The Nordic Model - Embracing globalization and sharing risks

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1.4 MAJOR CHALLENGES TO THE NORDIC MODEL GIVE RISE TO AN URGENT NEED FOR REFORM The Nordic welfare state is vulnerable to changes in employment and the age structure of the population The demand for welfare services tends to grow and the relative cost of producing them tends to increase, which is why spending on welfare services rises faster than GDP Functional as it may have been in the past, we believe that the Nordic model today is subject to a number of challenges that will put it under serious pressure and call for fundamental reform in order to make it sustainable. The root of the challenges is inherent in the basic set-up of the Nordic welfare state, which is based on tax-financed public provision of a large number of social services: child care, basic and advanced education, hospital care and health services, and care for the elderly. This is an important aspect of the Nordic model, in that it makes the access to such basic welfare services independent of income and employment status. But it is also a problematic feature, which may in the long run lead to an impasse in public finances. This is so for two reasons. First, demand for (some) welfare services tends to increase faster than income (a phenomenon known by economists as “Wagner’s law”). Second, by their very nature, productivity in the production of welfare services tends to increase at a lower rate, if at all, than in the production of goods (or other services). Assuming equal wage developments across sectors, unit costs must then increase faster in the production of welfare services than in the economy as a whole (a phenomenon known by economists as “Baumol’s law”). The two phenomena taken together imply a tendency for total spending on welfare services to rise faster than GDP over time. As long as the production of these services remains in the public domain, or as long as they are tax-financed, the tax burden must also exhibit a tendency to rise continuously with GDP. This is a problem of the welfare state that we have been living with for decades now. However, starting from an already high tax burden, the efficiency cost of further increases in tax wedges will at some stage rise steeply, and high taxes will eventually cause serious harm to employment and growth. It seems to us that we may be close to a critical point where the deadweight losses due to high tax wedges Introduction and summary · 19
– and, particularly, their effect on labour force participation rates – start to bite seriously. This is particularly so in view of some of the consequences of globalization and demographic change. Globalization is in general beneficial to economic growth as it provides an opportunity to increase the returns to factors of production via international exchange of goods and services and/or via international factor mobility. Nevertheless, increasing international mobility of labour also poses, if it continues unabated for long, a threat to the welfare state and the Nordic model. The entitlements to education and retirement as well as to care or benefits in the case of sickness, disability and unemployment belong to all citizens as individuals in this model, while the cost of these entitlements are born collectively and shared by all via the tax system. With higher mobility of labour it becomes increasingly possible to benefit from the entitlements without sharing the cost (paying the taxes). There are many examples. Graduates from domestic taxfinanced universities increasingly make their careers (and pay their taxes) abroad. Citizens who have spent most of their working lives (and paid their taxes) abroad, return to their home country after retirement to collect the benefits of free (or cheap) hospital care and care for the elderly. Unemployment rates and the frequency of disability pensions tend to be higher for certain immigrant groups than for domestic citizens. With increasing claims on entitlements due to “social tourism” and eroding tax bases due to factor mobility and tax competition between nations, the long-run sustainability of the Nordic model could be in serious jeopardy. The most serious challenge to the Nordic model, however, is caused by the changing demographics, given the extensive role of the public sector in providing age-dependent social services and transfers. The age composition of the population will in most European countries change rather dramatically in coming decades. The shift is driven by two factors: a temporary “baby boom effect” as the large cohorts of the 1940s and 1950s reach retirement age, and a permanent effect caused by a continued increase in life expectancy. As a consequence, the working age population in Finland will decline from 66.5 per cent of the total today to 57.5 per cent by 2040. The share of those over 65 will increase from 16 to 26 per cent of the population, and the share of very old (above 85) will Tax competition and social tourism may become an increasing source of concern for public finances The dramatic shift in the demographics is the most important force undermining the financial sustainability of the welfare state 20 · The Nordic Model
Page 1 and 2: The Nordic Model Embracing globaliz
Page 3 and 4: ETLA B232 ISBN 978-951-628-468-5 IS
Page 6 and 7: THE AUTHORS Torben M. Andersen is P
Page 8 and 9: CONTENTS PREFACE THE AUTHORS 1 INTR
Page 10: 8.5 The future of public services -
Page 13 and 14: Globalization is primarily an oppor
Page 15 and 16: ices financed by taxes, which are h
Page 17 and 18: 14, respectively, out of a total of
Page 19: are the effects of technical change
Page 23 and 24: not contesting economic growth as t
Page 25 and 26: 1.6 AN EFFECTIVE WAGE BARGAINING PR
Page 27 and 28: etter be tried in individual cases
Page 29 and 30: The scheme of the social contract c
Page 31 and 32: is worthy and realistic. But the de
Page 33 and 34: supportive interaction of openness
Page 35 and 36: The financial deregulations in the
Page 37 and 38: horizontal axis). These indices are
Page 39 and 40: does can nowadays be seen, in a bro
Page 41 and 42: employment increases in the public
Page 43 and 44: are not at the top of the league, t
Page 45 and 46: ENDNOTES 1 Wikipedia refers to popu
Page 47 and 48: consider employment and productivit
Page 49 and 50: from the mid-1980s. Finland has gra
Page 51 and 52: % 7 6 5 4 3 2 1 0 IT expenditure, %
Page 53 and 54: As technological change is to a sig
Page 55 and 56: 3.3 SOCIAL EQUALITY Economic effici
Page 57 and 58: 0.9 0.8 0.7 Net Fin Den 0.9 Composi
Page 59 and 60: ANNEX: GROWTH ACCOUNTING The Nordic
Page 61 and 62: sources of GDP growth in the EU15,
Page 63 and 64: 11 These decompositions have been c
Page 65 and 66: 4.1 THE WELFARE STATE AS A SOCIAL C
Page 67 and 68: The extent, coverage and quality of
Page 69 and 70: % % 80 80 60 60 40 20 0 OECD max Fi
Page 71 and 72:
% 80 Total Old age % 80 60 60 40 40
Page 73 and 74:
tem is seriously affected. Today, t
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Historically, however, the share of
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More children. Since the problem is
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Actually higher growth may make the
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dependency ratio driven by the baby
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82 · The Nordic Model
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to handle much bigger fields today,
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Table 5.1 Projections of public hea
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5.4 AN EASY FIX - BRING SERVICES BA
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Box 5.1 Growth and the welfare stat
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it implies that the long-run defici
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The level of taxation is already hi
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One may ask why this problem arises
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globalization may contribute to bot
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able to pay to seek private solutio
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102 · The Nordic Model
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ily policies that Nordic demographi
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absolute and relative terms than hi
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in the participation decision of th
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Table 6.2 The activity rate, aggreg
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Thus, responsible unions should res
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als take part in various unemployme
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Box 6.2 What is the Danish “flexi
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ENDNOTES 1 In his history of the ec
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particularly noteworthy in a euro a
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7.2 COORDINATION AND DECENTRALIZATI
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also depends on the business cycle.
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ut not in any dramatic way (cf. fig
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displays higher nominal rigidity th
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model stem from an age in which the
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mostly in the years 1980-2000. For
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Table 8.1 Government expenditure by
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ure. This selection bias alone will
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that everyone gets their worth as m
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8.3 THE CASE FOR GOVERNMENT PROVIDE
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maximizing firms tend to focus exce
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than zero based budgeting) are impe
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sectors, place at or above the medi
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The demands for objectivity limit w
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assessed case by case. The importan
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c. Vouchers Vouchers are issued by
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mechanically in the political debat
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ENDNOTES 1 The private sector inclu
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The biggest hurdle to overcome for
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ment has a higher return when spent
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REFERENCES Adema, W. and Ladaique,
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Jonung, L. and Hagberg, T. (2005):
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Is there a Nordic model? What are t
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