Towards Sustainable Social Sector Expenditures in the New Member Countries of the European Union

Pradeep Mitra*

Keynote presentation at an international conference on Advancing Economic Growth: Investing in Health

Chatham House, London, June 22-23, 2005

*Chief Economist, Europe and Central Asia Region, World Bank

Views expressed are the author’s and do not necessarily reflect those of the World Bank

Contents

Size of Government

Health sector: issues and reform options

Pensions: issues and reform options

Aging and some policy options

Conclusions

Tax revenue is high for income level, especially in Central Europe …

Source: IMF World Economic Outlook database; IMF Government Financial Statistics database;

New member states EU-15; Other high-income OECD*; Middle-income high-performing countries**; *USA, Australia and New Zealand; **The choice of middle-income high-performing countries varies from one chart to the next, in part dictated by data availability. This does not affect the comparisons made.

Tax Revenue of the Consolidated Central Government Including Social Security (percent of GDP) average 00-03

0

5

10

15

20

25

30

35

40

45

0 5000 10000 15000 20000 25000 30000 35000 40000 45000

Latvia

Poland

Lithuania

Slovak Rep. Czech Rep.

Hungary

Slovenia

Estonia

Israel

SingaporeKorea

Hong KongCosta Rica

Mauritius

Thailand Malaysia

Tunisia

… driven by social security taxes

Source: IMF World Economic Outlook database; OECD in figures 2004 edition

* Malaysia, Tunisia, Brazil, Korea and Mexico; ** Greece, Ireland, Portugal and Spain; ***Australia, Japan, New Zealand and USA

Tax Composition Structure, 2002

0

10

20

30

40

50

60

70

Baltic states Central Europe Middle-income highperformingeconomies*

EU cohesioncountries**

Other EU Other high-incomeOECD***

In p

erc

en

t o

f to

tal ta

x b

urd

en

Indirect and unclasif ied taxes (in percent of total tax burden) Direct taxes Social Security

Public spending high for income level in Central Europe …

Source: IMF World Economic Outlook database; IMF Government Financial Statistics database; OECD in figures 2004 edition

New member states EU-15; Other high-income OECD*; Middle-income high-performing countries**; *USA, Australia and New Zealand; **Costa Rica, Israel, Korea, Malaysia, Singapore, Thailand and Tunisia

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

45.0

50.0

0 5000 10000 15000 20000 25000 30000 35000 40000

GDP per capita

To

tal

go

ve

rnm

en

t e

xp

en

dit

ure

(in

pe

rcen

t o

f G

DP

)

Estonia

Lithuania

Latvia

Poland

Czech Rep.

Slovak Rep.

HungarySlovenia

… driven by social benefits, while …

Source: IMF World Economic Outlook database; IMF Government Financial Statistics database; OECD in figures 2004 edition

Economic Expenditure Composition of Consolidated Central Government, 2002

0

2

4

6

8

10

12

14

16

18

20

Baltic states Central Europe Middle-income highperforming economies

EU cohesion countries Other EU

In p

erc

en

t o

f G

DP

Compensation Use of goods and services Social benefits

… capital spending relatively low, …

Source: WB SIMA; IMF World Economic Outlook database

New member states EU-15; Other high-income OECD*; Middle-income high-performing countries**; *USA, Australia and New Zealand; **Costa Rica, Chile, Israel, Korea, Malaysia, Mauritius, Singapore and Tunisia

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

0 5000 10000 15000 20000 25000 30000 35000 40000 45000

GDP per capita

Ca

pit

al

Exp

en

dit

ure

(p

erc

en

t o

f G

DP

), a

vera

ge

199

6-2

00

1

Poland

Estonia

Czech Rep.

Latvia

Lithuania

Slovak Rep.

Hungary

Slovenia

… health spending is comparable to other European countries, and may even be on the low side in some new member states…

Source: WB SIMA; IMF World Economic Outlook database

0

2

4

6

8

10

12

0 10000 20000 30000 40000 50000 60000

GDP per capita

To

tal h

ealt

h e

xp

en

dit

ure

(%

of

GD

P)

EstoniaLatvia

PolandLithuaniaSlovak Rep.

Czech Rep.

Hungary Slovenia

New member states EU-15; Other high-income Europe* *Switzerland and Norway

Amongst a wider group of comparators including well performing middle-income countries health spending is not out of line …

Source: WB SIMA; IMF World Economic Outlook database

New member states EU-15; Other high-income Europe*; Middle-income high-performing countries**; *Switzerland and Norway; **Costa Rica, Chile, Israel, Korea, Malaysia, Mauritius, Singapore and Tunisia

0

2

4

6

8

10

12

0 10000 20000 30000 40000 50000 60000

GDP per capita

To

tal

healt

h e

xp

en

dit

ure

(%

of

GD

P)

Estonia

Lithuania

Slovak Rep.

Latvia

Czech Rep.

Hungary

Poland

Slovenia

… while health outcomes are broadly in keeping with income level

New member states EU-15; Other high-income OECD*; Middle-income high-performing countries**; *USA, Australia, New Zealand, Canada, Switzerland and Norway; **Chile, Costa Rica, Israel, Korea, Malaysia, Mauritius, Singapore, Thailand and Tunisia

Source: IMF World Economic Outlook database; WHO Statistical Information System

Expected years spent in poor health (for males at birth)

5

6

7

8

9

10

11

0 5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 50,000

GDP per capita

Exp

ecte

d a

vera

ge

ye

ars

in

po

or

he

alth

fo

r m

ale

s a

t b

irth

Lithuania

Latvia

Slovakia

Estonia

Poland

Hungary

Czech Republic

Slovenia

Luxembourg

Denmark

USA

Issues in the Health Sector

However, commitments are higher than actual spending - health sector indebtedness is growing – and is particularly severe in the Visegrad countries. Only Estonia and Latvia, among the Baltic states, and Slovenia in Central Europe have managed to exercise adequate expenditure control

Amongst the Visegrad countries, Slovakia has managed to reduce the recurring deficit in the health system (through introduction of user fees, changes in pharmaceutical procurement, and hospital restructuring)

Going forward, advances in medical technology, inter alia, will generate pressures for higher spending

Some options to contain upward pressures on health spending

Address oversupply of hospital infrastructure (debt growth is particularly visible in regions with excessive or concentrated oversupply of hospital beds) – this on the agenda in most countries but progress slow in most

Rationalize benefits package (currently generous by European standards), including through restricting services available for free (co-payments for care are limited in the Visegrad countries except Slovak Republic)

Better management of pharmaceutical expenditure – most countries regulate price however very few have made progress in limiting quantity (usage)

While pension spending does not appear to be high in the European context…

Source: “International Patterns of Pension Provision” by Palacious and Parrales-Miralles, 2000; IMF World Economic Outlook database; EUROSTAT

0%

2%

4%

6%

8%

10%

12%

14%

16%

0 10000 20000 30000 40000 50000 60000 70000

GDP per capita

Pen

sio

ns a

s a

sh

are

of

GD

P

LithuaniaEstonia

Slovak Rep.

LatviaCzech Rep.

Hungary

Poland

Slovenia

New member states EU-15; Other high-income Europe* *Switzerland and Norway

….amongst a comparator group which includes well-performing middle-income countries pension spending looks high in Central Europe

Source: “International Patterns of Pension Provision” by Palacious and Parrales-Miralles, 2000; IMF World Economic Outlook database; EUROSTAT

New member states EU-15; Other high-income Europe*; Middle-income high-performing countries**; * Switzerland and Norway; ** Chile, Costa Rica, Israel, Korea, Malaysia, Mauritius, Singapore and Tunisia

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

0 10000 20000 30000 40000 50000 60000 70000

GDP per capita

Pen

sio

ns a

s a

sh

are

of

GD

P

EstoniaLithuania

Slovak Rep.Latvia

Czech Rep.Hungary

Slovenia

Poland

Some Issues in Pension Spending:

High spending is partly a legacy of transition – pension systems were used to ease economic restructuring, resulting in very high beneficiary to population ratio

Unlike health, pension reforms in new member states (except Czech R and Slovenia) have set them on path to sustainability

In addition to reforms in these two countries, options for further pension reforms included: further raising retirement ages (currently among lowest in Europe), curbing benefits per year of service (currently among highest in Europe), and changes to indexation to give greater weight to protecting real incomes of pensioners)

Curbing high labor taxation and social benefits is made more urgent by shrinking labor force and growing elderly

Working age population

Elderly population

Source: UN Population Prospects 2004; WB staff estimates

Senior dependency ratios deteriorate continually and are similar to EU-15, worse than US and better than Japan

Source: UN Population Prospects 2004; WB staff estimates

Note: Senior dependency ratio is equal to share of those above 65 to working age (15-64)

In addition to raising retirement age, migration could be partial solution for most new EU members …

Current migrant* share and additional stock to maintain 2020 overall dependency ratio** at current level

Source: UN Population Prospects 2004; WB staff estimates

* Any foreign born resident is defined to be a migrant. ** Overall dependency ratio is equal to children (under 15) plus seniors (over 65) divided by working age (15-64)

0%

10%

20%

30%

40%

50%

60%

Baltics Japan USA New EU CentralEurope

EU 15 . Latvia Estonia CzechRepublic

Slovenia Poland SlovakRepublic

Hungary Lithuania

Current 2005 dependency ratio, 2005

Current US share of migration

… together with increased labor force participation rates

Changes in labor force participation rates to maintain 2020 overall dependency ratio at current level

0

10

20

30

40

50

60

70

80

90

100

New EU Baltics USA Poland Hungary Latvia Estonia

Current Additional

Lisbon target

Source: UN Population Prospects 2004; WB staff estimates

CONCLUSIONS

The size of government in the Visegrad countries and Slovenia is too large owing to generous social benefits financed by high social security contributions, and has the potential to slow income convergence

Health outcomes, while poorer than EU-15, are broadly in keeping with income levels. So is health spending, but ...

Containing pressure on health spending arising from population aging and advancing medical technology and improving the effectiveness of spending requires reforms such as (i) addressing oversupply of hospital infrastructure, (ii) rationalizing the generous benefits package provided free and (iii) improving management of pharmaceutical expenditures.

Pension spending, while not high in a European context, is high for income levels, particularly in Central Europe (the Visegrad countries and Slovenia). However, pension reform in all but Czech Republic and Slovenia has improved fiscal sustainability. In addition to reform in these two countries, further reforms in all countries could include (i) further raising retirement ages, (ii) curbing benefits per year of service, and (iii) changes to indexation to give greater weight to protecting real incomes of pensioners.

Continuing health and pension reforms are needed to create the fiscal space for capital spending (including infrastructure), which is low compared to well-performing middle-income countries.

Broader policy options to contain the dependency ratio at current levels in the face of an aging population in the new member states include an increase in immigration and raising the rate of labor force participation.

CONCLUSIONS (cont.)