Governments Should Make Coordinated Cuts In Social Security

An internationally coordinated cut in social security spending would generate significant gains for society – substantially larger than any that might derive from frequently advocated macroeconomic goals like ''ending boom and bust''. That is the contention of Professor James Pemberton, writing in the latest issue of the Economic Journal. Acting independently, he argues, governments make policy decisions that are too egalitarian. And while current talk about harmonising benefit levels across the European Union seems to be concerned with maintaining current levels of social security spending, the real gain would come from harmonising down.

Pemberton''s argument revolves around the inverse relationship between the level of social security and national savings: an increase in a pay-as-you-go (PAYG) social security system, where current tax revenue is used to finance current claims, results in a reduction in national savings. This in turn raises world interest rates and lowers per capita incomes.

When each national government acts independently, the indirect effects of their actions are ignored. In this case, the impact of their individual decisions on world interest rates is negligible even though collectively they exert a considerable influence. Governments are aware of this relationship but they – rationally – choose to ignore it. But if all countries reduced social security provision together, the resulting rise in world saving would lower world interest rates, with beneficial effects for each national economy. The result in terms of social security would be that claimants would receive a smaller share of a bigger pie – and, according to Pemberton''s results, bigger to an extent that it more than outweighs the smaller share.

The mechanism through which reducing PAYG funded transfers raises national saving is that people who previously received state benefits will now alter their behaviour by increasing their saving in order to compensate for the loss of, say, a future state pension. This depends largely on people''s attitude towards their future, which is not uniform: some proportion of the population are forward-looking life cyclers who save for their future; and the remainder are ''live for today'' shortsighted myopes who do not.

Pemberton''s results show that social security coordination always results in a welfare gain for society. And policy coordination always means a reduction in social security spending, which in turn means life cyclers will always be better off. But coordination is unambiguously inegalitarian: in absolute terms, myopes can lose or gain, depending on their numbers, but in relative terms they will always be worse off.

Since governments in many countries are under pressure, for both political and economic reasons, to reduce public expenditure on social security, this is an issue of immediate practical importance. The launch of monetary union within the European Union has led to growing discussion about the scope for further cross-national cooperation. Social security could be one such context where cooperation pays off.

''Social Security: National Policies with International Implications'' by Jim Pemberton is published in the July 1999 issue of the Economic Journal. Pemberton is Professor of Economics at Reading University.