Unfunded welfare

Much of Western Europe is living beyond its means, with current welfare programmes promising benefits that are not fully financed by today’s taxpayers, thereby shifting the bill to future generations through debt, higher future taxes, or reduced services.

Demographic change has undermined pay-as-you-go welfare systems. Most Western European welfare programmes including state pensions, healthcare, and unemployment insurance, are financed on a pay-as-you-go basis rather than from fully funded savings.

In other words, current workers fund current retirees. But Europe is ageing rapidly owing to low fertility rates, often below replacement levels, longer life expectancy, and smaller working-age populations.

This creates a structural imbalance with fewer workers, more retirees, and longer benefit durations. As bodies such as the OECD and IMF regularly note, maintaining current benefit levels under these conditions implies much higher future tax burdens or rising public debt.

Generous welfare promises exceed long-term revenue capacity. Western Europe generally offers universal healthcare, state pensions replacing a high share of pre-retirement income, extensive unemployment and disability benefits, and subsidized education and housing.

These commitments were designed during decades of faster growth and more favourable demographics. But economic growth has slowed, and tax bases are eroding owing to globalization, automation, and capital mobility. The result is a gap between promised benefits and realistic future revenues, especially when political systems resist benefit cuts or tax increases today.

Public debt shifts welfare costs to future generations, with many Western European states running persistent deficits to fund welfare spending. There is intergenerational imbalance because today’s voters receive benefits, but tomorrow’s taxpayers will have to service the debt.

High debt levels mean future generations may face higher taxes, lower public investment, reduced welfare benefits, and increased vulnerability during economic crises. This is often framed as intergenerational unfairness, since future citizens did not consent to the spending decisions that bind them.

Political incentives favour short-term generosity because welfare programmes are shaped by democratic politics. Older voters vote at higher rates, retirees benefit disproportionately from pensions and healthcare, and costs are diffuse and delayed.

This encourages the expansion of benefits, resistance to reform, combined with underestimation of long-term costs. Institutions such as the European Union have repeatedly warned that without structural reform, age-related spending will crowd out other priorities.

It is also the case that implicit liabilities are larger than headline debt figures. Official debt statistics often understate the problem because in addition to explicit debt, governments carry unfunded pension obligations and future healthcare commitments. When these implicit liabilities are included, some analyses show that the true fiscal burden far exceeds reported debt-to-GDP ratios, reinforcing the claim that current consumption is being financed by future obligations.

Although optimists argue that future growth will solve the problem, the facts are that productivity growth has been weak for decades, and welfare programmes themselves may dampen labour supply and innovation. And there are climate transition policies and defence spending to add new fiscal pressures

Without significantly higher growth, sustaining existing welfare promises will become increasingly difficult. The case that Western Europe is living beyond its means rests on the fact that welfare systems were built for a different demographic and economic era, that current benefits are not fully paid for today, and that debt and unfunded promises shift costs forward

Political systems delay reform, so it will be future generations that will face the adjustment. The fiscal sustainability critique is a central and influential challenge to contemporary European political economy, and there may not be a solution to it.

Madsen Pirie