The Nordic Model - Embracing globalization and sharing risks

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sion of welfare services. This is an assumption about technology (our version of the “Baumol hypothesis”), that we discussed above. The effects of more growth on the state of public finances can now be explained in simple terms with the help of figure 5.1. First, higher growth means more output and incomes and thereby it leads to a bigger tax base and higher tax revenues (box A in figure 5.1). This is the effect that people have in mind when they claim that we should solve the public finance problem through more rapid economic growth. Second, higher private sector productivity will raise real wages not only in the private sector but in the whole economy, including in the public sector (as a consequence of market forces and/or wage coordination by unions). The rise in the public sector wage bill increases public expenditure and absorbs part of the increase in tax revenues (box B in figure 5.1). Third, public pensions and other transfers will fall relative to wages unless they are protected through indexation (to wages) or increased by discretionary decisions. Political pressure will normally prevent transfers from falling permanently behind general income developments. Assuming this distributional constraint to hold, public spending on transfers will absorb the rest of the increased tax revenues (box C in figure 5.1). Invoking the “Baumol hypothesis” (or the “Baumol disease”) and the distributional constraint prevents more growth from improving public finances. Fourth, higher incomes are likely to increase the demand for services, including the demand for publicly provided welfare services. The income elasticity of demand is normally positive and for some of these services, such as health services, it is likely to be quite high. Growing incomes will therefore be associated with growing demand for welfare services and pressure on the government to increase their supply as well as to improve their quality. Again, more public spending is called for (box D in figure 5.1), though by now there remain no additional tax resources to draw upon. The likely overall result is therefore that more growth in itself leads to a deterioration rather than an improvement in public finances. It may help public finances only if public sector wages and/or transfers are allowed to fall behind general income developments. A fifth consideration (not shown in the figure) is that higher incomes may increase the demand for leisure and reduce the amount of work supplied at a given (net) wage rate. The supply of labour will diminish since the income elasticity of demand for leisure is positive (and presumably sizeable), and the subsequent decline in employment will reduce the tax base. To repeat, the preceding is not an argument against growth in itself. Growth is indeed important for material well-being, and it is important that productivity should continue to increase if Finland is to remain a high income country. The message of the box is rather that growth is not a solution to the financial problems that the welfare state is facing. Or to put it differently, policies boosting growth will not have a double dividend by both improving material well-being and ensuring sound public finances. More difficult policy choices have to be made to ensure the financial viability of the welfare state. Welfare services: rising costs and increasing demand · 91
it implies that the long-run deficit of the primary balance is “only” about 3.5 per cent of GDP compared to 4.3 per cent in the base scenario. This result may seem to contradict our statement above that productivity growth is not a solution to the financial problems arising from ageing. However, the reduction in the deficit in scenario A arises as a consequence of the index clause in the Finnish system for earnings pensions, according to which pensions are adjusted by 80 per cent of the rise in consumer prices and 20 per cent of the rise in wages. Thus, an increase in productivity, which in the model is reflected in a corresponding increase in real wage growth, leads over time to a decline in pensions relative to wages. 3 Real wages in this scenario therefore increase more than the real value of pensions, and the income distribution will change in favour of those in work. Hence, this scenario actually underlines the conclusion made above, which is that increased productivity growth is a solution to the financial problem of the welfare state only if all people are not allowed to benefit from the increase in the pie. This is a possible route for reducing the public deficit, though More rapid growth increases the tax base but also the public wage bill and transfers as well as demand for welfare services and leisure – growth will not solve the problem of public finances Primary balance as a per cent of GDP % 0 -1 -2 -3 -4 A Baseline B % 0 -1 -2 -3 -4 -5 -6 2010 15 20 25 30 35 40 45 50 -5 -6 Figure 5.2 Growth and public finances in Finland, 2010–2050 A = 0.5 % more productivity growth. B = A + 0.25 % more welfare service growth. Source: Ministry of Finance. 92 · The Nordic Model
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The Nordic Model Embracing globaliz
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ETLA B232 ISBN 978-951-628-468-5 IS
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THE AUTHORS Torben M. Andersen is P
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CONTENTS PREFACE THE AUTHORS 1 INTR
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8.5 The future of public services -
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Globalization is primarily an oppor
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ices financed by taxes, which are h
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14, respectively, out of a total of
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are the effects of technical change
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- and, particularly, their effect o
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not contesting economic growth as t
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1.6 AN EFFECTIVE WAGE BARGAINING PR
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etter be tried in individual cases
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The scheme of the social contract c
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is worthy and realistic. But the de
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supportive interaction of openness
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The financial deregulations in the
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horizontal axis). These indices are
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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
Page 75 and 76: Historically, however, the share of
Page 77 and 78: More children. Since the problem is
Page 79 and 80: Actually higher growth may make the
Page 81 and 82: dependency ratio driven by the baby
Page 83 and 84: 82 · The Nordic Model
Page 85 and 86: to handle much bigger fields today,
Page 87 and 88: Table 5.1 Projections of public hea
Page 89 and 90: 5.4 AN EASY FIX - BRING SERVICES BA
Page 91: Box 5.1 Growth and the welfare stat
Page 95 and 96: The level of taxation is already hi
Page 97 and 98: One may ask why this problem arises
Page 99 and 100: globalization may contribute to bot
Page 101 and 102: able to pay to seek private solutio
Page 103 and 104: 102 · The Nordic Model
Page 105 and 106: ily policies that Nordic demographi
Page 107 and 108: absolute and relative terms than hi
Page 109 and 110: in the participation decision of th
Page 111 and 112: Table 6.2 The activity rate, aggreg
Page 113 and 114: Thus, responsible unions should res
Page 115 and 116: als take part in various unemployme
Page 117 and 118: Box 6.2 What is the Danish “flexi
Page 119 and 120: ENDNOTES 1 In his history of the ec
Page 121 and 122: particularly noteworthy in a euro a
Page 123 and 124: 7.2 COORDINATION AND DECENTRALIZATI
Page 125 and 126: also depends on the business cycle.
Page 127 and 128: ut not in any dramatic way (cf. fig
Page 129 and 130: displays higher nominal rigidity th
Page 131 and 132: model stem from an age in which the
Page 133 and 134: mostly in the years 1980-2000. For
Page 135 and 136: Table 8.1 Government expenditure by
Page 137 and 138: ure. This selection bias alone will
Page 139 and 140: that everyone gets their worth as m
Page 141 and 142: 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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