chapter  5
25 Pages

The viability of the welfare state

ByJAMES J. HECKMAN

The welfare state is a late nineteenth-century invention. Its provisions for economic security are now accepted as rights in many countries. Franklin Delano Roosevelt proclaimed Freedom from Want as one of his Four Freedoms. The Universal Declaration of Human Rights adopted by the United Nations goes further in guaranteeing the right to work, the right to a standard of living with adequate health and well-being, including food and medical care in the event of an emergency. Many perceive such social rights as an integral aspect of a well-functioning state, and covered under the rule-of-law. The case for the welfare state that motivates these proclamations is that it

protects its citizens against the consequences of risks beyond their control (Agell 1999). The case against the welfare state is that it blunts incentives and reduces productivity. Supporting this point of view is that the economic performance of many welfare states has been poor. There has been a rapid runup in unemployment in most Western European welfare states in the past 20 years. When properly measured, many Western European welfare states have much higher rates of unemployment than are reported in the official statistics. Incentives to withdraw from work, to go underground, to evade taxes, to retire early, and not to produce, are high. Immigration levels are also high in many European countries. There are

serious problems with immigrant assimilation created in part by welfare-state policies. There is slow growth in human capital – a vital ingredient for a modern economy. In addition, there are low rates of business formation, weak incentives for entrepreneurship, and low levels of research and development. There are high taxes on labor and, in many countries, on capital. Poverty traps are often created that discourage work. The forces creating the pressure on the welfare state are globalization and an

inability to tax internationally mobile factors of production. The increase in the unpredictability in trade and technology, the increasing openness of economies, and the secular bias against unskilled labor in trade and technology are also the forces that create the demand for the welfare state as an insurer against

risk, and as a protector against the reducedwages that the unskilled experience when the demand for their skills is reduced. As economies become more open, it is much more difficult to shelter workers and firms from the rigors of the market. And in fact, less-sheltered economies like the US and UK have shown substantial increases in wage inequality and social inequality due, in part, to these trends. In the current environment, a premium has emerged for flexibility and

responsiveness of economies. High levels of workforce skill and a regulatory environment that supports change allow economies to benefit from new opportunities. An economic order that was well adapted to the more stable and predictable environment of the 1950s and 1960s and that had a large role for unskilled labor to play has become dysfunctional in the early twenty-first century. The opportunity cost of security and preservation of the status quo – whether it is the status quo technology, the status quo trading partner or the status quo job – has risen greatly in recent times. While reforms have been made in Europe, they have mostly been small-scale in nature. Europe has to run and not walk to keep up with the pace of global change, and it is barely even walking, although by European standards, it is rapidly reforming. Not all welfare states have lagged, or at least they have not all lagged in the

same way. It is fruitful to examine differences in economic performance among different welfare states. This is the topic of the chapters. The key to a successful welfare state lies in devising proper incentives to encourage actors at all levels of the economic system to respond to the new opportunities. In principle, a welfare state can provide the proper incentives for productivity and at the same time afford a measure of security and dignity for its citizens. But it has to respect incentives.