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.

… 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

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

… driven by social benefits, while … Source: IMF World Economic Outlook database; IMF Government Financial Statistics database; OECD in figures 2004 edition

… 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

… 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 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

… 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)

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 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

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)

… together with increased labor force participation rates Changes in labor force participation rates to maintain 2020 overall dependency ratio at current level 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.)