The year is 1861 and the Civil War is tearing America apart. As both the Unionists and the Confederates struggle to attract fresh recruits to their armies, someone comes up with an ingenious plan: offer generous pensions to soldiers and their widows. It seems to do the trick—hundreds of thousands swiftly join the fight.
When do you suppose the last payment was made from the Civil War pension scheme? The 1930s or 1940s, when the oldest war veterans were approaching the end of their lives? In fact, the scheme did not make its final payout until 2004. One enterprising 21-year-old woman had taken it upon herself to marry an 81-year-old veteran in the 1920s, leaving the state with a remarkably long-lasting bill until she died at the age of 97.
Imagine this same problem writ large across not just a whole nation, but the entire developed world, governments having promised to provide generously for their elderly citizens, only to realize decades later that the same citizens are living too long and sucking up too much of their cash. Behold the pensions and welfare crisis.
“Pension reforms, like investment advice and automatic enrollment, will strengthen the ability of Americans to save and invest for retirement.”
Steve Bartlett, former US congressman
Evolution of the welfare state Although states have occasionally offered pensions, education and other benefits to some of their citizens since Roman times—usually in exchange for military service—the existence throughout the world of welfare states and social security systems is a relatively new phenomenon. Until the 20th century countries tended to tax their citizens purely in order to protect them from crime and invasion. However, in the wake of the First World War and the Great Depression, as the scale of penury faced by so many families became clear, countries such as the UK and US evolved into “welfare states”—where taxes are used to redistribute money to those judged most in need—whether it be the old, infirm, unemployed or sick. The original model was developed in Germany by Bismarck only a decade or so after the Civil War ended on the other side of the Atlantic.
The theory behind pensions and social security is as simple today as when the system was first devised: the citizens of a country should contribute toward a general fund when they are in work and good health, and in return that fund will help provide for their welfare when they are sick, unable to work or want to retire.
The Beveridge Report
The catalyst in the creation of welfare states was William Beveridge’s seminal 1942 Report of the Inter-departmental Committee on Social Insurance and Allied Services, designed to clamp down on “Want, Disease, Ignorance, Squalor and Idleness.” As governments turned half an eye to the postwar world, it became clear that something needed to be done to ensure that people were properly supported in the future, and the Beveridge Report provided an ideal template. The combined ordeal of the Great Depression and the war had highlighted the fact that, in certain extreme circumstances, the private sector simply could not protect people from hardship. However, the report argued that, given the state’s size and hence bargaining potential, it could secure better, cheaper and more economical healthcare and pensions for its citizens.
Nowhere were Beveridge’s ideas more enthusiastically applied than in Japan, which dramatically improved its citizens’ life expectancy and educational qualifications by setting up a major system of social security, hospitals and schools after the war. The quality of its giant welfare state is widely regarded as having helped the country bounce back so vigorously in subsequent years.
The problems Despite it having pulled many families out of poverty, and having dramatically improved health and academic standards throughout the Western world, many argue that the welfare state has also brought with it some major problems: one socio-economic, the other fiscal.
The socio-economic quandary is that state welfare systems can discourage people from working. There is much evidence to suggest that offering unemployed workers income support can discourage them from going out and looking for another job (see Unemployment). Despite having swelled to mammoth proportions, welfare spending appears over recent decades actually to have reduced productivity in various countries, including the UK and various northern European states.
Then there is the problem of how to fund such systems in the long run. Most social welfare systems are funded out of governments’ current budgets: they are largely pay-as-you-go, with today’s taxpayers funding the pensions bills for today’s retirees rather than their own future pensions. Such a system worked very successfully in the post-war years: the massive explosion of population in the late 1940s and 1950s—the so-called “baby boom”—meant there were plenty of young workers paying their taxes into the pot throughout the 1960s, 1970s and 1980s. However, with fertility having dwindled since, various countries, including the US, UK, Japan and much of Europe, are facing a massive bill in the future.
The problem is particularly acute in the US. The American system includes a state pension for all (“social security”), Medicare—free health insurance for the elderly—and a number of other smaller programs including Medicaid—health cover for the poor—and temporary unemployment support. However, the system is facing a major crunch as the baby-boomer generation retires. The share of the US population aged 65 or over is set to increase from 12 percent to nearly 21 percent by 2050, with this crop of pensioners living longer and demanding more medical care than ever before.
Solutions to the pensions and welfare crisis
Welfare in the future According to generational economists, who study the way one generation’s decisions can impinge on the next, the costs of welfare in the coming years—tied to the shrinking size of the working population—means that the US is, by most definitions of the term, heading for outright bankruptcy. Similar predictions could be made of Japan, where over 21 percent of the population is already over 65, projected to rise to equal the working population by 2044.
There is evidence that fertility rates have started to increase slightly in the UK and US, thanks largely to a glut of teenage pregnancies in the former and the fecundity of Mexican immigrants in the latter. However, even this is unlikely to spare either country from an impending shock.
The painful truth is that either the pensioners will have to accept less generous handouts or tomorrow’s citizens will have to pay more in taxes. It is a quandary that will dominate politics and economics for some decades to come.
the condensed idea
Beware promising money you can’t give
| timeline | |
|---|---|
| 1880 | Bismarck sets up the first state pension and medical insurance scheme |
| 1908 | David Lloyd George introduces pensions in the UK |
| 1942 | The Beveridge Report is published |