Transcript | 3. lecture: Unsustainability of the welfare states - University for modern Slovakia

In last week's lecture we have shown the development of the world economy during the global crisis and prospects for the next four years. We also analysed the development of the debt of developed countries and we said that this development is unsustainable in the long term. In this lecture we will discuss this unsustainability in detail. We will base on a study of economists from the Bank for International Settlements (BIS) in Basel, titled "The future of public debt: prospects and implications."

In the last lecture we showed that today's level of debt of developed countries is very high and that in this year we will have already eight developed countries with public debt over 100% whereas before the crisis it was only Japan, Greece and Italy. The future forecasts, however, are even worse. As mentioned in the previous lecture, the largest debt accelerator are public expenditures in regard to the aging population and in the short term also in relation to banks rescue and Keynesian stimulation of the aggregate demand during the crisis and afterwards.

The conclusions of the above study by the BIS economists therefore investigated mainly the development of long-term debt, depending on the aging of the population under different assumptions for public expenditure as share on GDP and public expenditures on aging, especially with regard to pensions. The fundamental conclusion is that without major changes and reforms, particularly in the area of ​​pensions and health care (but not limited to) the current system is unsustainable neither by budget nor by debt.

If the public spending share in GDP of developed countries remains at current level and if at the same time expenditures on an aging population grow proportionally to demographic changes, the debt compared to GDP would be 200% in Germany in 2030, in France in 2023, in the United Kingdom in 2020, and in the USA in 2022. Furthermore, it would deteriorate even faster, in 2040 Germany would have public debt of 320% of GDP, France 400%, USA 450%, United Kingdom 530%.

This is of course completely unsustainable and unpayable level of public debt. The best it is shown by data on the development of debt service on such debt levels. Only on annual interest UK would have to pay about 27% of GDP and the U.S. about 23%, like Greece and Belgium. Currently, the share of debt interest payments in the U.S. and United Kingdom floats at around 5% of GDP. UK currently collects annually in taxes and levies about 36.5% of GDP, i.e. if the tax rate remained unchanged, the interest of the state debt would wolf down 74% share of all income. In the U.S. it would be even up to 96% of all tax revenues.

This of course would not be possible and such a development would be unsustainable. What is the most optimistic scenario offered by the authors of the study? It is assumed that governments will succeed to reduce the government deficit of 1% per annum in the next five years and the expenses on aging population will be preserved at today's level, despite population aging. It is therefore a scenario that requires quite penetrative reforms, especially on pensions and health care. Nonetheless, developments in some countries would continue to be problematic, although not as much as in previous passive scenario. Public debt would decrease in comparison to the present levels in four countries - Germany, Austria, Italy, and the Netherlands. However, it would continue to grow in the U.S., UK, Japan, and France, although not as dramatically as in the passive scenario.

So the conclusion is clear. Continuation of the welfare states in the way it developed so far is impossible and unsustainable. The growth of public debt implies a vicious circle of higher taxes, lower growth, and higher unemployment. High deficits and debts are crowding out private investment and increase the risk surcharges. Moreover, as we showed in the first and second trimester of UPMS, global competition is intensifying even more after the global financial and economic crisis. This is true and will be true more than ever. Emerging countries, especially in Asia are fast-growing and increasingly compete with the most advanced countries. This is true not only for less developed countries such as China or India, which still mainly benefit from low labour cost, which is in case of China multiplied even more by maintaining an artificially undervalued Yuan. Europe faces strong competition also from Asian countries such as South Korea, Singapore or Hong Kong, which have a significantly lower level of redistribution, lower taxes and greater economic freedom.

The most difficult situation is in the U.S., Western Europe and Japan. Of course not all countries are equally bad with this. Germany, the Netherlands, Austria, Luxembourg and the Nordic countries are keeping well, while bigger problems have Belgium, the United Kingdom,  France, and most peripheral countries PIIGS (Portugal, Italy, Ireland, Greece, and Spain).

In principle, all these countries will need reforms that will improve competitiveness, will start sustainable economic growth, reduce public deficits and ensure sustainability of public finances. With certainty we can say that, while maintaining, or further developing the welfare state, as previously developed, it will not work. And this is just the biggest problem. People used to live comfortably in nursing state to care for them from cradle to grave, and are refusing to change. The reforms are always difficult to make since they bring changes and people have a natural fear of change. The political instinct at the same time says to politicians not do unpopular things because they lose the election. When years ago at the meeting of finance ministers of the European Union in Brussels discussed ad nauseam what reforms should be done to make Europe more competitive in the global competition, experienced European tirailleur Jean Claude Juncker said it clearly: "Of course we all know what to do, we just have no idea how to win the election afterwards."

So the reforms are what Europe needs now the most, and the most important condition is the politicians who are not afraid to name the problem, propose solutions, and promote these solutions, despite the political costs and risks of loss.