23rd November 2010
Policymakers trying to find a fair resolution to the current European debt crisis might benefit from the insights of a taxpayer beamed back in time from 2050. That may be impossible, but economists are attempting the next best thing by discounting pension promises and tax revenues and comparing them with today’s more visible debt burdens. The current woes pale in comparison.
According to a recent Standard & Poor’s study, today’s paragons of fiscal virtue are only a couple of decades away from becoming indistinguishable from basket cases like Greece. For example, prudent Austria, which currently has debt of just 72 percent of GDP, would see its borrowings balloon to 329 percent by 2050 if it honours promises to its ageing population.
It’s easy to dismiss this exercise as science fiction. After all, pension promises don’t have to be kept. Welfare budgets can be cut and taxes hiked. S&P’s time travellers concede that their gloomy projections only apply if no reforms take place.
Germany has already begun the belt-tightening: Academics at the University of Freiburg estimate that in 2001 the country’s pension liabilities – even after subtracting the present value of future contributions – stood at 200 percent of GDP. After six years of reforms, including raising the retirement age to 67, the figure had dropped to 90 percent. However, that still dwarfs Germany’s “official” debt-to-GDP ratio of 62 percent.
Imperfect as they are, these accounting exercises highlight the pain still needed to balance the books in the future. Another Freiburg study found that Germany would have to increase annual tax revenues by nearly 15 percent to pay for its pared-back promises. The UK needs to hike its annual tax take by almost 20 percent to make its finances sustainable. It’s troubling enough that these figures were calculated using census and mortality data half a decade out of date. But they also don’t take into account countries’ increased debt burden resulting from the financial crisis.
Generational accounting highlights the conflict between bailing out banks and the recipients of unfunded welfare and pension promises. That is one of the reasons why today’s bailouts are so politically contentious. One day, pensioners and bondholders alike will have to share the pain. That fight will make today’s debt squabbles seem minor.
