Sunday, October 22, 2006

Too Little Too Late?

by Edward Hugh

This is a short post, just to let everyone know that even if last week was a quiet week, we are still in the land of the living.

The title of this post refers to a comment Sterling put in Claus's last post. Really I very much agree. These most recent statements from Joaquim Almunia having something of a pathetic ring about them.

Unfortunately, Almunia is but a pale shadow of his EU predecessor (Pedro Solbes) in this context, a fact which is curious since the two come from the same country and the same party. As I pointed out to Claus, back in 2003, Pedro Solbes arranged a conference in Brussels on the issue of pension systems and their sustainability (anyone interested in this topic from a European perspective might find it useful to leaf through the papers). In his address to the conference, Solbes said the following:

* Our conclusions are worrying. On the basis of current polices, a clear and unequivocal risk of unsustainable public finances exists in at least half of EU Member States. Even countries which at first sight appear to be in a good position, face daunting challenges. Both reforms, with which I will deal later in the speech, and budgetary discipline have to remain high on the economic policy agenda. High debt countries, face a particular challenge as they are de facto obliged to run large primary surpluses and achieve ambitious debt reduction targets in order to ensure sustainability. This implies an enormous and sustained real budgetary effort. Alternatively sustainability in some countries appears to be based on sustaining very high tax ratios over several decades. The tax burden is a matter for Member States to decide, but there are questions as to whether high tax rates can be sustained in the face of globalisation and the increased mobility of tax bases. These conclusions underline the need for further increasing the focus on the debt level and long-term sustainability in the Stability and Growth Pact. Indeed, the upgrading of analysis on ageing populations was a central element in the proposals adopted by the Commission last November.

but the core challenge is economic growth.

* Over the past forty years, we have become accustomed to increasing levels of prosperity on the back of sustained increases in labour supply and high levels of productivity growth. However, ageing populations means that these sources of growth cannot be taken for granted in the future. The population of working age in Europe will start to shrink as of 2010 as the post war baby-boom cohort enter their retirement years. Unless offset by increases in productivity growth, a fall in the supply of labour will mean that the potential growth rate will fall. We have estimated that the pure impact of ageing populations will result in the potential growth rate falling by some 0.8 percentage points. A drop of this amount may appear small, but its cumulative effect would be a shortfall in GDP per capita of some 20%. Let me be clear. I am not suggesting that living standards will fall by 20%, but rather that they will be lower than what could be expected to be in the absence of demographic change. These changes in the labour market are not long-run concerns. Our recent economic forecasts show that these effects are already emerging in some EU Member States.

* A fall in potential growth is not only a concern because it will lead to a relative decline in prosperity vis à vis other industrialised countries. It is a major problem because it will make it ever more difficult to meet the expectations and demands of a growing elderly population. Much of the pension entitlements which citizens are accruing in public systems today are based on an assumption of a potential growth rate of around today's growth level.

Really Solbes has understood the problem pretty well, which is more, I fear, than can be said for Joaquim Almunia. (Policy watchers might like to note that Almunia was despatched to Brussels following the surprise victory of Zapatero's PSOE part in the March 2004 elections. The switch had two purposes, to bring back economic 'heavyweight' Solbes to strengthen Zapatero's team, and to remove mediocre 'machine man' - and heir apparent to the discredited Felipe Gonzalez - from eye's reach and harm's way, so there could be a 'new broom sweeps clean' policy. Of course Europe's loss is Spain's benefit, but that hardly seems to be the important point given the gravity of the issues involved. This topic has simply been drifting since Solbes went, and Almunia's recent efforts do nothing to convince me that anything substantial has changed).

The report itself can be found here. If time permits next week I will try and offer some comments.

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