Reforming the European Welfare State

The deep economic crisis in Europe has shaken the foundations of the European Monetary Union. Many analysts have voiced doubts about the future viability of the euro. However, the economic storm has not only prompted worries about the currency; it has also revived and accelerated the debate about the sustainability of one of the social foundations of the Old Continent: the so-called "welfare state": That is to say, the socio-economic organizational model that provides a more equitable sharing of benefits and wealth among the entire population by extending certain social services and guarantees to every citizen.

The enormous budget deficits of those European nations that have been most damaged by the crisis have forced their political leaders to go beyond merely debating the issue. They have taken action in order to convince global markets that these countries' economies are sustainable and solvent, given the danger that they may no longer be able to finance their needs. To settle governmental accounts, nations such as Italy, Spain, Portugal and Greece have decided to cut public spending in areas considered basic to the welfare state: health care, education and social security, such as unemployment subsidies and pensions.

German chancellor Angela Merkel warned recently in an interview with the Financial Times that Europe must "work very hard" if it wants to maintain its system of social welfare while also being globally competitive. She said that in order to survive globalization, Europe must invest more in research and education, as well as reform taxation and labor regulations. "Europe today constitutes a little more than 7% of the world's population and generates 25% of global GDP, but it needs to finance 50% of all global social spending, so it is obvious that it will have to work very hard to maintain its prosperity and its style of life," Merkel noted.

Is Europe's current model of a welfare state sustainable? "In some respects, it is, but it will be hard to sustain other aspects without some sort of deep reforms," according to José Vicente Rodríguez Mora, an economics professor at the University of Edinburgh. He adds that the crisis of the welfare state is more political than economic. "The welfare state is sustainable only if the social consensus about its value is restored," Mora notes. "Nowadays, there are a lot of people — in general, people with more resources — who don't agree that [the welfare state] is the best option for them or their children. That lack of consensus can't continue" if the welfare state is to survive.

Antonio Cabrales, professor of economic analysis at the Carlos III University of Madrid, suggests that some pieces of the welfare state, notably health care and pensions, are facing challenges due to the continent's aging population. This situation "forces us to make changes, whether we like it or not."

Rafael Muñoz de Bustillo, professor of applied economics at the University of Salamanca, points out that discussion about the sustainability of the welfare state "often arise from an ideological position, and depend on the criteria that people have concerning what kind of society that want to have." He adds that when countries are in an economic growth scenario, or even when per capita income and technological progress remain steady, "it is hard to imagine that you are not going to be able to maintain the social protection mechanisms that have been accessible for lower-income people in the past. Obviously, when there is an economic collapse or environmental catastrophe, for example, things would change. However, I don't believe that is the scenario that people think about when they talk about the unsustainability of the European welfare state."

An Unsustainable Expense

According to the latest data from Eurostat, the European Union's office of statistics, in 2010, measures for social protection — such as unemployment assistance, health care and retirement, education —  represented the largest single slice of public spending for the member governments of the region; an average of 19.9% of the EU's entire gross domestic product (GDP). Spending on social protection varied from a high of 25.4% of GDP in Denmark, 24.2% in France and 23.9% in Finland to only 11.7% in Cyprus and 11.2% in Iceland. As a whole, EU countries spent 7.5% of their GDP on health care, as well as 6.5% of their GDP on general public services and 5.5% on education.

Social expenditures have continued to grow throughout the past two decades because of the new realities imposed by modern society and especially as a result of demographic changes. For example, there has been a decline in the "active life cycle" of citizens, and an increase in their "passive life cycle." This is because people spend a longer portion of their lives as students; young people are joining the workforce at a later and later age. Another factor is the increase in life expectancy. This has meant that the system for providing government benefits is being sustained by an ever smaller number of working people whose economic contributions have to be maintained by a larger and larger number of inactive people, such as retirees.

In addition, during the current economic crisis, increased unemployment has led to an even greater uptick in social spending, which has led to growth in the line item in various countries' budgets that is dedicated to paying unemployment benefits.

The Necessary Changes

The central issues facing the European welfare state are "problems involving fiscal competence: the efficiency of the tax system when it is time to collect taxes from the public — which weakens the financing of the welfare state — along with a lack of commitment to defend the European social model," says de Bustillo. "The rest of the problems, such as the so-called aging of the population, have a solution if there is a clear commitment to defend the system."

Carlos Gómez Bahillo, director of the department of psychology and sociology at the University of Zaragoza, notes that, despite all of the difficulties facing the European welfare state, "Social welfare benefit policies are not expected to disappear in European countries." However, he adds that such policies will provide protection at a level that is "a bit lower" than in the past. "People will have to give up a certain degree of coverage, which will wind up being inferior." 

On the other hand, Bahillo predicts that "the free character of many public services, including assistance programs, is not going to be guaranteed in a generalized way. It will be many years before we are going to be able to have the quality of life and welfare that we have enjoyed until a few years ago."

Rodríguez Mora agrees that one of the most important changes that will have to be made is in the system of retirement pensions. "At least in Spain, some serious reforms are needed, and they will create a model in which pensions depend a lot more on contributions and are much more capitalized." When it comes to unemployment subsidies, "surely they should change and decline in Spain since they are a serious problem." However, at the same time, Mora notes that "we cannot do with such high rates of unemployment as we have currently."

With regard to pensions, Cabrales suggests that "they should move toward a combination of extending the number of working years, increasing taxes and reducing retirement benefits. Exactly how many changes [the government] ultimately decides to make will be a political decision." When it comes to health care, however, Cabrales notes that circumstances are much more complex. "There are some obvious measures, such as getting people to improve their living habits, which is a cheap way to alleviate problems," Cabrales says. "But there will also have to be more emphasis on dealing with the cost effectiveness of all treatments and procedures and other organizational improvements. In addition, it is important for the economies [of the EU member-states] to become more productive in order to sustain more people with fewer workers, and that means spending more money in the short-term on education and innovation."

The Situation, Country by Country

According to Cabrales, these sorts of challenges "are more serious in those countries that have the most acute demographic problems, and have more problems with education and innovation, which make them less productive." He adds: "I am afraid that Spain and Italy are the worst [European countries] with regard to those two things."

Mora agrees, noting that "For Spain, things are awful. They will have to increase their general taxes to sustain their expenditures on education and health care, which we have become used to. They can do that, but not right now, and not in one big move. And the system of retirement pensions seems unsustainable," he warns. On the other hand, he says that the Nordic countries are in the best shape because "they made big reforms during the 1990s."

More specifically, the Nordic countries are the best examples for the rest of Europe to follow, according to the experts. Universalism is one of the main characteristics of the Nordic model of the welfare state, meaning that there is more generalized access to welfare state services and fewer conditions regarding access to social benefits. Another central characteristic of the Nordic countries is that they are sustained with high levels of taxes and high social contributions from both employees and employers. Usually, their services are very efficient and are characterized by high quality.

Rodríguez Mora adds that the rest of Europe "will have to imitate the Scandinavian model." Along the same lines, Bahillo cites Denmark, Finland and Luxembourg as models for the entire European Union to follow and imitate. More specifically, de Bustillo says that the right path forward for each nation "will depend on the ideal vision of society that each country has in its head." While he generally agrees with his colleagues, he adds some nuances. "For me, the Scandinavian model seems a particularly good example to follow because it combines competitiveness with solidarity and high levels of protection regarding risks of illness, unemployment, old age and so forth. The issue is that in order to have this model, you need — among other things — to be ready to support high levels of taxation. On the other hand, history shows that it is not easy to translate institutions from one country to another country, and institutions must be adapted to local conditions."

On the other hand, the experts dismiss the model of social protection established in the United States, which is characterized by a high level of privatization and deregulation of services. The American model "is not a panacea," notes Mora. "One good example of [this approach] is the health care sector, where the [American] government spends more than many European countries but you don't see any results" in terms of cost containment.

Past experience with the privatization of social policy, "provides us with more low points than high spots with respect to the alleged advantages of private management," de Bustillo says. "The United States, with a health care system based in the private market … devoted 17.6% of its GDP to health care in 2010, compared with 9.6% in Spain. This doesn't seem to be the road to follow if you are trying to reduce your health care costs." Unemployment benefits are something quite different, he adds. "There simply is no private market that winds up being attractive for private-sector firms with respect to protecting people from such a vast number of contingencies" that could lead to unemployment.

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