NTA2020 Honkatukia

Global Meeting on Population and the Generational Economy, August 2020

Presentation: Juha Honkatukia, Risto Vaittinen, To Have and Have Not - Evaluating the costs and benefits of the welfare state with an AGE model of Finland with Intergenerational Accounting


"The aging of the population affects most European economies and challenges the sustainability of public funding in many of them. Aging constitutes a twin problem for the economy, as taking care of the growing elderly population ties up more labour in the care sectors while at the same time crowding out other service and manufacturing sectors. The problem is most visible in countries, where these services are publicly provided and funded, such as the Nordic countries, where aging translates into increasing tax burdens shouldered by the progressively smaller working age cohorts. Thus, while the provision of universally available health care is very much at the heart of the Nordic welfare state, the uncertainties of the benefits of the welfare state of the future combined with the present-day certainties of having to face the bill may be undermining the legitimacy of the Nordic model in the eyes of younger generations. The alternative would be a more market-driven provision of welfare services. Whether and how this would be beneficial has not been studied. In the current study, we consider the economics of these inter-generational issues. In particular, we model the inter-generational distribution of the benefits of public health and social care provision and the tax burden of its financing, and the role a choice between public and private welfare services may take in the future.

Our study concentrates on Finland, where a comprehensive reform of the public health and social care sectors is in progress. The methodological points of the paper, however, are not limited to Finnish institutions. Our primary findings concern the implications of inter-generational effects of welfare sector reforms, but our approach has important macroeconomic implications beyond the welfare sectors that may well have been overlooked in the policy debate. The Finnish reform introduces a huge research and policy evaluation agenda: while even in the future, the health care and social service sectors are to receive most of their funding from the public coffers, the allocation of the funding is to be based much more rigorously than previously on objective criteria, reflecting extensive register data on the costs, effectiveness and equitability of the provision of these services in different age cohorts. These data are also to form a basis for the estimation of future resource – personnel and funding – requirements, as well as the sustainability of the regional, public finances. In Finland, the National Institute of Health and Welfare (THL) is tasked with collecting most of these data and with monitoring the reformed health care and social service systems. The coverage of the data is unique, encompassing and linking data on individuals’ health and financial records, as well as costs of service providers and administration, and also income transfers between the different agents. This paper uses the data to calibrate demand for health care services as an outcome of welfare maximization and public and private health and social care provision in a dynamic CGE model of Finland. The paper also uses data from household income and consumption surveys to allocate income and consumption spending as well as direct taxes and tax-like expenditures to age cohorts. The approach can be easily incorporated in any CGE model that allows for some modularity particularly in the treatment of household demands.

Our approach produces several new insights into the implications of an aging population on the care sectors and public finances. Projecting the demand for social and health care services on the basis of population forecasts alone, we find that, by 2040, the Finnish population would need about a third more care services than it does at the moment. Aging alone explains 26 percentage of the growth in care demand, while population growth only accounts for 6 percentage points. The central innovation of the study is to incorporate this projection in a CGE model with endogenous decisions made by households on the demand for care services. This is accomplished by calibrating public service provision in households’ utility functions. This calibration is made possible by our register data and opens up several research questions. First, we can interpret the effects of aging in terms of utility: Aging constitutes a deterioration in the utility of the households that necessitates a compensating increase in the demand of care services to maintain the current level of utility. Second, our methodology provides a way of measuring the evolution of regional equality . Finally, we can easily estimate the marginal cost of funds for public service provision. The integrated model also shows the resource costs of service provision in terms of potential growth. The rest of the paper is organised as follows: The second section describes the theoretical extension of the paper. We show how the provision of public health and social care are introduced in a CGE model as, first, consumer’s choice of demand for care and, second, a choice between privately and publicly provided care. The extension allows us to offer an economic interpretation to the effects of aging and to analyse the reform in terms of efficiency and welfare. The third section deals with the various data sources. The National Institute of Health and Welfare (THL) collect register data on health care and social services at the level of individuals and service providers. These registers cover the whole population and enable easy aggregation for different purposes. For the current study, we collect data on the costs and personnel requirements of health care and social service provision. The section also describes how these data are used in demography-driven projections on health care, social service, and income transfers. These projection feed into the CGE model which is then used to analyse the effects of the reform from the points of view of welfare, regional growth and fiscal sustainability. Finally, we describe the use from household surveys and registers that form the basis for the generational allocation of consumption, factor and other incomes, and taxes. The fourth section shows how the extended FINAGE model, a dynamic AGE model of the Finnish economy, can be used to analyse the current reform. We consider various ways for the government to allocate the provision of public services based on criteria of efficiency and equity, and the alternatives for encouraging the role of the private sector by pricing public services. The final section concludes and offers some suggestions for further research.


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