The Financial Crisis and its impact on longer term trends in social expenditure

Section 3 above sets the background necessary to assess the possible impact of the current financial crisis on the longer term trends in social expenditure. Potentially unsustainable growth in age related expenditure is dampened in the EU projections by fou key assumptions:

Reductions in current high levels of structural unemployment higher levels of employment,

reduced eligibility for early retirement,

increases in the official retirement rate being reflected in higher employment among older workers and

cuts in pension benefits being carried through

One outcome would be for the impact of the current recession to be purely cyclical. The very high forecast levels of unemployment would decline as the EU economy bounced back. A very optimistic scenario would be for a complete bounce back with the loss in output during the recession being compensated by an off trend recovery in output.

The history of previous large downturns in the labour market give some help in assessing the likely impact of this financial crisis. The large increases I unemployment in the early 1980s and to a lesser extent early 1990’s had lasting effects on most countries in the EU and more widely in the EU.

An important source for analysing the issues faced by social integration policies is the recently released study of inequality and poverty in the OECD – “Growing Unequal? Income Distribution and Poverty in OECD Countries”². The study reports that

in the past 20 years income inequality has increased in three quarters of OECD countries Income poverty has increased in two thirds of the countries

More recently the strongest increases happened in Norway Germany and the United States

The increases in inequality measured by changes in the Gini coefficient are shown in the OECD’s chart below. The OECD’s study shows that the increases are the result of the increasing dispersion of market incomes, gross incomes from labour as well as incomes from capital. In addition there has been an associated widening of savings partly reflecting the ageing of the work force in all countries. This is shown in Figure 7. Redistribution through taxes has dampened the underlying market income dispersion but not offset it.

Figure 6. Income inequality, 1985-2005

Source: Growing Unequal?, OECD 2008

Figure 7. Market income inequality increased faster than disposable income inequality, except in the late 1990s

A further factor in the widening of income dispersion has been the way in which employment growth has been distributed. Alongside growing employment rates especially of women there has been a rise in the number of jobless households and a corresponding growth in two earner households. This is also reflected in the pattern of household formation with growing numbers of single households and especially a growth in lone parent households. Job losses have been felt mainly among those with no qualifications and poor education.

The result of these changes has been a long term structural increase in social expenditure as policies designed to foster social integration have tried to offset the underlying increases in poverty and inequality. The chart below using OECD data on social expenditure shows that the consequences of growing inequality and poverty has been an increase of about five percentage points in social expenditure. This increase seems to be structural and permanent.

Figure 8. OECD Social Expenditure as % age of GDP

The key question facing social policies in the face of the current financial crisi is whether the pressures that are increasing social expenditure will be permanent or cyclical. The background is that the EU and most of the OECD countries are entering the period when populations will age rapidly and bring added pressures on social expenditure. Projections of ageing expenditure in the EU suggest that provided optimistic assumptions are made about the labour market over the coming half century the increases in projected expenditure will be sustainable on average although some countries will be faced with particular challenges.

The assumptions necessary to achieve social expenditure growth are looking less plausible in the light of the consequences of the financial crisis. Recent forecasts of GDP growth are suggesting much larger falls in GDP in 2009 than previously projected and for many EU

countries these falls will be greater than those experienced in the 1980s. The summary forecast taken from the Spring forecast is shown below

Figure 9. Short term EU Economic forecasts

This will lead to increases in social expenditure at a time when the effects of ageing are starting to become apparent. If the financial crisis is a financial symptom of the need to make substantial real economy adjustments it is likely that these pressures will have long term consequences for social expenditure in the EU. The upward shift of five percentage point in total social expenditure seen since the 1980s could easily be repeated. Structural increases of this magnitude would wipe out the hoped for savings from improved labour market conditions in the EU’s long term expenditure projections. In addition the fiscal consequences of sorting out the financial banking crisis will lead to public sector deficits unprecedented in peace time.

All these factors will mean social protection expenditure will be under increasing scrutiny as Governments seek ways of reducing fiscal deficits.

Since the world financial crisis erupted in 2008, it has not only influenced world economics to a great extent, but also impacts on the social welfare of every country. For China, whose