The Big Question: Does the Welfare State Make Countries Richer?

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This is one of a series of interviews by Bloomberg Opinion columnists on how to solve the world’s most pressing policy challenges. It has been edited for length and clarity.

Justin Fox: The coronavirus pandemic has caused a dramatic expansion in government-funded social welfare programs in many countries, including the United States. A major theme of your new book, “Making Social Spending Work” — as well as some of your earlier work — is that the welfare state is a free lunch. What do you mean by that?

Peter Lindert, Distinguished Professor of Economics, Emeritus, University of California at Davis: It’s a free lunch in the sense that it doesn’t lower our average incomes, but at the same time it does provide other things such as more equality, cleaner government, etc. Lifespans are longer, welfare states do not run bigger deficits, poverty is lower.

JF: Your definition of welfare state is what?

PL: A welfare state is one in which more than 20% of national income is devoted to social spending, ignoring education. Why ignore education? Because if you include education, we not only would have more welfare states, but it would be obvious that [social programs] have positive effects, because schools do that.

Now, as it happens, a whole bunch of countries have temporarily come into that welfare-state range, including the United States. We have done what I’ve called the Fosbury flop. That is to say, we went over the bar into the welfare state backwards, because during the pandemic incomes collapsed and we had to spend on all kinds of aid for people because they were in such bad conditions.

JF: A lot of economic papers have been published, especially back in the 1980s and 1990s, arguing that there were huge costs to almost every aspect of the welfare state. Were they all wrong, or were they addressing different things?

The Big Question: Does the Welfare State Make Countries Richer?

PL: They were bluffing. It was just fashionable to say, “As everybody knows, there are serious disincentives to work and productivity from the welfare state.” They didn’t have the evidence.

JF: Wasn’t there some empirical work that found a negative link between government spending and growth?

PL: Not really. There was one econometric study by Bob Barro, as I recall, which found that something called government consumption had a negative effect on economic growth. But that government consumption is not social welfare spending. It was basically the government paying itself high salaries. The sample included people like Mobutu Sese Seko of Congo and Ferdinand Marcos of the Philippines, and by golly, their government consumption looked bad for economic growth. I don’t think that tells me anything about Denmark and Sweden.

JF: One of the things you talk a lot about in this book and previous work is that governments take pretty seriously the arguments made by conservative economists that welfare is a disincentive to work.

PL: When people go for the fable that welfare is about paying somebody to be unproductive all of his life, they ignore that real world governments don’t work that way. Governments understand the issue of work incentives — and they’re also spending their social spending mainly on things other than simple handouts. They’re investing in young people’s education, health, etc.

JF: And those have more positive effects.

PL: Yes, the positive effects outweigh the negative effects of the kinds of social spending where you could statistically find negative effects on work.

JF: In the U.S. right now, a number of business leaders and elected officials are saying that supplemental unemployment insurance is discouraging people from working. I guess you’d want to wait and see what subsequent research shows, but you wouldn’t be shocked if generous jobless benefits did create some perverse incentives, right?

PL: You said it exactly right. I’m waiting for careful statistical studies of what this generous unemployment compensation has suddenly done. It would not surprise me if it made some people hold off and not get a job. But there’s multiple reasons why people are not jumping right back to work right now. There’s the simple fact that you have to take care of your kids and the schools are still messed up, and many people just have this fear of going back to the workplace and getting Covid.

JF: On the taxation side, a lot of the countries with the biggest welfare states actually don’t have unusually progressive tax systems — and they’re very reliant on value-added taxes.

PL: They are certainly no more progressive in their taxation than low-spending countries like the United States or Japan. [But] when you get good public health insurance and so forth, you’re equalizing people much more on that expenditure side than you are in just the tax system alone.

JF: One term you use a lot is that the welfare state is a “Darwinian success”: namely, if you look out in the world to see what has survived and has succeeded, it’s the welfare state.

PL: Yup, it has. It’s always amazed me how many times people can journalistically write about the “crisis of the welfare state.” In fact, it’s a survivor. In late March of 2020, every voting Republican in Congress in both houses voted in favor of this incredible jump in unemployment compensation, aid to small businesses, basic welfare spending. President Trump signed it. The asset markets have been smiling ever since. The economy stopped its plummeting and is well on the way back up now.

Will this be permanent thing? Some of it will. If you look at past crises like the world wars, you never came back off the social spending that they helped promote. You always stayed with some of it.

In the United States, I’m optimistic about a particular kind. It’s a small share of the budget, but I think it’s a big deal, and that is help for parents of pre-primary schoolchildren. As I went to press with the book in the in late 2020, I had to say, gosh, it should take just a nudge for America to finally join the rest of the rich world in having these kinds of basic credits for new parents, to help them be there for their children and nonetheless keep their jobs.

Well, now we have this benefit in the American Rescue Act of 2021. It’s there only temporarily, but I agree with other observers that it’s going to stick because, really, how can the Republican opposition say, “No, I’m sorry. We must let this program stop so that we can go back and double the share of American children that are in poverty?” That’s going to be a tough sell. I’m pretty sure that Americans will do this really important job of investing in the young, especially the young and the poor.

JF: Another big and growing part of social spending is pensions and other aid to the elderly. Is that a threat to this success story for the welfare state?

PL: It’s a threat if you get it wrong. The countries that get it wrong and actually underinvest in youth while giving generous pensions are not the classic European welfare states. It’s countries that use pensions to pay off a politically powerful class in its old age — think of Brazil, Turkey, Argentina. These are goodies for the rich that are paid for basically by general taxes that the poor pay a share of.

If you’re not such a country, should you be concerned about pension spending? Is your country getting older? Most are, and that is a problem. As long as the share of the population that is old, or retired, or both, keeps marching up, you don’t want it to mean forever-rising shares of national income are taxed for the sake of pensions. You’ve got to make sure that the amount that is set aside per year of retirement or old age keeps going up more slowly than general wages for the young. You can’t let pension benefits keep being tied to wage rates and march as fast as wage rates.

JF: But that’s how we do it in the U.S., right?

PL: It’s a mix. Some of the bottom part of Social Security is tied to the wage rate, but that’s OK because the rest of it is tied to the cost of living index, which is going to go up more slowly.

JF: On both that and aid for children and families, you paint the U.S. as being just a couple of nudges away from a pretty good system. Health care is different.

PL: Very different.

JF: That’s one where you definitely argue that the Darwinian winner is universal health care.

PL: Universal health insurance. The health care doesn’t need to be provided by the government. It is in England and Wales and Scotland by historical accident and it’s worked OK there, but you don’t need to have the government run it. The main thing is you’ve got to insure people publicly. Why publicly? Better health brings gains to society as a whole, so let society as a whole step up to the plate and pay much of this insurance. Don’t make it conditional on pre-existing conditions and things like that.

JF: In the U.S. we have created all of these players who will see that as taking something away from them.

PL: Yes, and those players would include the huge insurance companies that sell your employer-based health plans. That’s kind of an American trap. It’s not that any sort of free-market country falls into this trap, it’s specific to the United States.

First, we trapped ourselves into having these tax breaks that excuse your health plan with your employer from income taxes, and also from the employer’s corporate profits tax. And then as the country got older, the elderly got politically motivated and said “Wait, as soon as I lose my job or retire, I’m going to be without health insurance.” So that gave us Medicare in 1965. Socialized medicine, but only for those over 65. Why should generous public coverage of your health insurance be specific to having your 65th birthday? That’s a loser of an idea.

JF: Something you bring up a lot in the book is that one can never be absolutely certain about the effects of these policies on growth, because there isn’t a big enough sample to come up with statistically significant results. So how confident can we be about the conclusions you’ve reached about how social spending can boost economic growth?

PL: The evidence has stacked up. The spirit of my current book is, “Wow, just look what we’ve learned over these last 20 years.” More countries have experience with social spending, and much more sophisticated statistics. Microeconomists like Hilary Hoynes, Diane Schanzenbach, Liz Cascio and others now do very sophisticated work. They have to take historical data and make it imitate a laboratory experiment. Economics is getting there, and it’s supporting everything I’ve been saying about the need to invest taxpayers’ money in youth.

JF: Speaking of historical data, you’re an economic historian who spent a lot of your career digging deep into things like probate records in 17th century England. Your recent books, however, have been more focused on current policy choices. Was that always there in the background? Or did it come to you as your career went on that, “Oh, wow, this stuff I’m doing, it’s actually really relevant?”

PL: That was there from the get go, even when I was an undergrad. But here’s what an economic historian does on questions like this: We are entrepreneurs seeing a market opportunity. Economists are kind of clueless about history, and historians for various reasons don’t like economics. We who are economic historians have this wonderful opportunity to take what has actually been happening over time, and show what the current policy options seem to be in this long-run context. I love it. It’s fun. I hope to do it forever.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Justin Fox is a Bloomberg Opinion columnist covering business. He was the editorial director of Harvard Business Review and wrote for Time, Fortune and American Banker. He is the author of “The Myth of the Rational Market.”

©2021 Bloomberg L.P.

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