Can we afford the welfare state?

Despite all the panic, we probably can. Nicholas Timmins on the misplaced fears

FOR THOSE who believe in the welfare state, it has been a rotten week.

First, a committee of inquiry chaired by a former chief executive of the NHS raised the alarm about the gap between resources and demand in the health service. New charges must be considered, he said, or else a limited "core" of services, with those able to afford it encouraged to pay for quicker or more extensive services privately.

Then a report from the International Labour Organisation warned of a Europe-wide crisis in the financing of welfare. Existing methods of funding pensions, unemployment protection and health care were in danger of becoming unsustainable, it said.

To cap it all, William Waldegrave, Chief Secretary to the Treasury, declared his intention to get public spending "well below" 40 per cent of GDP - a level which would require big cuts in welfare spending.

Dire portents of this kind have become commonplace; after nearly 50 years, our welfare system seems to be cracking. A combination of medical advance, rising public expectations and an ageing population are pushing the bills beyond the point where we can pay them. The only answer, we are told, is more private provision and a smaller safety net.

Yet in the midst of all this gloom, it is tempting to ask the old question: "Crisis? What crisis?" Everything in the garden may not be rosy, but neither is the system on the brink of collapse. In international terms, our spending on welfare is far from extravagant. Moreover, many of the dark shadows looming over us may well turn out to be just that - shadows. We do not need to panic.

THE welfare state has three principal elements: social security, health and education. They all undoubtedly have their problems. Since 1979, education's share of government spending has stayed broadly static - although there is now widespread agreement that more needs to be spent.

Spending on the NHS is up - from just over 10 per cent of government spending to just under 13 per cent. That increase has largely been driven by a sharp rise in the number of elderly people, whose health care tends to cost more. But the immediate pressures are easing. Between 1991 and 2011, the number of elderly people will increase at half the rate that was seen between 1971 and 1991.

The dramatic rise has come in social security. Its share of spending is up by a half - from 22 per cent in 1979 to 31 per cent today. The driving forces have been a rise in the number of pensioners, a dramatic switch in housing subsidies away from the bricks and mortar of council houses to the rents people pay, and higher unemployment, with pounds 13bn of last year's pounds 85bn benefit bill directly attributable to the rise in unemployment. Unemployment is also an acknowledged if unquantifiable factor in the increase in other demands for benefit, for example from single parents. Unemployment, however, has been falling slowly.

Not such a disastrous picture. When we turn to the future, we need to split social security into two: pensions, and benefits to those below retirement age.

In the latter department there is a crisis, but it is over how the welfare state is working, not its immediate affordability. Higher rents, more unemployment, more single parents mean that almost one in three people now live in households where someone is claiming one of the main means- tested benefits - a rise of 50 per cent on 1979. A gradual restructuring of the way this money is spent is badly needed - including raising tax thresholds and switching towards a system that helps people into work rather than pays them benefit on condition they do no work. The Government has made a slow start in this direction; Labour is working hard on the idea. At least in theory, paying less to people to help them into work, rather than paying all their living costs to keep them out of work, could reduce the benefit bill.

From those above pension age, there certainly appear to be horrific financial pressures. The immediate demographic trend offers us something of a breathing space, but little more. There will be only a small increase up to about 2010 but then the number of elderly will rise much more dramatically as the post-war baby boom generation reaches retirement age. From 9 million people aged over 65 today, the number is projected to be close to 15 million by 2040 before falling again as those currently in middle age die.

This affects the "support ratio" - the relationship of the number of people of working age to that of the over-65s. Economically, the former have to support the latter. At the moment there are around four people of working age for each pensioner in Britain; by 2040 it will be more like three to one.

But the Government has already taken dramatic action to ensure that this "support" does not take the form of huge tax increases to fund a huge public pension bill. First, women's retirement age is to be raised to 65. Second, reforms by Norman Fowler and Peter Lilley, the former and present secretaries of state responsible for social services, have cut the final cost of the State Earnings Related Pension Scheme by more than two-thirds.

As a result, and on the Government Actuary's figures, the proportion of earnings required to fund state pensions is not set to rise in the next century at all - it is set to fall. In other words, on current policies, the taxation to fund state pensions will cost less in real terms in 2040 than it does now. No crisis of unaffordability there.

On present pensions policy, according to John Hills, a welfare state specialist at the London School of Economics, "there is no crisis for the public finances in the long term. The question rather is whether present pension policies are sustainable."

For while Britain has relatively well developed occupational and private pensions - the UK has pounds 500bn invested in them, more than the rest of Europe put together, and the money should make the next generation of pensioners, taken as a whole, better off - the picture is different for the less well-off who rely solely on the state. On present plans, the benefits will rise with prices, not earnings. As a result, pensioners who rely solely on state benefits will not share in economic growth. Relatively, they will increasingly fall behind. Restoring the link with earnings would improve their position but it would be expensive. Employer and employee national insurance contributions would have to rise gradually from around 18 per cent of gross wages to a peak of around 26 per cent in 2040. That would be a significant increase, which is why the Labour Party and others are looking closely at a new "pension guarantee", one that would top up the income of poorer pensioners through a less intrusive means-test, while costing much less than a full earnings link.

However, even if the more expensive route of restoring the link with earnings is taken, by 2040 the effect of ageing on health, education and the whole of the social security budget would be to increase public spending by less than 5 per cent of GDP, according to calculations by Mr Hills.

Such a rise would be no greater than that produced over the three years from 1990 when the recession bit and the Government increased public spending ahead of the last election. It is not a literally unaffordable sum, in the sense that the cash isn't there to be found. It is a political decision whether to find it. On the somewhat large assumption of other things being equal, it implies a level of public spending that would be less as a share of GDP than current levels in several other European countries including France, Italy and the Scandinavian countries.

Pensions then, need not be about to cripple us. There may be trouble ahead but, relatively speaking, we are well placed to face the music and dance.

CAN THE same possibly be true of health, about which such dire warnings have been heard? The gloom is pinned to three causes: rising expectations; medical advance and, once again, the ageing of the population.

Rising expectations are nothing new. Which health minister said this? "It is the same in every social service. There is greater demand because the standards of the population are higher than ever before." Not Virginia Bottomley, not Stephen Dorrell, but Aneurin Bevan, the founder of the NHS, in 1949. (To be strictly accurate, he used the words "working class" before "population".) Wealthier countries expect higher standards - and there is no reason to assume that as Britain grows wealthier it will not be able to afford them.

On ageing, we may be the victims of a curious mathematical illusion. The figures show that the over-85s cost health and social services almost pounds 4,000 a year on average - 15 times as much as someone of working age. We assume, then, that larger numbers of old people means a huge increase in costs, but this may not be the case.

It is equally known that much of health spending goes on the final six months to a year of life. Does the large figure of pounds 4,000 a year reflect the inevitable cost of old age, or simply the cost of dying? It is probably a bit of both. But if a significant element is simply the cost of dying, the implications are very different than if they are all the cost of age. For it means that the burden on the taxpayer of increasing numbers of old people is not nearly so dramatic as multiplying the rising numbers of elderly by pounds 4,000 implies. And other trends could affect the burden - pressures to let people "die with dignity" rather than subject them to every possible medical intervention may also curb costs.

What about medical technology? Micro-surgery, transplants, fancy drugs, hugely expensive scanners; surely this is one bill that is running out of control? Not necessarily.

An example: in 1980 Michael Bewick, a transplant surgeon at Dulwich Hospital, bankrupted his health authority almost single-handedly by spending pounds 350,000 in 10 months on an anti-rejection drug. Today, however, its price in real terms has dropped by more than 80 per cent and it is in widespread use. "The fact is that when you start doing something new it costs a lot," Mr Bewick says. "But as it becomes more successful and more people use it, it becomes cheaper and cheaper, just like computers."

Take a look into the future - at the transgenic pig. If that allows pig kidneys to be transplanted, Mr Bewick argues, it will be possible to provide kidneys for 10,000 patients presently relying on dialysis at a cost of pounds 25,000 to pounds 30,000 a year because there are too few donor organs.

"There will be a short-term cost providing them with kidneys - and massive annual savings thereafter," he says. "In addition, more of them will be able to go back to work and pay taxes."

This has happened in the past. In the 1940s and 1950s the NHS ran a string of sanatoria and a fleet of mobile X-ray vans which toured the country screening people for tuberculosis. Better health and new drug treatments virtually wiped out TB. The money went on something else.

It remains true that medical progress tends gradually to increase the overall cost of health care - but at a rate that growing economies are likely to be able to afford. The argument that on its own it will bankrupt the NHS is, on present evidence, nonsense.

Amid all the projections about future costs, it must be remembered that, like the claims that a single new drug will break the bank, they tend to assume that nothing else changes. In recent years, for example, the trend has been markedly towards earlier retirement. But with declining numbers in the workforce and longer and healthier old ages, there must be a reasonable chance that retirement patterns will change. The economy will still require workers. With fewer young workers, unemployment may well fall, and the possibility that people will work on, part-time, past traditional retirement ages, earning income and paying taxes, must be in prospect. Rigid retirement ages are a relatively recent phenomenon - and many countries are already raising their retirement ages past 65.

IN SUM, therefore, there are marked upward pressures on welfare state spending, but it is far from clear that they are catastrophic. The picture is much more complex than the messengers of doom would have it.

So why the atmosphere of crisis? In part it has arisen because rolling back the welfare state and switching from public to private provision is the agenda of the Conservative right. And in part because the vested interests who would benefit from more private spending - the drug industry, health insurers, private pension providers, and private hospital groups and home owners - have been hard at work.

Another reason is that the generation of a sense of crisis may ease the public spending cuts that Tory backbenchers are desperate to see in order to achieve pre-election tax cuts. The Labour Party - traditionally the defender of the welfare state - has, under Tony Blair's leadership, become so terrified of being linked to higher taxes that it has largely vacated the field, so the traditional political voices of defence have been silenced.

The left, in fact, has no coherent response to the Tory right's agenda. Some favour restoring national insurance, despite that meaning higher taxes. Others, such as Frank Field, favour compulsory contributions to what in effect would be new forms of friendly society, with the state paying in for the poor. Others favour a merger of taxes and benefits into a new "basic income" - something both Labour and the Tories tried and failed to do in the 1960s and 1970s.

In some areas, such as pensions and parts of education, increasing private provision makes sense. In others - private unemployment insurance, for example - it is probably impossible. As Mr Lilley has pointed out, those least likely to be able to afford the premiums are those most at risk of losing their jobs. And any move to shift the NHS towards a system of charges and insurance would risk hitting not so much the poor - who would have to be covered to at least some basic level - but those in low-paid work who would struggle to meet the premiums, decreasing their work incentives in a part of the economy where there are already disincentives enough.

The most marked social change in the past 15 years has been the dramatic growth in inequality. A quarter of the population now lives below half average income, against less than 10 per cent in 1979. "Without the welfare state, that position would have been far worse," Professor Julian Le Grand of the LSE said last week. "Welfare services are arguably the only bulwark against increasing poverty and ill-health, social misery and perhaps social instability. The question is not whether we can afford to have a properly funded welfare state; it is whether we can afford not to."

Andrew Dilnot, director of the Institute of Fiscal Studies, said: "The issue is not really about affordability. In the literal sense these services can all be paid for. What is at stake is a political decision about whether to pay for them communally or individually. If we do it communally, through taxation, then we redistribute from the affluent to the less affluent. If we do it individually, then people get what they pay for. The better off will do better, but at the price of more inequality. It is really that simple a choice."