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The End Of The Welfare State

What happens in the OECD countries when as a group their general government expenditures have exceeded 50 percent of GDP, when government expenditure on individual goods (i.e. social welfare expenditure) is twice its expenditure on collective goods (e.g. infrastructure, public order, defence), and then -- bang bang -- some bubbles pop, some too-big-too-fails go belly up, advanced economies experience hard landings, and debt-to-GDP rises from 55 percent to 75 percent as governments compensate for unemployment and bank losses, and scramble their stimulative forces to avert depression? 

So, Lenin, what is to be done?

1. Too Much

The OECD considers that the fiscal trajectory of most of its member countries became unsustainable as a result of the crisis beginning in 2007. Just in order to stabilise debt-to-GDP ratios by 2026 the OECD calculates countries will need to improve fiscal balances by 3.6% on average. Reducing debt back to 2007 levels by 2026 (and for Eurozone countries to comply with 60% debt-to-GDP ratios required by the Maastricht Treaty) would require much tougher fiscal tightening. In either model, the Nordic countries (with high taxes) and South Korea (with low spending) and, for example, Germany, require no consolidation or minimal consolidation, whereas the USA, UK, and Japan require a lot of consolidation.

Some consolidation can occur by finding efficiencies and eliminating waste in the public sector. But debate centres on reconciling a need for renewed growth with spending cuts and maintenance of safety nets. Spending on some collective goods, like infrastructure, complements economic growth goals, whereas not all social spending is essential for a safety net. The effects on incentives, and the crowding out of different forms of ‘capital’ to private enterprise by non-essential social spending, can be counterproductive to growth. Even the Nordic ‘welfare miracle’ may be unsustainable if it means government revenue stays above 50 percent of GDP and gradually disincentivises innovative private enterprise.

Social spending as a percentage of GDP in OECD countries rose from 8% in 1960 to 22% in 2012. Outliers include France and Denmark at over 30%, the EU-21 at 25%, and US at 19.3%.

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As the OECD points out, “fiscal consolidation is not in itself a policy. Rather, it links to underlying issues and imbalances in sectors such as welfare, pensions, health care and education”.

The crisis 2007-2009 caused a sharp real increase in social spending, much of it to pay for unemployment and housing benefit. Social spending plateaued in 2010. As of 2012, it is not heading down. There is variation between countries in specific sectors and in overall spending. In Greece and Hungary social spending declined in 2011/12. Korea’s social spending increased by 30% from 2007, but remains under 10% of GDP. Were it not for OECD emerging economies (Chile, Mexico, Korea), average welfare-to-GDP ratio would be much higher.

2. Smarter & Leaner

The Economist predicted last year that Asia will see a sharp rise in welfare spending as it tempers the productivist model that until recently “subordinated social policy to economic goals”. However, Asia will seek to avoid the mistakes of social expenditures in Europe and Latin America -- “Asia’s governments ... have little desire to replace traditions of hard work and thrift with a flabby welfare dependency”. In fact, East Asian dynamos might not greatly increase welfare-to-GDP ratios ... ever ... or certainly not to European levels. Instead, they may innovate new social service approaches for coping with disequilibrium capitalism.

The main debate on welfare before the crisis was about moving away from a traditional emphasis on unemployment, pensions, and health, and towards social services that focus on young families and complement the market economy (examples are child care, parental leave, vocational education). Because of the crisis, this Social Investment model tested principally by Nordic countries entered a new phase, characterised ever more intensively by innovations to improve efficiency, and experimentation with market delivery systems. The new ‘style’ is driven by a need for fiscal sustainability, and growing awareness of the limits on societies’ willingness to pay the high taxes which permitted avoidance of consolidation crisis.

The effects of the crisis upon ‘styles’ of social spending varied. Nordic determination to avoid debt-and-deficit spending is driving smarter-and-leaner welfare innovation. In other European countries and the United States, in contrast, the crisis may have slowed rather than speeded up new approaches to social spending. Although voters are often in favour in general terms of cutting social spending, they resist specific proposals, especially those that might affect them personally -- like retrenchment of pensions and health, and, to a lesser extent, cuts in benefits. ‘Social investment’ to assist working families in a market economy is not popular.

Generational change and economic crisis are bringing shifts in attitudes to welfare. In Germany the young are newly confident about rules-based market economics. In parts of Southern Europe the young are more likely to get-up-and-go-get-work in Latin America or Germany. In Britain it seems that young people are more ‘classically liberal’, more critical of welfare dependency, and likely to be humming Gladstonian lyrics of retrenchment.

The young are still not sufficiently powerful to influence policy. The effect of the crisis upon public opinion seems broadly to have reinforced a preference for the traditional conception of welfare state, most notably a preference for secure pensions and health expenditures.

3. Stop Here (No More)

Political leaders, policy wonks, and scholar-ideologues now have a responsibility to shape public opinion by pushing rationally for rules-based limits on social spending. If they wish to retain preeminence during the new era of globalisation, advanced economies cannot permit a return to pre-crisis trajectories of growth in social spending. Preferably spending would be reduced; at the very least it should be frozen at 22% percent of GDP (OECD average).

Remember, it’s not just the debt-to-GDP sustainability ratio that matters. As important are incentive effects of excess social spending on work, innovation, self-reliance, and competitiveness, the crowding out of markets, reduced market learning, and diminished human socialisation to markets. Social service industries could be a new economic frontier for prosperous societies, and, potentially, a leading export sector for a resurgent West.

In light of the fact that economic depressions are positive social and institutional turning points, a radical new consensus model might emerge which is Neither-Nordic-Nor-Normal. The new normal can be a combination of Nudge and Market. Populations should *not* be paying 50% of income in taxes rather than in market-payments for services like child-care, and for insurance like parental-leave, health, pensions. Instead of producing non-essential insurance and services, government’s natural monopoly is to enable, regulate, and police those markets, and to nudge purchases of these socially and economically desirable goods. Politically-determined standards of consumer choice and consumer rights retain their validity in the ‘new normal’.

Governments necessarily maintain responsibility for safety nets which protect people who are fairly judged unfit for employment or who are transiting from destroyed jobs to newly created jobs. In a mixed economy it is reasonable that government produces some healthcare, some education, and public goods like large-scale infrastructure. But there is no justification whatsoever for government producer monopolies in social services.

The people of OECD countries do not live in Welfare States ... yet. They live in societies where the state provides some welfare more or less efficiently and affordably, more or less predictably and impersonally. Yet if social spending continually increases as a proportion of GDP they will live in welfare states eventually. In socialism, the society is enveloped in the welfare state, and markets are a residual activity.

Main sources:

OECD, ‘Governance At A Glance’, August 2012, webpage
OECD ‘Social Spending During The Crisis’ Data Update 2012 pdf 
P. Diamond and G. Lodge, ‘European Welfare States after the Crisis’ (Policy Network) January 2013