Which OECD country is the highest social spender?

 

Before answering this question, we need to define what the OECD counts as social expenditure. It is mainly a combination of what we call welfare spending (including pensions) and health spending, but it also includes incapacity-related benefits, active labour market programmes, as well as unemployment and housing benefits. What it is not is just public social spending. In all OECD countries individuals spend some of their own money (either directly or through their employer) on social expenditure. In the UK, for example, private social expenditure exceeded 6% of GDP in 2019 according to the OECD, mainly in the form of pension contributions.

The answer to the question posed by the title, using this data, comes from the diamonds in the chart below.

That France is top is probably not a huge surprise , but that the United States is second (just below France) might. The blue columns represent public (state) social spending, and the US is indeed fairly low here, but the US has the second highest private sector social spending among OECD countries. France is at the top partly because it has a very generous pension system (see this recent post), while the US is so high in part because it has a very expensive (and inefficient) health system.

Given how many hits of the keyboard are spent discussing public spending on health, pensions and other items, combining public and private spending in this way can be a useful corrective. What matters to most people is how big their pension is, or the quality and accessibility healthcare is, rather than the form in which they pay for it.

The OECD splits private social expenditure into two types: mandatory and voluntary.

In countries where private social spending is high, in both Switzerland and Iceland it is largely mandatory, in Canada and the UK it is almost all voluntary, while the Netherlands and the US it is mixed. The last two involve mandatory health payments (Obamacare in the US). Mandatory payments might give consumers some choice over providers, but otherwise mandatory payments are similar to a tax. In the UK the largest component of voluntary social expenditure involves private pensions. Again this gives consumers more choice than any state pension would, but for individuals the option of not buying is hardly advisable, which means they do not have additional money to spend on other things. The big advantage of a state pension over private pensions is that the latter exposes individuals to interest rate risk at the time their pensions need to be turned into an annuity.

So while the choice between public, mandatory private and voluntary private provision is important, the amount of social expenditure from whatever source is at least as important. Of the G7 countries, which spent the least on social expenditure in 2019? In the chart above it is the UK. This has not always been the case, as the following chart shows [1].

Key: In 2010 from top France,US,UK,Germany,Italy,Japan,Canada

In 2010 the UK had the third highest social spending in the G7, but the trend over the following decade has been consistently downwards. Because our Conservative government has been obsessed with cutting taxes and squeezing the state, without much attempt at reducing the scope of what the state provides in the UK, we end up having less spent in many areas (including social expenditure) than most people want. [2]

This is a crucial fact to bear in mind the next time someone moans about how much the state spends on health, pensions or some other item of welfare spending. It is a point I try to emphasise whenever I discuss public spending on health or pensions, or aggregate public spending figures. An emphasis on total social spending is also crucial when looking at data on tax.

According to OECD figures for 2020 for the G7, the country with the highest total tax as a share of GDP is France at 45%, followed by Italy at 43%. Germany is significantly lower at 38%, and then Canada and Japan lower still at 34% and 33% respectively. The UK is at 32%, while the US is lowest at 26%. The UK is a low tax country, with only the US lower among the G7. But as the figures above show, these differences reflect the form of financing of social spending at least as much as the total amount of social spending. Those who suggest that low taxes in the US mean that people there have more money to spend are being disingenuous, because US citizens need to pay, either directly or indirectly, for social goods that are provided free in other countries.

For this reason much of the public debate about the size of the state misses key issues. What should be central to this debate is how types of spending, including social spending, are financed rather than the amount that is spent. For example, is it better for the state to provide most pensions (as in France) or is it better for individuals to pay for their own pension schemes? Is a health service privately funded via insurance companies (either voluntarily or through mandated payments) less efficient than something like the NHS. How much tax people pay will follow from that discussion, yet tax is all too often how such discussions start.

[1] Data for 2019 in four of the G7 countries are not shown here, perhaps because data in the previous chart is partially estimated.

[2] Those who can afford it can try and make up the difference by, for example, buying private medical insurance, but the quality of private sector health care in terms of medical outcomes is highly dependent on the NHS.

Why fiscal consolidations (spending cuts or tax increases) don't reduce debt to GDP ratios, and why politicians continue to tighten at the wrong time

 

The claim often made for fiscal consolidations (cuts in public spending or increases in taxes) is that they are required to reduce the ratio of public sector debt to GDP. But while fiscal consolidations are likely to reduce public sector debt, they are also likely to reduce GDP, so the impact on the debt to GDP ratio is unclear. Research just published by the IMF suggests that, based on past evidence, the average effect of fiscal consolidations on the debt to GDP ratio is negligible (i.e. virtually zero).

Looking at the study in more detail, the results are even worse for proponents of austerity. By austerity I don’t mean fiscal consolidation in the form of spending cuts, but any fiscal consolidation undertaken when output is below trend. Here is a figure from the study.

On the left hand axis is the probability that a fiscal consolidation will reduce the debt to GDP ratio, where the average probability is 51%. The first column shows that a positive output gap (GDP is above trend i.e. a boom period) turns that probability into 57%. The second column shows that if the world economy is above trend that ratio goes from 51% to 60%. The final column shows that if private credit is high relative to GDP, the probability that a fiscal consolidation will reduce the debt to GDP ratio falls to 42%.

In 2010, all economies were recovering from recession (so the domestic and world output gaps were negative) and private credit was high relative to GDP (although falling rapidly following the financial crisis). So 2010 austerity was significantly more likely to increase the debt to GDP ratio than to reduce it. As many of us said at the time, 2010 was exactly the wrong time (indeed, probably the worst time) to embark on fiscal consolidation, because not only would austerity lower GDP, but it would raise debt to GDP because lower GDP would more than offset lower debt. Which is exactly what National Institute modelling, among others, said would happen back in 2011.

Some have suggested that while that lesson might have been relevant in an environment of low interest rates (where rates can easily hit their lower bound), that era has recently come to an end. This is where a second piece of IMF research, in the same WEO, becomes very relevant. It looks at historical trends in real interest rates, tries to explain them in terms of key drivers, and then assesses where they might go in the future.

The bottom line is that we have not entered a new era. Instead real interest rates are likely to go back to the same low levels that we saw before the pandemic. One reason for this, demographics, is relatively predictable. Another is the global slowdown in productivity growth. Productivity growth is less predictable, but with no pick up in sight continuing modest productivity growth seems like a good assumption. Unless there is something big that is missing from the analysis, the age of low real interest rates (what economists call secular stagnation) is still with us.

In practical terms this means that the trend level of nominal interest rates in the advanced economies, the level that would neither stimulate or depress activity in the medium term and where inflation is at target, is between 1% and 3%. That means that as inflation falls, so will current interest rates. We have not left the era when an economic downturn could easily put interest rates at their lower bound. As a result, it will remain the case that while monetary policy is the first choice for controlling (excess) inflation, it is fiscal policy that needs to be the

first choice for avoiding recessions and boosting recoveries.

The message of this evidence is familiar to anyone who understood macroeconomic theory well before 2010: leave fiscal consolidation for the good times. Yet this is a lesson politicians, and those that advise them, find it very difficult to learn.

So why are so many politicians, and much of the media, so resistant to accepting that fiscal consolidations - if necessary - should be reserved for good times and never undertaken in bad times. A large part of the answer is that, for most politicians on the right, fiscal consolidations are not primarily about reducing the debt to GDP ratio, but instead an excuse to cut public spending and reduce the size of the state. It is what I have called ‘deficit deceit’. No wonder that in the UK over the last 13 years the government’s fiscal rules seem to change very few years, because they are typically chosen to squeeze public spending rather than enhance macroeconomic management.

However I don’t think that is all. The cyclical nature of the government’s deficit (rising in bad times, falling in good) encourages politicians to do fiscal consolidation at the wrong time and discourage them from doing fiscal consolidation at the right time. [1] They do this because deficit targets treat governments like cash-constrained individuals, who if they are short of money have to spend less and if they are flush with money they have to spend more.

In theory this need not happen if credible governments ditch debt targets, and ensure deficit targets are medium term, like a 5 year rolling deficit target. It shouldn’t happen if credible governments ensure this medium term deficit target excludes public investment, allowing public investment to reflect social returns, government missions and the cost of borrowing. It shouldn’t happen if these medium term deficit targets are chosen intelligently, allowing debt/GDP to rise when it makes sense to do so. And finally it shouldn’t happen if these medium term deficit targets are ignored if fiscal policy is needed to avoid a recession, or to stimulate the recovery from one.

That is how sensible fiscal policy would work. If it did, fiscal consolidation would only occur in good times, and it would be effective in reducing debt/GDP. Fiscal consolidation would not happen in bad times, allowing fiscal stimulus to end bad times, and consolidation would only happen in good times if that made economic sense.

But small state politicians are not the only reason why this doesn’t happen. The other reason is the media. Not just the right wing media, that wants a small state, but also the media that likes to think of itself as non-partisan. As I explained here, in the world of mediamacro meeting deficit targets are indicators of ‘government responsibility’, and rolling targets that never arrive just don’t wash. We have a medium term rolling deficit target today, but the media still gives us monthly (!) commentary on the latest numbers for the deficit, with predictable and endless speculation of tax cuts or spending cuts.

This isn’t because most journalists in the media have the wrong model of how economic policy should work, but rather they have no model at all. As a recent BBC report implied, the main feature of much journalism about economic issues is economic ignorance. That is why, for example, ministers can keep asserting that giving doctors or nurses more money would raise inflation without such statements being challenged. (Higher pay for NHS staff or teachers does not put pressure on prices, so it is not surprising that the evidence shows no link to inflation.) If all journalists think they know is government deficits or debt are ‘a bad thing’, then this creates what I have called mediamacro.

Politicians work in a media environment, so many find it hard to combat mediamacro. If the media wildly inflate the importance of deficit targets, and fail to understand why these targets are much more long term than inflation targets, then politicians will be tempted to act as if the media’s view is correct. For this reason deficit targets encourage politicians to do exactly the wrong thing with fiscal policy, consolidating when the economy is weak and the deficit is rising, and undertaking fiscal expansion when the economy is strong and the deficit is falling (or in surplus). [2]

How do you counteract both deficit deceit from the right and mainstream media ignorance? The obvious answer, as Chris Dillow suggests, is to give knowledge an institutional voice, which in this case means enhancing an independent fiscal council. Our own, the OBR, was set up by George Osborne to play a much more limited role. The Treasury farmed out its fiscal forecasting, but none of its macroeconomic analysis. That split makes little economic sense, and it needs to change.

An OBR that was able to provide fiscal policy analysis alongside its forecasts could enhance public discussion of fiscal policy options, and give space for politicians who want to promote good policy to counter media ignorance. That advice could range from acting as a watchdog to stop the government fiddling the process to more general advice about the form of fiscal policy rules. As long as it took its lead from the academic literature and remained independent, this enhanced OBR would improve public debate about fiscal policy, which in turn should help improve policy itself.

[1] Basing targets on cyclically adjusted deficits does not work, because cyclical adjustment is too uncertain.

[2] The example that always springs to my mind here is Spain after the creation of the Euro. Spain should have been running a more restrictive fiscal policy because its inflation rate was above the Euro average, but because the budget was in surplus and because of the centrality of deficit targets in the EZ, the political/media just couldn’t cope with the idea of even larger surpluses.

The poor judgements of Nigel Lawson

 

For someone who has been described as the “economic brain of Thatcherism”, it was inevitable that evaluations of his career would be ideologically polarised. He was after all the person who started privatisation, created the City’s ‘Big Bang’ and who cut top tax rates. Yet in the eyes of history, successful politicians need competence as well as ideology in order to make good decisions and judgements. The view I want to put forward here is that Lawson had an uncanny knack of making bad decisions.

It is perhaps telling that a number of articles following his death contrast his period in office favourably compared to our more recent Chancellors. It has to be said that this is an incredibly low bar. Equally some have focused on his undoubted intellect while in office, and prefer not to dwell on his more recent championing of Brexit and climate change denial. I want to suggest that the Nigel Lawson who was in charge at the Treasury had the same quality of judgement as the later Nigel Lawson who promoted Brexit and climate change denial.

To be fair, let me start with some of the things he got right. Abolishing corporation tax stock relief made sense, and as far as I know no one has thought to bring it back since. Abolishing corporation tax investment allowances survived for a considerable period of time, but they have returned in recent years. He was right to try and align income and capital gains taxes, something today's politicians should note. He was right to want to abolish mortgage tax relief, but Thatcher prevented him doing so. He also fought a long running battle to prevent Thatcher introducing the poll tax.

The first major thing he got wrong was monetarism. He was part of the Treasury team when Thatcher got elected, and although Howe was Chancellor it was Lawson who was the intellectual heavyweight in those initial years. (He moved from the Treasury to become energy secretary in September 1981). Although some people talk about monetarism in ideological terms, here I want to use the term in a more technical way, as a means of stabilising the economy through hitting targets for the quantity of money.

Monetarism didn’t make sense either in theory or practice. In terms of theory it made little sense to set interest rates to hit an intermediate target (some measure of money) rather than the final objective (inflation and output). It was a bad policy in practice because it caused a recession that decimated UK manufacturing, resulting in a prolonged period of very high unemployment. This was never the intention of the policy, because those putting it forward thought it would cause little disruption.

Ironically the 80/81 recession was predicted by initial internal Treasury forecasts. Macro forecasts are notoriously bad at predicting recessions, but for once a key forecast got it right. However the team of politicians and advisors that came with the new government, of which Lawson was a key member, regarded both the model and the civil servants that produced that forecast to be hopelessly Keynesian, so they ignored the warnings. A final desperate attempt to hit monetary targets led to the notorious 1981 Budget, where taxes were raised in the middle of a recession, delaying the subsequent recovery.

With the demise of monetarism, Lawson looked to an alternative intermediate target - the exchange rate. He decided to peg sterling at 3 Deutschmarks from March 1987, at a time when interest rates were too low. In addition, in the 1988 budget he reduced the top rate of tax from 60 per cent to 40 per cent, and to avoid appearing to favour the rich he also continued to reduce the basic rate. This combination of monetary and fiscal largesse, together with a credit boom (see below), meant that inflation doubled from around 5% to around 10% just after Lawson resigned in October 1989. Once again it seems he ignored Treasury advice on this.

In 1986 he presided over the biggest deregulation of the UK’s financial sector: the “Big Bang”. As well as preparing the ground for the failure of UK banks during the Global Financial Crisis thirty years later, it also led to the demutualisation of many Building Societies, with banks increasing their involvement in the UK mortgage market. Both led to much easier credit conditions for UK borrowers, leading to a housing boom. House prices rose 16% in 1987 and a further 25% in 1988. This also increased goods and services consumption, adding to what today is known as the Lawson boom.

In his time in the Treasury Lawson therefore helped create one recession, and laid the groundwork for a second. While his successor’s decision to enter the ERM at an overvalued exchange rate undoubtedly made the 1991 recession sharper than it had to be, some sort of downturn was likely in order to reduce the high level of inflation caused by the Lawson boom.

Of course these major mistakes may have had an ideological motivation, but it is possible to combine political motivations with good judgement. Lawson failed to do that. While Liz Truss as Prime Minister is rightly derided for blowing up the bond market, Lawson played a major role in blowing up the UK economy, twice. Indeed I suspect it is ideology that sustains Lawson’s reputation in many quarters. In reality, although their knowledge and intellects may have been very different, there is a similarity between the arrogance of Truss and Lawson in terms of pursuing ideological convenient but predictably disastrous economic ideas.

Lawson was Chancellor for 6 years, which is a relatively long period, and we can justifiably add an extra 2 for the period from 79 to 81 when he was Financial Secretary. The obvious recent comparison, therefore, is with Gordon Brown (10 years). Brown may have had a degree of luck in presiding over 10 years without any significant fluctuations in inflation or output (there was no boom or bust), but the contrast with a recession and a boom for Lawson does tell us something about both [1]. Of course Brown (as PM) was eventually brought down by the Global Financial Crisis, but arguably the groundwork for the impact of that global shock on UK banks was laid down by Lawson’s Big Bang rather than Brown. [2] In contrast the decimation of UK manufacturing in the early 80s owed a lot to the arrogance of the monetarist revolutionaries who took over the Treasury in 1979, and the Lawson boom of the late eighties rightly bears his name.

It should also never be forgotten that Lawson was Chancellor when North Sea Oil started bringing large amounts of money into the exchequer. Standard macroeconomic theory suggests that a temporary resource bonanza like that should mainly be saved, so that future generations can benefit from it. That is what happened in Norway. This saving does not have to be done by the government, but by using it to cut taxes (the basic rate was reduced from 30 per cent in 1983 to 25 per cent by 1988) Lawson gave no indication to taxpayers that this was a temporary bonus that should be saved. This policy failure can be contrasted with Brown’s decision in 2003 not to join the Euro, which most people would now regard as the right decision.

In 2013 Lawson advocated Britain leaving the European Union, arguing that “economic gains would substantially outweigh the costs”. In 2009 Lawson became chairman of The Global Warming Policy Foundation, a registered charity involved in promoting climate change denial. I hope the account above suggests that both were not some kind of later life aberration, but just more examples of making very poor choices.

So when people argue that we’d be a lot better off if there were more people like Lawson in public life today, I have to disagree. There is no doubt that Lawson was far better qualified than many other Chancellors, and also that he was clever, so why did he get these major judgements wrong? I think a large part of the answer is arrogance. As Julia Langdon writes: “His fierce intellectual approach to all aspects of policy meant that he always gave a higher priority to achieving his aims than to what others thought.” Those ‘others’ it seems included Treasury civil servants, many of whom were his intellectual equal, and who warned him about the mistakes he was about to make. If you take off the ideological blinkers, Lawson’s legacy is getting most major judgements wrong.

[1] By creating the independent Monetary Policy Committee of the Bank of England in 1997 Brown handed over stabilisation policy to others, and until 2007 they did a pretty good job.

[2] To his credit Brown played a major role in bringing that global crisis under control.

What France can teach the UK about Pensions

 

If you read some of the UK headlines, it seems that France is having difficulty adjusting to the reality of longer lifespans. Its previous retirement age (the age when you can get a state pension) was 62, which is well below most other countries. Macron has made that 64, in a reform imposed on parliament. 64 is still relatively low, yet there have been strikes and demonstrations against this change that have been large even by French standards. A rolling strike by bin collectors in Paris has left rubbish on the streets. Commentators are asking whether these protests will bring about the end of the current constitutional order in France.

At a macro level, it makes sense to raise the pension age alongside life expectancy. In most European countries, including France and the UK, state pension schemes are unfunded, which means that today’s pensions are paid for by those working today. If people live longer you either need to reduce the value of the state pension, raise those contributions, or raise the retirement age. Yet while the life expectancy of those reaching 65 increased substantially in the decades before 2010, increases have been more modest since then. The OECD data below is for women in the G7 countries. Note that UK life expectancy has always been low compared to all other G7 countries except the US.

The French pension age was raised to 62 from 60 in 2010, and by 2019 (before Covid) life expectancy at 65 had risen by around half a year since 2010. So the case for raising the retirement age in France from 62 to 64 is not obviously because of increases in life expectancy since 2010. Indeed projections suggest that the French pension system, while it will go into deficit at the end of this decade, will break even again by 2035 without any increase in pension age.

So how does France afford to have a relatively low retirement age compared to other countries? It is not because state pension levels are low. France spends around 12% of GDP on state pensions, which is significantly higher than the OECD average, which itself is above the UK. The answer therefore has to be higher levels of contributions, either directly or indirectly through a tax subsidy. I noted in a recent post that although France had higher levels of productivity than the UK, mean household incomes were not higher, and a major reason for this is that French workers retired earlier. Higher French productivity was paying for a lower retirement age than the UK and elsewhere, rather than higher post-tax incomes.

France has not always been an outlier in terms of having a low retirement age. It was the socialist President François Mitterrand who in 1981 cut the retirement age from 65 to 60. Has France got this trade-off between income and retirement right, as Simon Kuper suggests, and most other countries have it wrong? The strength of popular feeling against Macron’s higher retirement age would suggest French people think so, although it is impossible to know how much of this is seeing a benefit (retiring early) without seeing the cost of that benefit (lower post-tax incomes while working).

The first lesson that France has to teach the UK (and perhaps other countries) is to have that debate. One of the consequences of having a predominantly right wing press and a predominantly right wing government is that early retirement in the UK is seen as a problem, rather than an achievement. Debates over pensions in the UK too often treat contribution rates as given, rather than part of a trade-off between the retirement age and contribution levels. As I have noted before, the UK debate typically fails to place things into an intertemporal context, and instead talks about workers versus pensioners as if workers will never retire.

The second lesson that France has to teach the UK is whether it makes sense to have a national retirement age at all. Once we move from the aggregate to thinking about individuals, the unfairness of a uniform retirement age becomes obvious. If the retirement age was 64, someone who starts work from the age of 18 will work (and therefore contribute) for 46 years before retiring. Someone who has a degree will, if they retire at 64, work three years less but still get a state pension. It would seem to be fairer at an individual level to do away with a retirement age, and instead be allowed a full state pension after working a certain number of years. (The option to retire before that number of years should always be available, but with a less than full pension.)

This unfairness is recognised in France, but not in the UK. France has had a ‘long careers’ provision where those who started working at an early age can retire on a full pension before the official retirement age. That system is strengthened as part of raising the retirement age to 64, so people who have worked for 43 years can retire with a state pension before 64. Thomas Piketty argues that If you have 43 years of service, then you should be able to take your full pension, full stop. [1]

However this idea of replacing a retirement age by a years worked criteria emphasises a different potential unfairness problem, because state pensions are annuities that you receive for as long as you live. If everyone had the same life expectancy, then those who started work early and therefore retired early would receive a pension for longer than those who retired later. How much is this an issue? Just as when you start work varies by (or perhaps even defines) class, so life expectancy also varies by class.

It would be easy to argue that this potential unfairness, created by replacing a fixed retirement age by years of service criteria, doesn’t arise in practice because of an ‘unhappy coincidence’ that the life expectancy of those who start work earlier is shorter by the same number of years than those who work later. The evidence we have from France for those benefiting from ‘long careers’ and therefore early retirement in France is complex, but does not suggest such an unhappy coincidence exists. However, even if there was no difference in life expectancy between those who start work at 18 and those who start work at 21, say, that is not an argument for a common retirement age, because that is obviously unfair to those who start work at 18 and therefore contribute more to their pension with no additional benefit. [2]

If those who started work at 18 can retire on a full pension at 61 through the long career route, why does France have a retirement age at all and why is it being raised? The answer lies in the detail, and in particular the allowances for taking time off to look after children. In this respect the UK system, which gives credit for those receiving child benefit, is more generous than the system in France, although of course it is easier to be generous when the level of the state pension is so much lower. It might seem odd that these details have provoked so much anger, but as Piketty points out if they didn’t affect a lot of people by a considerable amount Macron wouldn’t be using so much political capital on insisting on raising the retirement age to 64.

The controversy in France over pensions has rather little to do with affordability, and instead is about lifetime choice and fairness across class. France was unusual compared to most countries because workers paid more to fund and enjoy a longer retirement, particularly for the working class who started work at 18 and particularly working class women. The danger in ending this is it will create one more weapon for the populist right.

[1] Why does France recognise the unfairness to those who start work early created by a fixed retirement age, while the UK does not? Indeed, why does raising the retirement age in the UK cause so little controversy compared to France. The obvious reason is class, and in particular the lack of political power in the UK for those who didn’t do a degree. Raising the retirement age from 62 to 64 in France primarily affects the working class, because those who did a degree and started work in their early twenties will need and often want to work beyond the age of 64 to get their full pension. It is the trade union movement in France that is leading the protests against raising the retirement age.

[2] One way of dealing with different life expectancies across occupations has been proposed by Ian Mulheirn. He suggests treating the pension as a lump sum that would have to be invested in an annuity, and the annuity provider would adjust for different group life expectancies. My own view is that a government run scheme would be preferable, because private annuities expose pension holders to interest rate risk.