...against fictions and other tall tales

Saturday, 11 August 2012

Myths about the burden of the welfare state: Insights from Harold Wilensky's new book

It's not uncommon these days to hear that the problems affecting the public finances of European nations are linked to the high welfare standards that are characteristic of European public administration.  According to this view, the cost of welfare programs, including social security and other forms of government-protected minimum standards, are simply too expensive and must be cut dramatically if Euro countries such as Greece, Spain and Portugal are to "regain control" of their public finances.

A related claim also suggests that the high level of taxation required to support welfare state systems stifles growth and undermines a nation's commercial competitiveness.  Accordingly, cutting social programs is viewed as a necessary first step toward lowering corporate tax rates and, ultimately, attracting businesses and promoting growth.  One commentator recently summed up this view as follows: "To thrive, Euro countries must cut the welfare state".

In my opinion, there are several problems with this line of reasoning.  The first is that viewing the European sovereign debt crisis as a consequence of the degree of generosity of welfare state policies completely disregards the fact that several Europeans nations with elaborate welfare systems are not suffering the same problems as, for instance, Greece and Spain.  Kurt Huebner has summarized the problem of linking the European debt default crisis to the costs of welfare state entitlements succinctly in a recent policy note:
If too high entitlements, in other words high welfare state standards, have caused the sovereign debt default crises, we would expect that societies with the highest and most generous welfare states would be top-ranked in the group of sovereign debt default economies. According to general prejudice this would be Sweden, Denmark, Norway, Finland and Germany, Austria and the Netherlands. The last time I checked nearly all of those economies were ranked in the top – but in the group of economic high-achievers and not high debtors. In other words: making a causal link between sovereign debt crises and welfare state entitlements is not confirmed by empirical data.
As for the claim that the high levels of taxation that is required to support welfare state systems is detrimental to economic growth, this too is unfounded.  In a recent blog post, Martin Wolf refuted the argument that lower taxes are the principal route toward better economic performance.  On the contrary, Wolf demonstrates that, not only are today’s most solvent countries highly taxed, but also that the level of taxation has no incidence on economic growth.  For this reason, Wolf suggests that the current focus among policymakers and commentators on reducing the tax burden is misguided:
Indeed, among the eurozone countries shown, crisis-hit Ireland, Spain and Italy had relatively low average tax rates. (They also had fiscal surpluses or negligible fiscal deficits, prior to the crisis. But that is a topic for another occasion.) The heavily taxed eurozone countries on the right hand side of the chart (from Germany on up) are all now relatively crisis-free.

The conclusion to be drawn is that a tax burden (within the range of 30 per cent to 55 per cent of GDP) tells one nothing about a country’s economic performance. It is far more a reflection of different social preferences about the role of the state. What matters far more are culture, quality of institutions, including law, levels of education, quality of businesses, openness to trade, strength of competition and so forth.
But what about the impact of welfare policies as a whole on a nation's economic performance?  Surely, one would assume that high welfare standards would be a net cost to the economy and society?  Again, as with the claim that a high tax burden is detrimental to growth, this too is a misguided assumption.

The most comprehensive explanation of why the welfare state is not a drag on economic performance is found in the work of the late Harold Wilensky, Professor Emeritus of Political Science at UCLA, Berkeley.  Wilensky's most recent book entitled American Political Economy in Global Perspective (2012) provides a highly detailed and up-to-date analysis on the political economy of the welfare state.

In this book, Wilensky presents findings stemming from over 40 years of in-depth research on 19 rich democracies that, among other things, support the view that modern welfare policies do not have adverse effects on productivity and national income.  The book points to empirical evidence that supports this conclusion and lays out in a clear and convincing manner the argument that welfare systems are not a drag on economic performance (2012:7-14; 46-55). 

According to Wilensky, there are two main reasons why the welfare state is not detrimental to a nation's economy.  First, Wilensky argues that many sectors of social policy are simply productivity enhancing.  The following excerpt from the book summarizes this point quite well:
Mass access to medical care and health education via schools, clinics, and child care facilities reduces long-term medical costs and in some measure enhances real health and lifetime productivity; preventative occupational health and safety programs in the workplace reduce absenteeism and turnover and other labor costs; active labor market policies supplement and in some countries reduce reliance on passive unemployment insurance and public assistance and improve the quality of labor; innovative family policies reduce the cost of both mayhem and poverty, they also reduce income inequality and gender inequality, which are a drag on economic growth.  These are substantial offsets for the costs of welfare-state benefits to the nonworking poor, handicapped, and the aged.  The net economic effect of all the programs labeled the "welfare state" is therefore either positive (before 1974) or neutral (since 1974). (Wilensky, 2012:6)
As for the second explanation of why high welfare standards are not detrimental to economic performance, Wilensky argues that nations with highly developed welfare state systems are also nations with institutional structures and legal frameworks that foster the habit of consensual bargaining among the government, businesses, unions, interest groups and other social partners, whether it be through public institutions (e.g., legislative assemblies, intergovernmental relations) or private institutions  (e.g., governance boards, conflict resolution committees).  More specifically, nations with these types of institutional structures and bargaining arrangements in place (e.g., Norway, Sweden, Finland, Denmark, Netherlands) promote coalition-building among political and societal groups, as well as effective labor relations.  In addition, these institutional structures and bargaining arrangements foment a politics of moderation that minimizes confrontation between social actors, as well as reduces both policy paralysis (i.e., inaction by government even though there is strong support for certain policies by citizens and dominant social actors) and political brinkmanship between partisan groups.

In sum, nations with consensual bargaining arrangements in place encourage the development of public policies that are more reflective of the aspirations of the electorate and, as a consequence, that are less apt to fall prey to polarizing partisanship or result in costly citizen backlash and/or rollback, as is common in more confrontational democracies such as the US (e.g., tax-welfare backlash).

According to Wilensky, the most significant economic benefit flowing from this consensual form of political bargaining is that it facilitates productive trade-offs among the government, political parties, businesses and unions, many of which have positive impacts on productivity and economic performance.  The trade-offs favorable to good economic performance and typical of consensual democracies include the following:
  • Labor embraces restraint on nominal wages in return for social security and related programs based on social rights and modest increases in real wages;
  • Employers provide job protection in return for wage restraint, labor peace and sometimes tax concessions (e.g., lower taxes on corporations and capital gains);
  • Employers provide participatory democracy in the workplace or community in return for labor peace and wage constraint;
  • In return for all of the above, the government improves its tax-extraction capacity (i.e., capacity to increase taxation with minimal backlash from public), thus enabling it to offer more generous and popular social programs;
  • Faced with strong unions and with the habit of making such trade-offs, management tends to cooperate with labor in return for the implementation of a wide range of government policies, including less intrusive regulations and more effective implementation of laws and executive orders. (Wilensky, 2012:46-49).
In addition to these trade-offs, Wilensky points out that consensual democracies benefit from lower strike rates, a higher rate of gross fixed capital investment and wage restraint during economic shock periods (2012:51).  According to Wilensky, the higher rate of capital investment and lower strike rate are the main causes of good economic performance for these nations.  Also, these nations benefit from less confrontation between social and political actors and strong countervailing sources of consensus where, for instance, the dominant influence of big business is matched by the power of big labor.  Finally, as a result of the greater degree of cooperation that exists between social partners in consensual nations, policy paralysis is more easily overcome and economic shocks are more quickly and effectively addressed and mitigated.

Now, I should emphasize that Wilensky is not suggesting that nations with consensual bargaining arrangements have stronger economies than nations with more "confrontational" bargaining arrangements (e.g., US, Canada, UK, etc).  On the contrary, Wilensky makes it clear that during the last four decades there has been "two roads" to good economic performance; nations with consensual bargaining arrangements (i.e., "high road" strategy) and nations with more confrontational bargaining arrangements (i.e., "low road" strategy) have performed equally well when examined from a purely economic standpoint.  The difference is that nations that have adopted the metaphorical "high road" do much better in terms of social and political performance (e.g., income and gender inequality, health, job security and education).  In other words, according to Wilensky,
[e]ither [road] can at various times and places result in good economic performance.  The sharp contrasts appear in social and political performance.  The choice is a matter of one's values. (Wilensky, 2012:190).
Before concluding, I should address one common objection that is often made by critics of the view presented above, which is that recent global developments such as increased immigration, international competition, the spread of multinational corporations (MNCs), and the deregulation of labor markets, to name but a few, pose significant challenges to the viability of the consensual bargaining model of governance and undermine the economic base that enables the trade-offs above to materialize.  In other words, the critique suggests that this model is outdated and no longer adapted to the modern world economy.  However, according to Wilensky, such developments have only had a moderate to small influence on consensual bargaining.  For instance, on the impact of MNCs, Wilensky notes that there is little evidence that MNCs have undermined the nation's capacity to accommodate the conflicting interest of social partners by means of consensual bargaining.

That said, Wilensky argues that there is one recent development that does threaten the survival of consensus-enabling arrangements and institutional structures that help sustain effective welfare state systems: the increasing power and ideology of central banks and the internationalization of finance.  Wilensky's view on this issue is highlighted in the following excerpt:
Perhaps one recent trend does undermine the capacity of modern democracies to shape their economic destinies: unregulated internationalization of finance and the increasing independence of central banks, a clear threat to collaborative relations among labor, industry, and the state and to flexible use of fiscal policy (taxes and spending).  Reinforcing this trend is the flow of recently ascendant American economic doctrines across national boundaries: a blend of 19th century liberalism (unmodified free markets, private property, minimum government), Reaganomics, and monetarist ideology.  This was the ideological base for the deregulation of the financial sector at the root of the meltdown and Great Recession. (2012:151) (my emphasis)
A word on the Eurozone crisis and the need for a countervailing force to the ECB

Although American Political Economy in Global Perspective does not address the current European sovereign debt crisis, my impression is that Wilensky would have given preference to a solution that would not only directly address the financial problem facing the periphery Euro nations (either through the creation of "Eurobonds" or the ECB purchase of periphery nation debt) but also promote the emergence of a countervailing force that would match the influence of the ECB.

In my view, two sets of proposals could help to achieve such a result, namely, the creation of stronger EU institutions (including a democratically elected EU president, see Charles Goodhart's recommendations here)*, as well as the proposal to implement European-wide wage-setting (see Andrew Watt's article here), a proposal that I think could give rise to a stronger, more centralized labor presence at the EU level.

Here are the relevant sections of the book relating to the concept of countervailing power and central bank independence and influence:
The German labor movement for decades remained a major countervailing force to the Bundesbank...[T]he postwar record of low inflation with only medium unemployment is a product not only of the Bundesbank's autonomy but of a labor movement that has traded off wage restraint and industrial peace for social benefits and worker participation.[...] The consensual bargaining between labor, government, and industry eases the Bundesbank's task of controlling inflation without greatly reducing employment.  The ascendance of the European Central Bank, however, changed all that.[...] (Wilensky, 2012:128)

That several of the countries whose central banks had limited autonomy before 1990 (Japan, Austria, Norway, or Belgium, 1965-1974, 1985-1989) outperformed countries with more independent central banks (Canada, Netherlands, Denmark, or the US before 1980) should give pause to those who adopted the "Bundesbank model" for the European Central Bank without the German labor, management, state, political, education and training and other institutions that made it work.  Unfortunately, the European Union has neither the offsetting institutions to constrain such a bank's behavior nor the European-wide welfare state and job creation antidotes to its strong deflationary medicine. (Wilensky, 2012:132) (my emphasis)
* Paul McCulley has also suggested that the ECB president "needs a boss" to whom he or she would be directly accountable. I very much agree.

References

Huebner, Kurt, Political Exploitation of the Crisis of the Eurozone, Policy Brief, Institute for European Studies, University of British Columbia, February 2, 2012

Wilensky, Harold, "Trade-Offs in Public Finance: Comparing the Well-Being of Big Spenders and Lean Spenders", International Political Science Review, Vol. 27, No. 4, 333-358, 2006 (to view an earlier version of this article, see here)

Wilensky, Harold, American Political Economy in Global Perspective, Cambridge: Cambridge University Press, 2012

Wilensky, Harold, Rich Democracies: Political Economy, Public Policy and Performance, Berkeley: UCLA Press, 2002

18 comments:

  1. Circuit... an excellent piece!

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  2. Nice post.

    You may also be interested in Alex Izurieta's article where he talks of a supranational fiscal and wage authorities to resolve the crisis.

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    1. Oops forgot the link

      http://www.networkideas.org/news/aug2011/Irvin_Izurieta.pdf

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  3. Very insightful post. Brilliant rendition of one of the greatest empirical social and political economists of the 21st century. You highlighted the landmark of HW's vision of democracies: the need for institutional convergence in the public sphere and political consensus by all stakeholders on the fundamental values of government and markets. Your initiative in addressing the Eurozone dilemma is a commendation in itself and a marked tribute to Wilensky. You juxtapose the empirical anomalies of welfare economies and conclude correctly that the 'brand' does not warrant the critique.

    You summarized the work and the man most eloquently,and sidestepped the academic praise justly attributed, focusing on the extraordinary contributions his thought made to public policy, and fiscal policy in particular. Harold Wilensky was a man for all seasons, certainly in the line of Mannheim, and Bell but much wider in scope of interest and breadth of knowledge. To Mannheim's ideological penchant, Wilensky was deeply empirical; to Bell's cultural skew, Wilensky was a militant but cautious pragmatist and not to endorse a polemic-highly institutional. His intent was to achieve progress and growth at all levels by advocating optimality: win/win for all actors reminding the institution and agency of its own constitutional role: act for the benefit of...

    !!!

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    1. It's difficult to praise Harold Wilensky. It wasn't his style to invite personal recognition. Actually, he never welcomed it; he was a man that praised others and demeaned his own contribution. Those who knew him will readily recognize this trait when he listened to jazz and when he cited classics and when he credited original thinking. This is not meant as an obituary of the man; obituaries are like bookmarks; they exclude 99% of the better and best. However, to Swells' exceptional appraisal (!!!) I would add: Wilensky surfed jaws. His mind challenged the greatest hurdles of social and political policy and thought. He was a mastermind of complex organizations, the likes of which will be difficult to match, not to say surpass. His stance was not only convergences, but moreso, and here the classical integrity of the policymaker, his recognition of the importance to account for human, communal and sovereign differences. Before the discovery of post modernism, Harold Wilensky was pegging stakes delinedating the social and political space for organizational behaviour as a function of democratic principles-the respect of Otherness, of Difference. For Harold Wilensky, the fundamnental tenet of a constitutional democracy was respect for the other-the always different other; the purpose of institutions was to enrich the possibility that complex behaviour offers. For Harold Wilensky, public policy was taking democracy seriously and overriding the defaults set by conventions and governments when the facts didn't fit.
      It's a credit to FRB that it raised his banner during this turmoil. Well done.

      !!! a great post Circuit.

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  4. @ all: These are great comments. Harold Wilensky's book is important from a policy standpoint. In my view, it should be mandatory reading for anyone who is skeptical of the conventional wisdom vis-a-vis welfare policy (the way it is usually discussed in the media). In fact, the type of institutional arrangement that Wilensky views as the most appropriate would actually go a long way to help advance the cause of post-Keynesians. Indeed, the type of institutional structure he recommends is entirely in line with that put forward by hordes of post-Keynesian economists, including Nicholas Kaldor, for addressing issues such as inflation (1982:61). I can't tell you how many times I've read that what is needed are more effective tri-partite (multi-partite) 'social partnerships'. I've already been on board with this idea but, in this book, Wilensky essentially provides justification that this is not an empty blueprint, but rather that it's effective in helping to achieve sound policy outcomes.

    @Ramanan: Thanks for the link. As you may have probably guessed (based on my previous posts), Izurieta is one of my favorites. A solid analyst. Indeed, it would be hard to save the EMU without some form of European fiscal authority. Goodhart too is right on that one.

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  5. Wonderful post, Circuit! Am copying to all my friends inside and outside the public service.

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  6. Your take from Wilensky on the need for coherence between social programmes and social policy is critical to his pragmatism. It slips the pundits, policymakers and politicians. In fact the whole conceptual framework that underlines Wilensky's policy approach is a prerequisite coherence and integrality between government and intragovernment policies and programmes. Signaling the German experience is welcome: unfortunately, Mr. Bernanke doesn't access the same type of entourage-Congress is lame and US Labor is dismayed by the extent of consequential damages. Inserting Wilensky within a post-keynesian narrative, I find, quite daring. It is what the 'keynesian brand' needs as a brilliant option. !!!

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    1. Indeed, I was quite impressed by the sections on the interdependence of public policies. The section on how health-relevant social programs improves the effectiveness of preventive medicine (p.83) was especially well done. IMO, the book is a must read for any student enrolled in a public administration or public policy program. And, of course, the bibliography is first rate.





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  7. this article and its comments are welcome because they single out an opportunity to enhance the prospectus for the post-keynesian and mmt 'brands' ( nice connotation ) by grafting the monetary policy onto Wilensky's political prescription for an operative democracy. Wilensky's insight and proposal for an efficient and effective public policy in a constitutional democracy is embedded in the complimentarity of social and economic policies. the most pragmatic framework is the social contract, and Wilensky's blueprint outlining the relationships between the varied institutional actors and agents, countervailing forces and vested interests, and their prudent entrenchment in an open public territory is viable. the last time (almost 50 yrs ago) we witnessed this type of visionary initiative was with Lyndon Johnson's !!! Great Society, commented on by some of your readers. since then public policy has been very infertile and fragmented in the US. provincial efforts in Canada were prevalent in Manitoba and some of the other western provinces generations ago, but they lacked, de jure, the fiscal collage, to render them effective. Trudeau courageously invoked the possibility, but had to forego the political vision to deal with a north american economy gone astray. Quebec's lip service to the social contract during the 70's and 80's was a syndicalist extortion of prudent economic policy and a sabotage of public governance. apart from Levesque and Bourassa who were well-intentioned, only Adelard Godbout had succeeded through the historical proxy of Jean Lesage to evoke the semblance of a 'coherent' social contract. unfortunately, Mr. Godbout's name has been surgically removed from the body-history of quebec politics-to quebec's loss and at its citizen's expense. would that keynesians embed Wilensky- he, among the few, addresses the fiscal parameters of policy implementation.

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  8. @Anon, thanks for sharing. Glad you enjoyed the post.

    @JH: Great take on Johnson. He was good. As for Adelard Godbout, I can't agree more. His record is actually quite remarkable, especially in light of the inaction of his predecessor/successor. Beginning with the nationalization of a big hydro-electric company, compulsory education, workers rights...the list goes on. A good documentary was made a few years back: "Traitor or Patriot" by the NFB. Well worth it.

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  9. Circuit: You may find the following interesting. It touches on W's adamant prescription for serious adjustments to our education policies, and your own (as well as many others) insistence that manufacturing should be the primary target of industrial policy in a highly recessionary global market.

    http://www.newyorkfed.org/research/staff_reports/sr566.html

    The work is very thick.

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    1. GC, this is great. Thanks! (And very thick, indeed)

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    2. nice complement to look at is Brookings Inst. http://www.brookings.edu/~/media/Research/Files/Papers/2012/8/29%20education%20gap%20rothwell/29%20education%20gap%20rothwell.pdf

      i concur with MI that the Fed's paper makes a remarkably similar conclusion by inference. the emphasis on the structural mismatch signals the necessity to import demand driven explanations and redefine industrial policy towards manufacturing and labor's response to promoting competitive output to the same. the latter may not be apparent given the complexity of organizations and relationships between public and private spheres.

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  10. Circuit !! @GC thick indeed! Multitude of insights and some very refined econometry by the group. I highlight their emphasis that improving the trade balance improves the deficit and specific manufacturing improvements by reducing skills mismatches supports trade improvements. A quantified prescription by and a good FRB.

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    1. This is a really good paper. Thanks to GC for pointing it out. It examines the problem of job mismatch from many angles, as MI suggests. Interesting that the geographic mismatch is not a factor but rather that the sectoral/occupational is.

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  11. JH, thanks for the link to the Brookings study. Fantastic account of how parts of the US labour market are currently demand-constrained. In addition, it shows that education policy has an important role to play on the supply side as well. I also appreciated the study's point that the lack of job openings in some areas may be evidence of a need to boost entrepreneurship and assist start-up firms via industrial policy.

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  12. I am sorry to say, nothing new in this thread...

    It is, in fact, simply regurgitated leftwing doctrine arguing, that there are exceptions to the socialist model.

    I hope to hear from someone whom disagrees, so that a debate can ensue...

    BTW, there more issues at stake other than welfare programs, which
    has lead to the decline of EuroLand...

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