Bad luck for our children

Philip Booth discusses the growing debt burden in the Yorkshire Post

The economics world is focusing again on fiscal policy and the level of government borrowing. In particular, battle lines are being drawn between those who believe that increasing government borrowing will help the economy and those who, like me, believe that more borrowing will add to our serious economic problems.

However, this focus on whether increasing borrowing will lead to a short-term increase in growth obscures the essential nature of the national debt. When the government borrows it spends now and sends the bill to a future generation of taxpayers: the government takes a conscious decision to impose the costs of the current generation’s consumption onto a future generation.

To do this is inequitable. But it would not be so bad if our national debt was only equal to the figure that Alistair Darling has announced. Real public borrowing goes way beyond the figure that governments admit to in their national accounts.

The most obvious hidden item is that from future pension liabilities. In state pension systems there is no fund accumulated to meet future pensions. Instead, the current generation of workers promises itself pensions which are to be paid by future generations of taxpayers. The French call this inter-generational solidarity because the implicit agreement is that the next generation of voters will vote itself pensions paid from their children’s taxes. And so it goes on…

The problem is that, in most European countries as well as in some under-developed countries, the future pension commitments are enormous and the populations of many countries are expected to shrink.

The official government debt for the UK is about £650bn and this is expected to soar due to Alistair Darling’s planned profligacy and the successive banking rescues. But, according to IEA figures, pension liabilities to public sector workers are about £1,200bn and other state pension liabilities are of the order of £2,500bn. All told, we are passing on over £4,000bn of government debt to the next generation. This is a staggering figure of around 270% of national income.

Will our children be able to afford to repay this debt? Two preconditions are probably necessary if the debt is not to lead to huge problems for future generations. The first is that we have a healthy, thriving economy. The second is that the working population does not fall dramatically compared with the number of pensioners.

In fact, we are certainly walking on a cliff edge. Public spending on health, welfare and education are all rising rapidly and the private sector of the economy is ever-more bound up with regulation and higher taxes. Quite apart from the fall-out from the current financial crisis the burdens being placed on the private sector of the economy are huge. The additional burden of financing the various commitments to which governments have more or less bound future generations might push us over the edge.

The demographics are going wrong too. State pensions may be sustainable if the proportion of older people does not rise. The problems arise when the number of old people rises faster than the number of people of working age. The taxes of the workers might then not be sufficient to pay the pensions of the retired. We may well have just such a time bomb ticking in the UK – indeed in much of the world.

Already, in the UK, we have more people above pension age than there are children, and the population is going to age quite rapidly. In continental Europe and Japan the situation is worse with some countries in the EU looking at demographic implosion. Many under-developed countries have stable or growing populations, as does the US, but China is facing what is often known as the 4-2-1 problem: one worker could be supporting two parents and four grandparents as the combined effect of increased longevity and the one-child policy take hold.

So, state pay-as-you-go pension schemes can be sustained if the birth rate does not fall. The problem is that, according to a recent IEA study, Pension Provision: Government Failure Around the World, the very existence of state pension schemes tends to lead to lower birth rates as the need for family support in old age is reduced. The evidence for this tendency is very strong.

One solution to this problem is pension privatisation and the greater use of funded pensions. This has been proposed by the World Bank and the idea has been rolled out in a number of countries – indeed, in the UK, we had a thriving private pensions industry until 1997.

Such reforms have their merits. But governments seem to throw spanners into the works at any turn possible. From the over-regulation and over-taxation of pensions in the UK to the recent complete expropriation of private pension funds in Argentina, private pension funds have been prevented from doing their job by interfering politicians.

The IEA study suggests that the best approach is just to have an economy with incentives to save. Governments should resist labelling particular types of saving "pensions" and giving it special regulatory and tax treatment.

Regardless of this, we have a serious problem in the UK. We are passing on a large burden of pension obligations to our children without having provided them with the means to meet them. One hundred years from the institution of the state pension, an unsustainable model is beginning to crumble.

Philip Booth is Editorial and Programme Director at the Institute of Economic Affairs and editor of Pension Provision: Government Failure Around the World.