What harm does running a European-style high-spending welfare state do to a country’s GDP? The answer, surprisingly, turns out to be “none at all”. Peter Lindert’s paper, “Why the Welfare State Looks Like A Free Lunch”, shows that a welfare state doesn’t depress GDP in the way that conventional economic analyses predict. Why not? Over to Lindert…
All our well-known demonstrations of the large deadweight losses from social programs overuse imagination and assumption. There are good reasons why statistical tests keep coming up with near-zero estimates of the net damage from social programs on economic growth. It’s not just that the tales of deadweight losses describe bad policies that real-world welfare states do not practice. It’s also that the real-world welfare states reap offsetting benefits from a style of taxing and spending that is pro-growth.
The keys to the free lunch puzzle are:
(1) For a given share of social budgets in Gross Domestic Product, the high-budget welfare states choose a mix of taxes that is more pro-growth than the mix chosen in the United States and other relatively private-market OECD countries.
(2) On the recipient side, as opposed to the tax side, welfare states have adopted several devices for minimizing young adults’ incentives to avoid work and training.
(3) Government subsidies to early retirement bring only a tiny reduction in GDP, partly because the more expensive early retirement systems are designed to take the least productive employees out of work, thereby raising labor productivity.
(4) Similarly, the larger unemployment compensation programs have little effect on GDP. They lower employment, but they raise the average productivity of those remaining at work.
(5) Social spending often has a positive effect on GDP, even after weighing the effects of the taxes that financed the spending. Not only public education spending, but even many social transfer programs raise GDP per person.
(6) The design of these five keys suggests an underlying logic to the pro-growth side of the welfare state. The higher the social budget as a share of GDP, the higher and more visible is the cost of a bad choice. In democracies where any incumbent can be voted out of office, the welfare states seem to pay closer attention to the productivity consequences of program design. In the process, those countries whose political tastes have led to high social budgets have drifted toward a system that delivers its tax bills to the less elastic factors of production, in the Ramsey tradition.
Or, to summarise, social spending is good for personal productivity, and democracy is effective in ensuring that real-world governments avoid the costly mistakes that anti-welfare theorists assume. Apart from illustrating the dangers of hand-waving economic arguments, this tells us that the choice between a European-style high-welfare state, and a US-style low-welfare state, has nothing to do with promoting economic growth and is simply a matter of which kind of society we find more pleasant to live in.
[Via this Electrolite comments thread]