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The Political Future of Social Security in Aging Societies.

The Political Future of Social Security in Aging Societies Vincenzo Galasso The MIT Press: Cambridge, MA, 2006, 257pp, $35.

Comparative Economic Studies (2007) 49, 699-701. doi:10.1057/palgrave.ces.8100223

A pressing issue facing all OECD states is the sustainability of increasingly expensive social security systems. To be sustainable politically, according to Vincenzo Galasso's new book, a social security system must be 'supported by a majority of the members of the Parliament, or alternatively of the electorate, in all its features'. He argues convincingly that any changes must go beyond economics into the realm of politics because policymakers will have to reconcile the conflicting interests of different generations. In particular, he assumes that the growing ranks of the elderly will put pressure on elected officials to increase pension spending.

Six case studies (France, Germany, Italy, Spain, the UK, and the USA) each offer a detailed explanation of that country's social security system, including institutional characteristics (eg, contribution rates, benefit formula and indexation, eligibility requirements, and official retirement age), recent reforms, and a long-run forecast of its sustainability. The forecasts employ a simulation model based upon estimated parameters for each country, such as population growth, average employment rates, age of the median voter, productivity growth, current contribution rates to social security, and retirement age. Changes in median voter's age yield quantitative estimates the political constraints will have on the sustainability of each country's system. Galasso uses a simple majority voting model to replicate each economy's initial position. He then simulates a comparison between the initial 'steady state' of 2000 and another one for 2050. These simulations demonstrate to Galasso's satisfaction that not one of these countries has a sustainable system under current rules and projected parameters.

In France, for example, to improve the financial strength of the system, the retirement age for active labor market 'outsiders' (especially the young) has been increased along with the length of the contribution period. As in a majority of these countries, most of the increased cost of recent reforms will be borne by current labor market 'outsiders'. Moreover, model simulations for France predict that political pressure will push up the pension system's generosity. The range of acceptable reforms will be constrained by the growing size of the pensioner class.

Galasso argues that recent German reforms that link pension benefits to the pensioner/active worker dependency ratio will be inadequate without increased taxes. Italy has also shifted much of the cost burden to younger workers, with middle-aged workers avoiding the cost of recent reforms. Meanwhile, employers continue to face a rising tax wedge. Hence the long-run economic sustainability of Italy's pension system remains suspect, especially given Italy's rapidly ageing population and the government's power to modify the system.

Spain's system is even less sustainable on account of that country's sharply reduced fertility rate combined and steady increase in average life expectancy. Galasso see virtually no impact from 'silent' reforms there on the future political sustainability of Spanish social security. Substantial increases in contribution rates or other changes are inevitable.

In the UK and USA, security system sustainability problems are not so serious, owing to more individual savings, higher average retirement ages, and much higher employment rates among those over 60 years old. However, a higher current and projected risk of household poverty will likely increase political pressure to boost public pension spending. In the USA, where a growing number of private companies have reneged on promised pension benefits, a potentially explosive situation may arise.

Although each country's demographic parameters and forecasted sustainability differ, in each the long-run prediction is 'gloomy' without substantive reforms. Galasso believes the most politically acceptable reform for most of these democracies will be to increase the retirement age, though he also suggests some specific reforms in each case.

The strengths of this book include consideration of many key factors that will affect the social security systems' long-run sustainability, especially the influence of changing demographics on voter patterns. Some viewpoints have regrettably not been included, notably Mancur Olson's, which would have strengthened Galasso's emphasis on the need to account for political realities. Though all long-run forecasts are questionable, Galasso's parameters do not include an estimation of GDP growth nor private sector job creation, both of which would influence overall fiscal budget balances. The analysis could have been expanded to include the dynamic process in many high-income countries: lower GDP growth rates, changing demographics, rising tax rates (partly to fund-rising pension obligations), lower job creation, and rising fiscal deficits. These are affected by the international product life cycle that now favours east Asian producers over west European and North American producers. Galasso assumes improved quality of education will boost future job creation in these six countries; this is questionable, given evidence of declining quality of higher education in some of these countries, particularly France and Italy.

Unfortunately, Galasso's book does not address the successful pension reform case of Sweden, which has linked pension benefits to the pension dependency ratio. In setting up what Galasso calls a 'sustainability factor', the Swedes have established both economic and political sustainability, in my opinion. These shortcomings notwithstanding, Galasso provides an excellent contribution to the growing literature on social security system sustainability and reform.

James Angresano

Albertson College of Idaho, Caldwell, Idaho, USA
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Author:Angresano, James
Publication:Comparative Economic Studies
Date:Dec 1, 2007
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