Rival Economics? (Or, A Tale of Two Systems)

A Tale of 2 Systems
By DAVID BROOKS

Published: January 4, 2005

Over the past 50 years, we've been having a big debate over two rival economic systems. Conservatives have tended to favor the American model, with smaller government and lower taxes, but less social support. Liberals have supported programs that lead to the European model, with bigger government, more generous support and less inequality.

I wonder if that debate is about to change. In the next few decades both models are going to confront a big test: aging populations. The U.S. model is going to be challenged by this problem, but the European model is flat-out unsustainable.

Populations in the U.S. and Europe are both aging, but Europe is aging faster. According to the O.E.C.D., the dependency ratio - defined as the number of people over 65 as a percentage of the number of people 20 to 64 years old - will rise to 37 percent from 22 percent in the United States by 2050. But it will go up to 52 percent from 26 percent in the European Union.

In addition, European public pensions are more generous and retirees are more reliant on them. To sustain these programs, European government spending will have to rise. According to the European Commission, demographic trends will push public spending up by five to eight percentage points of G.D.P. in the E.U.'s 15 richest members. In Germany, public spending on pensions will rise from an already huge level, 10.3 percent of G.D.P., to 15.4 percent by 2040. And that's after recent benefit cuts.

To pay for all of this, taxes will rise and public debt will increase. A Standard & Poor's survey predicts that France and Germany could see their public debt grow to more than 200 percent of G.D.P. by 2050.

Europe may find itself locked into a vicious circle: an aging population means more public spending, which means higher taxes, which means lower growth, which means higher unemployment, which means more public spending, which means more taxes and even lower growth.

The former Dutch prime minister, Wim Kok, recently released a scathing report that found that "the pure impact of aging populations will be to reduce the potential growth rate of the E.U. from the present rate, of 2 percent to 2.25 percent, to around 1.25 percent by 2040."

Already, high European taxes make the European model look obsolete. European and U.S. workers are about equally productive per hour worked. But Americans work 50 percent more than Germans, French and Italians. In the 1970's, Western Europeans actually worked more than Americans. But as taxes rose and incentives to work diminished, Europeans cut back their hours or dropped out of the labor force.

Some economists, like the Nobel laureate Edward Prescott, believe higher tax rates explain the drop in work. Others believe cultural preferences also played a big role. Either way, high taxes have made Europe less productive just as it needs high output to support its retirees.

Partly as a result, European economies have underperformed for a generation now. As Olaf Gersemann has pointed out, the U.S. economy has enjoyed an annual real growth rate of 2.9 percent over the past 25 years. That's 55 percent more than western Germany, 48 percent more than France and 39 percent more than the E.U. as a whole. Back in the 1970's, European standards of living were catching up to U.S. standards. Now American G.D.P. per capita is about 30 percent higher than Europe's and the gap, if anything, is getting wider.

Which brings us to the current moment. In Europe, everybody is aware of the problem, but the remedies are so bad that most countries avoid them. Meanwhile, we in the United States are embarking on our own debate over the future of Social Security. Many liberals are claiming that we don't need to fundamentally revamp our system because there is no crisis. To the extent that's true, it is because we have not been taking their advice for the past 50 years.

We have stuck with a low-tax, high-growth economic model. This gives us the resources and the flexibility to deal with the problems caused by an aging population without having to face, at least for now, the horrific choices that confront our friends across the Atlantic.

The question is: Will we leave our children a system as flexible, dynamic and productive as the one that was, fortunately, left to us? Or, by doing nothing, will we succumb to the same ineluctable pressures that now afflict Europe, and find that we are immobilized at the exact moment China and India are passing us by?

http://www.nytimes.com/2005/01/04/opinion/04brooks.html?oref=login&oref=login