A Political Response to Changing Demographics?

This one is another one of those small posts which show the effects of demographics in developed economies. Here at DM we talk about all aspects of the changing demographic indicators and realities. In the realms of politics however there is a lagged effect in terms of how policy makers view and (are able to?) respond to the changing demographic profile of their countries. This is quite natural since policy makers need to worry about election and re-election. In that ligth a proposal to open the gates for unskilled immigration as proposed by Edward a couple of days ago seems as political suicide in many developed countries, at least for now. We of course would like to see such courage and prevision but we must also be realistic. So where are we then?

Basically many governments of developed economies have begun responding to changing demographics in one key area; namely in the area of growing life expectancy and longetivity. In essence many developed economies are becoming aware (they are beginning to feel it as well) that the dependancy ratio is rising and as such pensions schemes, health care schemes and in fact general welfare schemes are being modified accordingly. The general consensus seems to be something like; we need to work longer as function of rising longetivity and go quicker through the education system (specifically coined in a Danish context) in order to ameliorate the dependancy ratio. As always there is of course an article to go along; this time from The Guardian about the pressures on UK's pension system.

'Britain's pensions deficit could be larger than official figures suggest because workers are living longer than predicted, the regulator said yesterday.

Employers, already under pressure to plug deficits in their final-salary schemes, could be forced to inject further finance into their retirement funds to honour obligations to staff, said David Norgrove, who chairs the pensions regulator board.

(...)

A recent report by the Institute of Economic Affairs, a rightwing thinktank, argued that the increasing life expectancy, coupled with falling investment returns and low interest rates, had increased the public-sector pension deficit by a quarter to more than £1 trillion. The deficit in the private sector is estimated to be about £100bn on liabilities of £900bn.'

The obvious question which must come on the back of my post is whether it is enough? Is it enough to tweak existing structural mechanisms to better fit the compositional effect of an ageing population? Well at the offset it makes perfectly good sense; we are living longer and therfore we also need to push retirement age accordingly; this is logical. But at the end of the day it is probably not enough (fertility is low and falling as well) and certainly this is not a viable solution for a countries like Japan and Italy, or Germany for that matter. Here at DM (this includes our commentators as well!) we are still trying to get to grips with explaining what is actually going on as we move forward. However, we are getting there and it seems clear that the current political response to changing demographics is inadequate in many countries. So what should they do?

Cold Feet?

I wanted to highlight this story from BBC which immediately caught my attention: "EU Chief urges enlargement pause".

I know migration is only a fraction of the issue, but I do believe that on some level, this is a nationalist response (weird considering that the EU is theoretically not a nation) -- and I don't necessarily fault the EU for it. As analysts who study globalization and other social phenomena like population aging, it is easy for us to take for granted that, sooner or later, Turkey will end up joining the EU because the Union was founded on priciples of integration and inclusion. We support our claims by saying that Turkey is the only nation which can help alleviate some of the burdens of the EU's rapidly aging population.

However, right now, it seems quite obvious that trends are heading in the opposite direction and that Turkey will probably end up aligning more closely with Russia and Iran than the EU. As I see it, and I hate to sound like a broken record, this is a part of the nationalistic response to (perceived) predatory globalization - both in Europe and in Turkey.

I would appreciate some insights and comments from people closer to Europe.

Young And Over-Educated In Sweden?

by Edward Hugh

Well its been a quiet week over here at DM, and today is a grey drizzly day in Barcelona, so lets try and liven things up a bit with a (somewhat) controversial post.

It is curious to watch how some ideas which are rather badly thought out sometimes gain an acceptance and a status which they hardly merit. A classic case in my book is the Goldman Sachs idea of BRICs (this is ill-thought-out since Russia is very different from the other three, and it would be more coherent to have BTICs, substituting Turkey for Russia. We could then develop the parallel concept of the IRs - energy-rich non-democracies with serious problems: Russia and Iran). But another case in point (and it is the relevant one for this post) emanates from a McKinsey report which came out in the summer which was entitled Sweden's Growth Paradox.

Now first it is important to take note of the fact that McKinsey have a lot which is very much to the point about Sweden in the report, especially related to sustainability in the conext of population ageing:

Second, demographic change will put Sweden's public sector under intolerable pressure unless its productivity improves. An aging population will require more welfare services—paid for by taxes levied on working-age people, whose share of the population is falling—and technical developments in health care constantly increase the demand for it. If nothing else changes, the resulting increase in welfare costs would become too large to finance through the current tax system in only 10 to 20 years. Even our base case scenario indicates that the municipal income tax rate would rise to roughly 50 percent over the coming 20 to 30 years, from about 30 percent today, unless productivity rises. Since the taxpayers are hardly likely to accept such an increase, the quality of public welfare and health care services would have to decline.

So I want to be clear: Sweden obviously needs reform, this is not at issue here.But in this post I want to focus on one simple theme (or meme) in the report (For a review of some of the recent blogsphere 'noise' on Sweden in this context, see postscript). Essentially the idea in question is the following one:

Overall Sweden's inability to create new jobs has a negative effect on economic development and creates a growing de-facto unemployement. Today more than 15% of the able working population is without full employment. This includes students who want to work but remain at university since they cannot get a job, part-time employees looking for more work, and people who are on sick-leave or early-retirement above and beyond the levels seen in and around 1970.
Extract From: Sweden's Economic Performance: Recent Developments Current Priorities Synthesis, May 2006

Basically McKinsey suggest that there is a big market imperfection in the way young people in Sweden take choices about education, and essentially young Swedes are getting too much education. This idea is a widely accepted one, and none other than RGE Monitor's very own Brad Setser recently argued something similar in an Afoe thread:

I would say neither the US or France has produced enough jobs -- and certainly not enough jobs that match the wage expectations of their native-born population -- over the last few years, despite a similar housing boom. in france that shows up in persistently high unemployment rates, and, i suspect, in a tendency to stay in school a bit longer than is required just to create human capital (lots of folks seemed to do several DEAs while looking for a job back when I studied in france). In the US, this shows up in a falling employment to population ratio.

Now the interesting thing here is the idea of 'over-education'. This would seem to be a rerun of the young and ’overeducated’ argument first run by Lester Thurow some years back (I suspect it may also be connected with Easterlin’s version of cohort theory). The thought would seem to be that in unfavourable labour market conditions, young people in a 'challenged' cohort may be encouraged to continue their education by the difficulties of finding a job.

Now this interpretation may have had a certain validity in the US in the 70s (and in the presence of the boomer generation) but it isn’t clear that it is the case in Europe today where there are small and not 'boomer' cohorts. One of the problems is that no-one really knows how much education you need. US thinking seems to veer towards the lower end of the band, and to then - given the uncertainty - let the markets decide the rest, but as people from Paul Romer to Alan Greenspan have been arguing, the market mechanism seems to be resulting in an under-educated US population, heavily dependent on importing qualified labour.

I think this is to get thinks the wrong way round. What we may have in operation in Europe today is the confluence of two market imperfections which in combination may, via the law of unintended consequences, just serve to cancel each other out. The first imperfection undoubtedly comes from rigidity in the labour market, and the other from a time consistency problem in the way in which a well-functioning market would determine the level of education needed in the context of declining age cohorts.

Let me explain.

Basically in the US and in Europe what is currently being widely proposed is a model of skilled inward migration. This, I think, is a mistake and leads to the sort of resentment towards immigarnts that Nandan is worried about.

If we want to correct (in the short run, in the long run this will be impossible) imbalances in the population pyramids, what we need are lots of unskilled migrants. So one reform that is badly needed in many parts of Europe is an institutional one, which makes this possible, and which facilitates a massive expansion of relatively low wage employment.

OTOH what is also needed is reform in the educational system which means that young people in developed economies get a better eduction, and are thus well-placed to take advantage of the supply-side push created by the migrant influx and which will have a demand-side impact as people are needed further-up the value pyramid.

This kind of migration is much more sustainable, since the local population can clearly see themselves to be beneficiaries.

If you don't have this 'dual' process, then you risk having the kind of problem which exists in Italy (see this post) where according to the OECD:

Compared with other OECD countries, an above-average proportion of the Italian population has only lower-secondary education. This is especially true for older age-groups, but it is also true for younger ones. Forty per cent of 25-34 year-olds are in this category compared with an EU and OECD average close to 25%, and the results of the OECD Programme for International Student Assessment (PISA) show that Italian 15-year olds have attainments well below the average in particular in mathematical and problem-solving skills. There is a high proportion of youth which is in neither education nor the labour force, suggesting a difficult school-to-work transition. The risk of unemployment later in life is also considerably higher for those with only lower secondary education.

Furthermore, a smaller proportion than the OECD average has completed tertiary education, even though a relatively high proportion embarks on it. Years spent in obtaining an undergraduate degree are greater than the average, raising the opportunity cost of tertiary education and discouraging the formation of high level skills. The demand for high-skill workers may be hampered by the specialisation of Italian industries in low tech sectors and the small size of Italian firms, which reduce their R&D spending capability. At the tertiary level, a problem is an insufficient number of younger professors, for whom there are barriers to entry. Academic appointments lack transparency, promotion is not always linked to productivity, and Italy spends far less than the OECD or EU average on research and development, and significantly less on tertiary education. As a consequence Italy suffers from a pronounced net brain-drain.

So what we need to think about here is sustainability, demographic sustainability, social and political sustainability, and economic growth sustainability. Effectively what I am proposing is a new model for migration, and one which puts up-front the real needs of the developed economies. If this path is not followed then what we risk is a permanent drift down the value chain, as the scarce resource (young people) is over-priced in under-performing activities (someone has to care for the growing number of young people, and look, for eg at the growing importance of the health sector in the US economy). This creates, of course, a growing sense of frustration and increasing inequality, and a permanent feeling that what we have is a weak labour market, rather than the reality which is, of course, a shortage of young people.

Postcript: There has been a lot of commentary around the blogs over the last week on the change of government and the need for reform in Sweden. New Economist has given some pretty thorough coverage (see here, and here, and here), while my Afoe co-blogger Emmanuel has a rather different take, and indeed links to an article in the Economist which cites - guess what - the Mckinsey report. Also Mark Thoma recently had a post on Economists View which is not entirely irrelevant to the point at issue here. Basically the quality of education received by large sections of the US population needs to be improved, so it isn't only Sweden which is in need of reform.