Old before their time

Economics focus

Old before their time
Mar 3rd 2005
From The Economist print edition
Source

Labour-market reform remains the key to higher living standards

IN MANY European countries, calls for economic reform are heard more often than they are heeded. However, a new report by the OECD, “Economic Policy Reforms in OECD Countries: Going for Growth”, deserves attention. It may aid reform by providing more detailed advice and better measures of relative economic performance.

That is timely, because the need for economic reform is pressing. In the post-war years to the 1980s, the world's richest economies were mostly converging towards similar levels of income per person. During the 1990s, however, that convergence came to a halt. Nowadays, income per person in the euro area is around 30% less than in America (see chart). And average growth rates in the euro area lagged behind America's in the ten years to 2003. If that continues, as it did last year, the gap in living standards will continue to widen.

To understand how European countries might close the gap, the report examines two contributing factors. The first is productivity, defined as output per hour of labour. The second is how much labour is employed.

Some European economies score well on the first measure. The average French worker is more productive than his American counterpart; the average German worker, slightly less. Partly, however, good productivity figures are a reflection of the greater proportion of Europeans, especially those with few skills, who are either unemployed or not seeking work. Worse still, most of Europe has lower productivity than America.

Fortunately, the news is cautiously optimistic on the first front: productivity gains are being made thanks to product market reforms which, by fostering competition, have been shown to boost labour productivity. Measuring the progress in these reforms is tricky, however, since they involve thousands of regulations. For example, how is it best to compare a reduction in start-up costs with, say, a lowering of state control? The OECD has created a summary indicator of product-market regulation, assigning thousands of weights to different reforms, so that no single type of measure is favoured. On these measures, regulations have eased in all European Union countries since 1998. Happily, countries that regulated the most seven years ago have been the most active in deregulating.

Can further product-market reforms alone close the gap between America and Europe? Almost certainly not. Increasing the supply of labour matters just as much. Germany has recently made a welcome start by cutting jobless benefits and encouraging the long-term unemployed to seek work, but in Germany, as in other countries, there is still far to go.

The OECD pays particular attention to the low participation rates of women and old people in the labour market. In America, 70% of women are in work or looking for it; in the 15 members of the EU before last year's enlargement, only 61% were. Only one in ten EU couples with small children said that they prefer to rely on a male breadwinner for their income, yet four in ten lived that way. One explanation is that the incomes of second earners, who are usually women, are taxed at a much higher rate than the main earner. In Germany, spouses of people on the average production worker's wage must pay 53 cents in tax out of the first euro they earn.

An army in slippers

But the withdrawal of old people—or even those in late middle age—from the labour market is perhaps the biggest single cause of the participation gap. In America, 62% of those aged 55-64 have a job or are looking for one; in the EU the figure is only 45% (and sinks to 32% in Italy and 29% in Belgium, although Nordic countries score better). Some may chalk this up to a cultural preference for early retirement. If Europeans want to retire in middle age to a bungalow by the sea, the argument goes, why force them to work instead?

But government rules matter as much as tastes. Generous European pension and early-retirement schemes, along with disability and unemployment programmes, can make work especially unattractive for old people. Low minimum retirement ages have the same effect. Other benefit schemes, with complex rules, can also encourage people to stay out of paid employment. Indeed, past policies were partially intended to encourage people to retire early, to create “room” for younger workers.

The OECD has attempted to measure the implicit “tax” on working for someone nearing retirement age. This tax measures the pension and other benefits that old people forgo when they continue to work, expressed as a proportion of their wage. A common problem is that pension benefits cannot be deferred in their entirety in many countries. If you keep working, some benefits are lost altogether and cannot be collected later.

For 55-year-olds in Germany or France, this implicit tax amounts to 50% of the average wage for people in that group. For 60-year-old Dutch people, the loss of benefits is 90% of the wage; Belgians face an effective tax rate of 80%. Faced with such arithmetic, why should older people bother to work?

The OECD estimated what would happen if pensions no longer encouraged early retirement—suppose, say, that pensions guaranteed a fixed pot of money: less each year if you retire early, but more if you stay at work. It found that many Belgians, for instance, would work as late in life as people in Scandinavia and America. This supports the idea that old people today are responding more to incentives and less to a preference for leisure.

But who can say for sure? If the EU does reduce the obstacles to work, many Europeans might still choose to toil less than Americans. But that would be an entirely different matter—a choice made freely, rather than in response to powerful government-supported incentives.



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