Monday, July 25, 2005

The Welfare-State Squeeze

Japan says it is planning to send astronauts to the moon by 2025. The mission is apparently part of a larger plan to extract minerals from space. At first glance, this seems like a marriage made in heaven: a natural resource-starved nation with a tremendous technological base seems like an obvious candidate to go to another world to get them. Admittedly, it is a formidable engineering task, but so were telephones that can take pictures. Over time private productivity improves owing to human ingenuity, and the Japanese have certainly done more extraordinary things than this in the last 150 years.

But it will never happen. And the reason is not a shortage of imagination. Rather, it is that Japan, like most modern nations, is being slowly strangled by the increasing burden of the welfare state. In the sense I mean it here, this trend has drawn little comment. But the rising burden of state pensions and health care in aging populations is going to result not just in rapidly growing tax burdens, but in a sharp narrowing of the political playing field. Options for spending money that would have been eminently debatable in the flush decades of yore are simply going to be fiscally impossible because of rapidly growing entitlement spending. This spending is going to crowd out not just private-sector economic activity but opportunities for public spending of all kind. Below are OECD data on social spending as a percentage of GDP for several countries:


Japan is simply not going to be spending public monies going to the moon in light of ballooning expenses for promises made when promising was easy to populations now aging much more rapidly than once thought possible. This is a pattern that is repeating itself throughout the industrialized world. Social-welfare spending will increasingly crowd out research, education, law enforcement, and all the other contemporary functions in which governments engage.

The case of the U.S. is particularly interesting. While as a percentage of GDP social spending has been relatively stable, as a percentage of the federal budget it has not. According to the CBO, such spending was 31 percent of the budget in 1970, 44 percent in 1980, 45 percent in 1990, 53 percent in 2000 and 54 percent in 2004. It is common to hear that the inability to fund this or that federal program is due to inadequate taxation of the rich. However, the reason that social welfare spending as a percentage of all that Americans produce has not risen as it has elsewhere is because apart from wartime, the American people simply will not tolerate federal taxation much in excess of twenty percent for an extended period. (It was 20.9 percent in 2000, and after the Bush tax cuts is 16.3 percent in 2004, according to CBO data.) Taxes can rise and fall around the twenty-percent threshold, but entitlement spending grows without relent unless it is periodically restrained by the discipline of lower taxes. People thought that the late Sen. Daniel Patrick Moynihan was nuts when he said that the motivation for the Reagan tax cuts was to starve the federal treasury. But with twenty years’ hindsight that seems to be true, and we are fortunate that it was.

More and more treasured (regardless of their effectiveness) programs are going to come under siege, and the culprit will not be inadequate taxation of the rich but increasing crowding out by Social Security, Medicare, Medicaid and other smaller “entitlement” programs. And the word “entitlement” is unfortunate; no spending is an entitlement in the sense of deriving from natural law or even the Constitution, but is instead an “entitlement” because previous statutes provided for an automatic formula for increasing spending as years go by. But statutes can be repealed as easily as they can be enacted, and so with the 20-percent constraint completely binding the likely future is to be one of trimmed entitlements and reduced government activism in other areas.

Europe and Japan are, unfortunately, another story. In principle it is possible to lower the social-spending burden. Sweden did just that when such spending peaked at an astonishing 36.8 percent of GDP in 1993. But those kinds of cuts are much harder now. In Europe and Japan fertility is dramatically lower, the elderly more and more dominate the population. To see how bad the demographics are, go to the Census Bureau’s global population projections website. Compare the U.S. to Germany, Italy or Japan. The "population pyramids" you will be shown for the latter are close to inverted pyramids. Silke Uebelmesser has written of the imminent "gerontracy," a state of affairs whereby the elderly become such a potent political force that decreasing pensions becomes politically impossible. She predicts that Italy will cross that bridge in 2006, Germany in 2012 and France in 2014. Population aging there means a future of diminished expectations and intergenerational bitterness.


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