The Demise of the European Welfare Nation

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The economic crisis shaking much of Europe, most extremely in nations like Greece, Spain, Italy and Portugal, has been variously blamed on the global financial meltdown, the flawed design of the European Union, and even (predictably) on shenanigans on Wall Street which helped some EU member nations circumvent lending limits.

But something deeper and more fundamental is at work which the global credit crisis has merely helped to expose. Most European countries today operate under economic and labor policies crafted during the height of the post-war baby boom, featuring middle-class entitlements like generous pension systems that allow early retirement, liberal disability programs that exempt many laborers from work, and extended unemployment systems that make going on the dole and staying there easier than in the U.S. Europeans designed these policies in an era when there were, in many European minds, too many people competing for jobs and a bulging work population to support those who were retired or on disability.

Today, however, the demographics of most European countries are radically different. Their working age populations are shrinking, while their retiree cohort swells, placing a severe strain on government budgets and crowding out other spending. High taxes go to support this entitlement regime, and those who work are discouraged by such taxes to work harder, making it all the more difficult for countries to achieve the productivity gains that they so desperately need.

Europe requires a very different series of policies now which encourage people to stay employed longer, which make it harder to exit the workforce on the government dole, and which allow labor markets to be more flexible. Economists and demographers have been warning of this for years. Indeed, back in 2002 the demographer Paul Hewitt predicted a steep worldwide recession exacerbated by population changes "from which no welfare state will emerge intact." Still, winning the kinds of reforms that Europe needs is no easy task because government finds it very hard to take back the perks, once bestowed, that many Europeans now enjoy.

Greece is a good example of a country whose labor laws and social policies are at odds with its population trends. Yes, a series of Greek governments have been profligate, running up debt and financing the welfare state with long-term borrowing. But they've been doing this precisely because they are trying to swim against long-term demographic trends that are inexorable. Greece has one of the lowest fertility rates of any country in Europe, just 1.3 children per woman, nearly a full child below what's considered replacement rate. Moreover, this rate has been falling for decades, so that Greece's 65-and-over population has soared from just 11 percent of the country in 1970 to 24 percent today, and is projected to grow to one-third of the population by 2050. By contrast, Greece's working age population (defined as those ages 15-to-64) has reached its peak and is projected to decline 20 percent over the next 40 years.

Given these demographics, Greece has exactly the wrong labor and retirement policies in place. According to the Organization for Economic Cooperation and Development, Greece has among the most liberal pension systems, with generous payouts to encourage workers to retire early, including whole categories of workers in jobs deemed "arduous." Incentives matter, of course, so that even while Greece needs to be encouraging more of its citizens to work longer, they are doing the opposite: Only 42 percent of Greece's population aged 55-to-65 are employed, compared to 52 percent of the OECD on average and 62 percent in the United States.

Greece suffers not only from the lost national productivity of a shrinking workforce, but from the cost of high retirement payouts. Greece spends nearly 12 percent of its gross domestic product on pensions-compared to 6 percent in the United States. To support that burden Greece has among the highest rate of taxes on the average worker in Europe, 42 percent of income earned, compared to 37 percent in the OECD on average and 30 percent in the United States. No wonder so many Greek workers find it more profitable to retire or to evade taxes, another of Greece's problems.

Europe's other most troubled countries share many of Greece's characteristics. Italy and Spain have birth rates that have slipped as low as Greece's and shrinking labor working age populations. Yet early retirement is the norm. In Italy the average retirement age is 59, among the lowest in industrialized nations, and Spain is ranked only slightly higher. Only one-third of Italy's population aged 55-to-64 is in the workforce, and the average male worker in Italy will spend more than 25 years in retirement. In fact, with life expectancy increasing, a growing chunk of European adults spend more of their [adult] life retired than working. But the costs are staggering. Italy now spends 15 percent of its GDP on pensions, the highest in the Europe.

Many Americans tend to associate the term "welfare state" with a regime of anti-poverty programs reminiscent of the Johnson administration's War on Poverty. But in Europe the welfare state generally refers to an extensive array of entitlements enjoyed by middle and upper-middle income citizens. That's one reason why efforts to reform (that is, reduce) these entitlements have met with so much resistance in Europe. Even in staid Austria workers have taken to the streets to protest changes in the country's pension system. Still, change is coming because the traditional European welfare state is an anachronism that's unsustainable. Already countries like Sweden, Austria and Germany have made alterations to their pension systems, including Sweden's efforts to follow the Chilean model with a partial privatization of social security.

Change is coming to the United States, too. Although we are demographically robust compared to Europe (our working age population will increase by a projected 17 percent over the next 40 years) and we work longer, our own baby boom was so large that we'll still need substantial changes in Medicare and Social Security to meet our future obligations. Meanwhile, our states face a tough road because many of them have granted European-like retirement benefits to government workers that are exacerbating state budget problems.

Our road to reform shouldn't be as painful as what the Europeans face, except that rolling back benefits is often so difficult that action is only possible in a crisis. That may be the real message of the growing mess in Europe: getting back what government has already granted is so politically tough that it's best to proceed cautiously with new entitlements.


Steven Malanga is an editor for RealClearMarkets and a senior fellow at the Manhattan Institute

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