The Nordic Model - Embracing globalization and sharing risks

Economic growth is
important – but will
not solve the public
finance problem
Finnish welfare state? Actually the opposite may very well be the
case. If countries with large demographic problems are late in
reforming their systems, they may be a source of financial and economic
instability with negative repercussions on other countries.
If anything, it is better to have trading partners that either have
smaller problems or are front-runners in reforms.
Growth. If the problem is that we have to support more old
people, could the problem not be solved by a growth-oriented
economic policy? In this way the pie would become larger, and
perhaps we could then ensure the financial viability of the welfare
system. Upon reflection, this turns out to be less obvious than it
sounds. True enough, more growth will imply higher wages and
incomes and thus also more tax revenues. This will indeed give
more leeway in the public budget. However, the expenditure side
will also be affected.
The public sector has basically two types of expenditures:
wages paid to employees hired for the supply of various welfare
services and transfers of one kind or another. Consider the following
benchmark case in which we assume an unchanged supply of
welfare services and an unchanged distribution profile in society.
Under these two provisos, public expenditures will tend to grow
by the growth rate of the pie.
To see this, note that public sector wages will have to increase
by the same rate as wages in the private sector in order to maintain
(in the medium term) the public-sector work force. Hence,
this expenditure component increases by the same growth rate.
Similarly, if recipients of transfers are going to gain from growth
to the same extent as other groups in society, transfer expenditure
will also grow at the same rate. Thus, more growth in the private
sector will (roughly) raise the growth rate of public revenues and
expenditures by equal magnitudes. It will not create any leeway in
the public budget – under the assumption of unchanged service
supply and distribution. Nothing is, of course, precluding a change
in either of these two conditions. The point is that growth per se
will not contribute to solving the financial problems unless policy
makers decide or accept a decline in public-sector wages and/or
transfers relative to private-sector wages.
Demographics: from tail-wind to head-wind · 77