Peak State revisited

Last week, risk management analysts Maplecroft rated the UK and a number of other European countries as extreme fiscal risks. All but one of the countries at the top of the company’s Fiscal Risk Index are in Europe. Maplecroft reported:

Europe is home to 11 out of the twelve countries rated ‘extreme risk.’ These include: Italy (1), Belgium (2), France (3), Sweden (4), Germany (5), Hungary (6), Denmark (7), Austria (8), United Kingdom (10), Finland (11) and Greece (12). Japan (9) is the only other country in the highest risk category.

Now you could be forgiven for thinking that this is a bit odd. France, Sweden, Germany, Denmark, Austria, the UK and Finland all have AAA credit ratings. Sweden, Denmark and Finland are 3rd, 4th and 5th in Euromoney’s Country Risk league. Surely that’s about as close as you can get to safe.

But Maplecroft are not talking about short-term risk. They are talking about the fiscal position of these countries over the longer term.

The ‘extreme risk’ countries are characterised by increasingly ageing populations and high public spending on social security. Maplecroft states that high life expectancy will place more pressure on public expenditure because pensions will need to be paid to more people for longer and an older populace will place larger burdens on health systems. At the same time, the working-age population in these countries is shrinking; meaning contributions to public pensions will likely decrease.

In the UK, there are currently 25 old people for every 100 of working age (25%). This is forecast to rise to 38% by 2050. Whilst high, the UK projection pales against other ‘extreme risk’ countries, including: France 47%, Germany 59%, Italy 62% and Japan at the very top with 74%.

In a report from June 2009, the IMF suggested that the fiscal implications of ageing populations could dwarf the impact of the recent financial crisis in terms of national accounts. It estimates that the net present value of the financial crisis is about 11% of what ageing related spending will cost.

In other words, demographics will make the current levels of welfare provision unaffordable. If entitlements and expectations remain as they are now, the cost of pensions and healthcare will outstrip what the country can afford to pay.

Undercover economist Tim Harford agrees. He reckons that public sector occupational pensions could add £750bn to £1,000bn to the national debt. That’s in addition to the general cost of state pensions. Then there is the £130bn in PFI liabilities to be paid for over the next 25 years.

A similar conclusion was reached by the 2020 Trust and Ernst & Young last year when they calculated that maintaining current levels of welfare provision would see public spending rise to 52 percent of GDP by 2030. Using the same data, the Guardian came up with an even more pessimistic scenario. Assuming that growth only averages 1.75 percent for the next two decades, public spending would rise to 63 percent of GDP.

Would Britain be prepared to cough up the tax to pay for public spending at this level? There is no precedent for it in peacetime. It is true that public spending has rocketed since the Second World War. By the end of the 1960s we were spending as much in real terms as we were at the height of the war.

But it didn’t feel like it because we were a lot richer. The public spending which had taken up 70 percent of GDP during the war was only around 40 percent by the late 1960s.

Since the late 1940s, the level of public spending has been pretty consistent. It has hovered somewhere just below the 40 percent mark. Most of the  of the variation, including the most recent one, has been due to recessions, with the resulting dips in GDP and increases in benefit costs. It’s a simple division sum. If you make the number on the top larger and the number at the bottom smaller, even by a little bit, the percentage will jump.

The increase in public spending, therefore, follows a similar pattern to the increase in GDP. At a roughly constant level, around 40 percent of our GDP goes on public spending. As GDP goes up, therefore, so does public spending.

Which would be fine if everything were to carry on the way it has for the last sixty years or so. Unfortunately it won’t. We have an aging population and long-term liabilities which will place unprecedented demands on our welfare system. Add to that already high levels of public debt (projected to be close to 100 percent of GDP by 2014), with the interest payments needed to service it, and we are starting from an already precarious position. The 2020 Trust calculates that, even if our economy grew by the post-war average of around 2 percent, our public spending bill would be close to 50 percent of GDP by 2030. The demands on the public purse will mean that our traditional spending level of 40 percent will be nowhere near enough.

Britain and other western economies are experiencing a steady relative decline. The OECD estimates that its member countries’ share of the world’s wealth will go from 60 percent in 2000 to 43 percent by 2030. It is unlikely, therefore, given our demographic and fiscal outlook, that we can expect economic growth to be sufficient to pay for the sort of welfare state we have come to expect.

All of this means either that the level of welfare provision we have been used to, or the level of taxation we have been used to, will have to change. My money is on the former. The UK has never been up for Swedish levels of taxation; it’s doubtful that even the Swedes will be up for Swedish levels of taxation for much longer.

The welfare state, then, has peaked. It is now, like the UK’s relative economic position, in a steady long-term decline. We are unlikely to see high levels of state provision again. Historians of the future will no doubt argue about when the Peak State point was reached. What is almost certain, though, is that we are now well past it.

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17 Responses to Peak State revisited

  1. Pingback: Peak State revisited - Rick - Member Blogs - HR Blogs - HR Space from Personnel Today and Xpert HR

  2. Dewin Cymraeg says:

    Interesting; but how does raising the age at which people retire affect this? People can no longer be forced to retire at 65. It is likely that many will continue to 70+ (depending on their job) or move to part-time positions once the mortgage has been paid off and the kids are off their hands.

    People’s health tends to decline once they have retired. With people working for longer, their health is likely not to deteriorate as quickly, meaning the drain on health care systems may not be so drastic.

    My guess is that this nightmare scenario will be avoided with the simple change that people will be economically active for longer. People will make healthier choices – keeping fitter and eating better.

    Of course, it is also, unfortunately, likely that people will stop living longer as vital services are cut by the current government.

    • Rick says:

      Dewin, one of the things that Maplethorpe said was that the UK has a very low proportion of economically active over-65s (just short of 8%).

      I think you are right. One of the big changes we will see is those who can having to work for a lot longer than they ever thought they would.

  3. ForensPsych says:

    Dewin Cymraeg is right. Probably. The problem with all risk assessments (and I do them for a living) is that they have to assume that most things stay the same, with only the known “risk factors” changing. A major reason why the accuracy of risk assessment is so low is that this assumption is never justified. This is more true the longer the term over which we try to assess risk.

    People will age better. They already do. This means they will stay economically active for longer. I am now 3 years off the traditional retiring age, but have no plans to retire completely ever. So long as I stay fit and healthy and like what I do there is no reason to stop, though I might slow down a bit, having got the kids and mortgage off my hands.

    Medical advances are likely to have a major impact on ageing, especially as it is now more economically advantageous to do the research. This can only increase. Ways of maintaining mobility and eyesight (to name but two faculties) will help to keep us fit for work for longer.

    Of course, although we know many advances may be made, we do not know exactly which mones will. That’s the point: we can make some reasonable statements about risk, but we cannot foretell the future.

    • Rick says:

      ForensPsych – Medical advances may keep us economically active for longer but they also increase the cost of the NHS (or whatever we have by 2030). As you say, long-term predictions are difficult, but I reckon working longer and having to pay for more of our healthcare are two pretty safe bets.

  4. Really thought provoking blog post – I wonder what is the solution for these countries with the ageing population?

    • Rick says:

      Thanks Heather. I think making people work longer and pay for some stuff that is currently free is the most likely solution.

  5. Strategist says:

    May I raise an objection? You seem to start in the wrong place. There seems to be a missing dimension of imagination here.

    The question is: how do we deal with a limited period of time (which may be a number of decades) where an old baby boom feeds through to an aging population/top heavy population pyramid? How do we give all our people the safety net, dignity & care they need at a time when there has never been better technology, there has never been more production capacity, there has never been a better chance for everyone to be able to thrive?

    The route to an answer is to insist there is an answer, we *can* deal with the problem, we don’t need to fold our hand in dismay. We don’t need to fret about “relative economic decline” (that simply means that others are catching us up, which is good for the world!) We certainly don’t need to give in to the neoliberal shitheads who want to pillage then wreck the welfare state.

    Beware the cure that is worse than the illness! There is enough for everyone’s need but not everyone’s greed, etc. We can rebuild social solidarity.

    • Rick says:

      Strategist – I think imagination may be part of my problem. I can imagine it all too clearly.

      Joking aside, though, part of the problem with the medical technology that keeps us active and healthy for longer is that it is expensive. Improved technology is one of the factors pushing up NHS costs year-after-year. Providing it free to an ever increasing number of oldies is going to get very expensive.

      I certainly don’t agree with wrecking the welfare state. We’ve still got time to fix it if we accept that it won’t be quite as universal as it once was. The scenarios discussed in this post pan out over two decades. They do not justify slashing and burning the welfare state over 4 years.

  6. Mean Mr Mustard says:

    Unfortunate timing eh, considering that cheap energy which underpins all these deeply indebted overcommitted economies, is also set to fall dramatically over the same timeframe. Decreasing net energy, from harder to get sources, with sharp reductions in internationally traded oil volumes, and population overshoot too. And climate instability. Check out Chris Martenson’s Crash Course…

    • Rick says:

      Mr Mustard – the energy problem (especially given what’s going on in the Arab world at the moment) could be another fly in the ointment. You sent me the Chris Martenson stuff before and I meant to go back and read it. Thanks fior the reminder.

  7. vincelammas says:

    Dont forget the fact that OECD countries will have a smaller share of future global econmic wealth is not the same as saying they will be poorer. This is not a zeroo-sum game.

    If the global economy continues to expand slowly and on a sustainable basis, all economies will benefit … though OECD countries are clearly being caught up.

    If we can find a way to grow economic activity without destroying the planet there is a prosperous future ahead!

    I agree with Rick’s prediction we will see “less for free” and will work for longer. That should be possible without wrecking the UK or our quality of life.

  8. Mean Mr Mustard says:

    The argument goes that conventional ecomomic growth is wholly dependent on continually rising levels of energy input and debt. This is now reaching breaking point, as it surely must at some stage – think Liebigs Laws of the Minimum, something must max out, then the whole system will stall or fail. ‘Sustainable Growth’ is an oxymoron – it’s a finite planet… As well as Martenson, I’d recommend the weekly writings of John Michael Greer for those wanting a longer viewpoint and better quality and more sustainable lifestyle. Something beyond being a mere consumer of tat in an unsustainable bread and circuses industrial society.

  9. Strategist says:

    “Joking aside, though, part of the problem with the medical technology that keeps us active and healthy for longer is that it is expensive. Improved technology is one of the factors pushing up NHS costs year-after-year. Providing it free to an ever increasing number of oldies is going to get very expensive.”

    I simply don’t believe any aspect of that claim. Is the unit cost of the “medical technology” that we already have today (whether it be scanners or drugs) really going up in real terms. Or is it, as per all other tech products, going down? I might believe that the unit cost of human inputs (care workers, surgeons) is going up faster than we can afford, but that is not what you are claiming. Are you in fact arguing that the frontier of medical technology is continually being pushed outwards, and that unit costs at that frontier are high, and looks difficult to continue to offer for free as a trend ad infinitum? That also I can believe, but that is not the same as saying we can’t afford to continue to offer the level of medical “technology”/care that we have already achieved, the level of life expectancy we have already achieved (ideally, of those years, more of them active & healthy and fewer of the chronically crocked – which would also save money).

    My criticism of you as lacking imagination is not a cheap personal jibe meriting some kind of Cameron-style riposte. It was meant as a genuine constructive criticism. You are clearly a hugely expert & talented person. What society needs from people of your skills – and all the rest of us! I repeat this is not a personal jibe – is a bit less of the jaded cynicism and a bit more of the 1945 vintage attitude “OK, here we are bombed out, broke, debt at 250% of GDP, much of our young adult population killed or maimed, here’s a plan, let’s build new communities of good quality spacious housing and offer health care based on need free at the point of use” – ie let’s build our way out of depression by an effort of social solidarity.

    • Rick says:

      I didn’t think you were making a cheap jibe Strategist – sorry for being flippant!

      Jaded cynicism? Point taken. I actually think we will find ways around this stuff but it would help if people at least started planning for it. I’m absolutley convinced that the way we fund and deliver public services can’t go on as it is and that the cradle-to-grave welfare state will be seen by historians as a blip.

      That’s not to say it’s a totally gloomy future – it’s just one where we will all have to get more creative and do a lot more for ourselves.

      I like your 1945 analogy too. We have, after all, been in worse positions, as my mum often reminds me.

  10. TACJ says:

    Lots and lots of minor quibbles. But the key quibble, and the one I think gets to the crux of why I disagree with the “peak state” argument, is in your penultimate paragraph:

    “All of this means either that the level of welfare provision we have been used to, or the level of taxation we have been used to, will have to change. My money is on the former. The UK has never been up for Swedish levels of taxation; it’s doubtful that even the Swedes will be up for Swedish levels of taxation for much longer.”

    Now, the “peak state” phrase is a reference to “peak oil”, no? The idea with peak oil is that there is a set limit to how much oil is available, and beyond a certain point the amount of oil available will inevitably decline.

    But states aren’t like oil. States are created by humans to serve human purposes. As such we can choose what level to set state spending. If we want higher levels we can raise taxes and (continue to) raise the standards of health and social care. Or we can choose to freeze tax and throttle spending.

    But…

    Isn’t your whole argument predicated on there being lots more old people in the future? And don’t these old people vote? And don’t these old voters *want* a high quality level of healthcare and old-age care and all the rest of it?

    Demographic change will lead to changing patterns of political demand. While the baby boomers were making money they were quite happy to accept Thatcherite tax cuts. As they age they’ll be quite happy to vote for raising taxes to ensure a comfortable old age.

    As to issues of productivity growth: well, who knows? I doubt it will be zero (there’s plenty of tech in the pipeline, AFAICS), and I strongly suspect it won’t be negative. As long as the rate of pensioner/worker ratio growth doesn’t exceed the rate of productivity growth, we’re fine. If it *does* exceed it then the oldies will happily vote in favour of higher taxes and higher welfare spending (and workers, who expect to be old one day too, will also probably so vote too). Insofar as higher healthcare-spending diminishes productivity growth, then we have a problem, but it isn’t obvious to me that *that* problem inevitably leads to a decline in the ratio of state spending/GDP.

    So briefly: what size the state will be will be determined by politics. The issue is about who is expected to pay what when, and what voters will choose going forward. It *isn’t* about some kind of inevitable natural limit.

  11. Pingback: SR2013 | Dr Ian C Elliott

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