Where are we heading to … ? (Part 2)

No Country for Old men (…is anybody in charge here…?)

What are the implications of current social expenditure in OECD countries?

I have to admit, that the issue seems to me so obvious, that I still have the fear that possibly I totally misunderstood the numbers and the trends.

So I hope that among my readers, there will be someone, that will help me to find the (missing) information misleads me in my assessments.

Today Europe has about 500 million inhabitants. By adding the number of young people (aged 0-19) to the older population (above 65) in 2010, we have a resulting total dependency ratio of 63.2 % .

That means that in EU27 there are 63,2 young-age or old-age dependent persons for each 100 working people: 63,2/100 = 63,2%. In the EU-27 this is equivalent to about three people of working age for every two dependent people.

The number of people younger then 20 provides (but in some reports on young-age dependency, the young-age is defined as above 15 years old) the basis to calculate the young age dependency ratio. Today young-age dependency ratio is 23% and in 2060 it will be 25%. That means that there will be in the coming 50 years four persons in working age (20-65) for each young-age person (0-19). http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/Glossary:Young-age-dependency_ratio

The number of people aged 65 or more provides the basis to calculate the old age dependency ratio: today the old age dependency ratio in the EU27 is 26,2%: there are 26,2 old-aged persons for each 100 persons in working age (as above defined). In 2045 the old-age dependency ratio will be 45,42 and in 2060 it will be 52,55. http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/Glossary:Old-age-dependency_ratio

As you may have seen, confusingly, also old-age is defined inconsistently: in some Eurostat studies old age is assumed to be an age of 60 or above, in others an age 65 or above.

I will try to find out, the reason of such differences, that make almost impossible to come to mathematically exact calculations. For the moment, we cannot exclude that such different bases of calculation are considered useful in a given report to be presented for political decisions: a “technical” document (taken by non elected public officials) that has the aim to influence a political decision.

Whatever the reason, such differences may account only for a minor change in statistical numbers, and do nota affect the overall trends, that I am trying to highlight here.

The dependency ratios here quoted are represented at page 12 of the “EU Youth Report 2012,” http://ec.europa.eu/youth/documents/national_youth_reports_2012/eu_youth_report_swd_situation_of_young_people.pdf

accompanying the Commission Communication COM(2012) 495 on the implementation of the renewed framework for European cooperation in the youth field (EU Youth Strategy 2010-2018) http://ec.europa.eu/youth/news/20120910_en.htm

It strikes me, that such threatening numbers are used in order to design policies for young-aged or old-aged Europeans, when the true meaning of such numbers is, that the system is imploding, as I will try to show in the following part of this post. If you want to deepen the analysis, here you have some more data about demographic evolution in Europe.
http://epp.eurostat.ec.europa.eu/cache/ITY_OFFPUB/KE-ET-10-001/EN/KE-ET-10-001-EN.PDF
http://epp.eurostat.ec.europa.eu/cache/ITY_OFFPUB/KS-SF-08-072/EN/KS-SF-08-072-EN.PDF

Now, in the next 30 years the percentage of old-aged population in relation to working-age population in EU27 will increase from about 26%, to 45,42% (an increase of almost 60%). That is, in 2045, the ratio of old-age people vs. working age people in the EU27 will decrease from 3:2 to 2:1. A dramatic shift.

In the coming 50 years, the dependency ratio of the young will only slightly increase, according to the EU Youth Report 2012, where at page 12 you can see the development of old age and young age dependency in the coming 50 years. Young age dependency ratio is today 23% (23% of the total population is aged between 0 and 19 years) and it will increase to 25%. That means that there are 4 persons of working age, sustaining one young person out of working age. ec.europa.eu/youth/documents/national_youth_reports_2012/eu_youth_report_swd_results_of_eu_youth_strategy_2010-2012.pdf

In 2045, abut 30 years from now, we will have a total old-age + young-age dependency ratio of about the 70%: 24% young-age dependency added to about 45% old-age dependency . In 2060 it will be a little less then 80%. It means that in 2045 in Europe a little more then 50% of the overall population will work in order to maintain the remaining half of the population.

In 2060, there will be 1,2 working-age person for each dependent person.

So far so good, we all probably knew that there was a Demographic pyramid in the EU that is capsizing.

What is important also to know, is that if we compare such trends with Japan USA or Canada or Australia, there are significant differences, but the trend also in these countries/economies is the same. http://www.economist.com/node/13611235

The total old-age + young-age dependency ratio in the US in 2050 may be somewhere in the mid 60% range, but still the trend is the same.

China is a different story, because of its one-child policy, that will bring to a quadrupling of the number of old-age dependent people in the next 40 years. An explosive situation if not dealt with…

We learn from an important OECD paper, that social expenditure is roughly 30% of GDP in the OECD countries in 2009, with minor differences between Europe and USA: http://dx.doi.org/10.1787/220615515052
http://www.oecd-ilibrary.org/social-issues-migration-health/how-expensive-is-the-welfare-state_220615515052.

Now we also know from the OECD 2012 Tax Policy Analysis Revenue Statistics, that in 2011, the average taxation (on personal income, company income, capital gains, social security and consumption taxation) in OECD countries has been of about 33,8% of GDP, with the lowest taxation in Chile (19,6%) and the highest in Denmark (47,6%): http://www.oecd.org/ctp/taxpolicyanalysis/table_a_eng.xls
http://www.oecd.org/ctp/taxpolicyanalysis/revenuestatistics2012edition.htm

In 2011 EU27 taxes on production and imports accounted for 33.3 % and current taxes on income, wealth, etc. 31.2 % of total tax revenue. The share of current taxes on income, wealth, etc. has decreased from 2007 onwards with no recovery in 2010. The share of social contributions increased noticeably from 2008 to 2009 but decreased slightly from 2009 to 2010 to stand at 35.1 % of total tax revenue. http://epp.eurostat.ec.europa.eu/statistics_explained/index.php/Tax_revenue_statistics

Simplifying the EU27 tax revenues can be divided as follows:
– about 1/3 from VAT and similar taxes, like import tolls
– about 1/3 from income (personal and enterprise)
– about 1/3 social security contributions.

All this considered, we understand that social expenditure is the vast majority of public expenditure in OECD. In fact the percentage of social expenditure and the percentage of taxation are almost equal, if put on relation with GDP.

In every country the relation between taxes and social security contribution is designed in a peculiar way, so that we cannot make the statement that almost all taxes and social contributions end into the welfare system.

But looking to single OECD economies, like Germany, Italy, France, USA, we can see that social expenditure is the absolute majority of public spending (i.e. more then 50%) topping in some cases (Germany, Italy, France) more then 60% of total public expenditure.

Germany has a 2011 GDP of 3.479 billion and tax revenues of about 1.250 billion, calculated in US Dollars. Social expenditure in 2009 was about € 745 billion (a little less then 1 trillion USD). http://www.tagesspiegel.de/politik/deutschland/sozialbericht-2009-sozialausgaben-steigen-um-33-milliarden-euro/1558648.html
Four fifths of German public expenditure is social !

In Italy the social state is less generous: only two thirds of public expenditure are devoted to social expenditure. http://www.cliclavoro.gov.it/SondaggiStatistiche/Documents/NotaspesasocialeinItalia.pdf

What do we learn from these statistics?

Well, first that there is no such difference anymore between Europe and USA, when it comes down to social expenditure.

Secondly, we learn that it will be impossible to increase total taxation in order to cover in the next 50 years the dramatic increase of the dependency ratio. Either productivity will double (and with it income and GDP), or there will be the need to increase taxation (for the part not covered by productivity increase).

The OECD 2012 Tax Policy Analysis Revenue Statistics shows also clearly that over the last 50 years, taxation levels have been inversely proportional to GDP growth: in 1965 average OECD taxation was 25,5% of GDP and the growth rate was solidly above 4%. Now average taxation has increased by almost half, and growth in OECD is sluggish or non existent, also because of the accumulated debt in most OECD countries. For more detailed considerations on the optimal range of taxation on GDP, read the OECD paper of November 2011 on the subject: “What is a “Competitive” Tax System? ” http://www.oecd-ilibrary.org/taxation/what-is-a-competitive-tax-system_5kg3h0vmd4kj-en.

It seems very unlikely, that the demographic pyramid standing on its cusp will be sustainable, at the current pace of social expenditure. The most likely outcome will be, that the amount of social expenditure will have to be cut drastically, with the social consequences that we see in some EU member states today.

Looking to people rioting in Greece, UK, Spain and Italy, I ask myself: “does really the protesters believe that a social security system can work on borrowed (or non existing) money?”. I don’t think they have such foolish believes.
My impression is that they are furious, because nobody told them before, that promises made in the past decades where hollow at best, and false in any other case.
But looking together at the demographic pyramid and the taxation level, it becomes obvious that also the “virtuous” states in the next 50 years will have to halve the absolute amount of social expenditure, if not even to reduce it by two thirds, in the worst case scenario. There will be an unsustainable disproportion between what a single OECD citizen will have been asked to pay to the state, and the benefits that he will receive in exchange, some day.
This system has to be changed, because it will certainly produce anger and unrest in the next decades. And could de-legitimize democracy. Also during the last huge systemic crisis (1929-1932) democracies have been de-legitimized, because they unilaterally changed the underlying social pact, in a way that led the majority to disavow it.

But it will not be easy to change current social expenditure trends: the amount of social expenditure is seen as a “matter of fact” issue, that cannot be politicized: if someone is sick it has to be cured, if someone is jobless or socially weak/excluded it has to be sustained. So a myriad of public and private agencies increase every day the amount of social recipients, making “technical” assessments, that are (until now) beyond the reach of (informed) political decisions.
In Italy in 2008 there has been a 58% increase of “pensioni di accompagnamento”, according to the central book keeping agency (Ragioneria Generale dello Stato). It is not by chance, that such increase coincides with the deepest financial crisis of the last eighty years… http://www.cliclavoro.gov.it/SondaggiStatistiche/Documents/NotaspesasocialeinItalia.pdf
Same thing has happened in the US, with the social expenditure for disability: http://www.economist.com/node/21564418
If on the one hand, during a crisis, social expenditure rises. On the other hand, when the governments try to fix their budgets, rarely they cut expenditure on the socially weak. In 2012 in UK the effort to reduce the public deficit, has materialized in higher taxes and less capital expenditures: http://www.economist.com/blogs/buttonwood/2012/10/fiscal-policy
The consequence of all this, is a ballooning social public expenditure, that makes none of its recipients wealthier (on the contrary, recipients are increasingly socially segregated), but constantly increases the state’s social expenses.
Meanwhile one generation ago, those who benefited of social remittances, had the hope of being readmitted in the productive cycle of the society, and in effect used for a limited time social benefits, today they increasingly remain dependent on them.

On this path Europe (and most OECD economies), before the baby boomers generation dies out, will be “No Country for old Men” (and women, of course)…

And if people becomes disillusioned, angry, suspicious of anything that smacks of morality or social inclusion, well… then nobody will be in charge anymore. Again, we have only to look to Greece today and Argentina (ten years ago), to see that when public debt becomes unbearable, nobody is anymore able to take political decisions.
Already at this very moment, the vast majority in the “virtuous OECD countries” have the unsettling feeling, that the reciprocity of the social pact is biased and slowly unfolding, to their detriment . The system is opaque, so that too many don’t know for sure, if they are “givers” or “takers”.
This has to be stopped, before it is too late and decisions are taken by the mob or by “technical” bodies, with a (not so) implicit suspension of democracy and political accountability.