sustain under globalized tax competition and demographic trends.
Policy responses and reforms recommended
- General orientation:
- Reform, not dismantling: preserve social objectives while improving efficiency and individual responsibility through incentives.
- Reforms can reduce welfare-state costs without fundamentally changing government's social role.
- Pensions:
- Reform options:
- Increase the retirement age.
- Reduce or eliminate early retirement without commensurate benefit reduction.
- Reduce pension size via less generous indexation mechanisms.
- Promote individual saving and privately run pension programs to supplement state pensions.
- Timing and fiscal impact:
- IMF analysis: a 10-year delay in addressing pension reform would permanently increase the contribution rate to pensions by about 1 percent of GDP.
- A 30-year delay would raise it by 5 percent of GDP.
- Illustration: in France and Italy, unfunded gaps could disappear if mandatory retirement age were raised to 67, subject to many assumptions.
- Health and education:
- Options to reduce costs and improve efficiency:
- Introduce or increase patient charges.
- Develop standards to discourage unnecessary surgeries and very expensive technological choices.
- Use generic pharmaceuticals.
- Modernize hospital networks.
- Introduce modern technology and teaching methods; shift some higher education costs to the private sector.
- Not a call for wholesale privatization but for greater scope for private provision and cost-sharing where appropriate.
- Labor market and unemployment:
- Make labor markets more flexible.
- Keep employment protection legislation and minimum wage laws under review to avoid counterproductive distortions.
- Strengthen incentives and opportunities (training, activation) for benefit recipients to re-enter the workforce.
- Fiscal policy quality:
- Emphasis on improving the quality of fiscal adjustment and ensuring social safety nets, education, and health are included in program design supported by IMF financing.
Specific observations on France
- Structural features:
- Pension system remains one of the most generous in the industrial world despite early-1990s reforms.
- Unemployment scheme and health care costs are described as generous and rising.
- Intergenerational equity:
- IMF staff analysis suggests the tax burden on today’s young people will, over their lifetimes, be “more than half as large again as the tax burden on today’s middle-aged.”
- Long-term outlook:
- Without substantial adjustments, revenue and expenditure levels would be unsustainable and could undermine future prosperity.
Implications for developing and transition economies
- Different contexts:
- Developing countries: tight resource constraints, poverty, rapid population growth; social protection systems rudimentary and in infancy.
- Transition economies: need safety nets compatible with market mechanisms and revenue-raising.
- Some higher-income Asian countries already face aging.
- Design principles: two keywords — equity and cost.
- Equity principles from an IMF conference on equity:
- Sound macroeconomic policies are essential for promoting equity and growth in the medium to long term.
- Equity is multidimensional: opportunity, wealth, consumption, employment availability.
- Priority on improving prospects of the least fortunate through better access to education, health services, credit, and justice.
- Social safety nets should be cost-effective and well-targeted.
- Equity must be decided through societal consultation; it is not rigid.
- IMF role:
- Social protection and equity increasingly important in IMF policy dialogue and supported programs.
- Commitment to pressing quality of fiscal adjustment reinforced by external evaluation of ESAF.
- IMF staff active in seeking ways to preserve social achievements while improving efficiency.
Conclusion
- Survival of the welfare state requires important reforms to coexist with market economies and globalization under tax competition.
- Appropriate reforms can reduce unproductive spending, improve tax system quality, preserve social objectives, and enable economies to withstand globalization pressures.
- For lower-income emerging economies, as living standards rise, social protection standards may converge toward those of industrial countries.
International Monetary Fund — Address by Michel Camdessus, October 15, 1998 (98/23).