## 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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## Bibliographic details
- Published: October 15, 1998

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### 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  - Historical reference: Paul Leroy-Beaulieu considered taxes above 12 percent of national income “exorbitant” at the beginning of the century.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).*

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## References

- [France and the IMF](http://www.imf.org/external/country/FRA/index.htm)
- [Italy and the IMF](http://www.imf.org/external/country/ITA/index.htm)
- [Japan and the IMF](http://www.imf.org/external/country/JPN/index.htm)
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- [PRESS CENTER](http://presscenter.imf.org/)
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