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The choice of welfare states

Alberto AlesinaHarvard University

Beijing July 17, 2006Central University

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Three questions:

1) Why is there less redistribution of income from the rich to the poor in the US than in Europe?

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Three questions (cont.):

2) Differences among European social models: which work better?

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Three questions (cont.):

3) What are the possible lessons for Eastern and Central European countries?

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1) Why does Europe redistribute more?

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United States vs Europe: the difference

• Size and composition of government spending

• Pension systems

• Taxation

• Labor market regulation

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Possible explanations

I. “economic” explanations

II. political explanations

III. behavioral, sociological explanations

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I. Economic Explanations

1) The pre tax distribution of income: more pre tax inequality, more demand for redistribution in a democracy.

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It does not work: pre tax inequality much higher in the US than in Europe.

Gini coefficient is 38.5 in the US, 29.1 in Europe. In the US top 20 per cent gets 43.5 of pre tax income, in Europe 37.1 per cent.

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2) more wage inequality (and increasingly so in the US versus Europe)

• especially: larger differences between very low wages and average wages in the US relative to Europe

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3) Social mobility• Are American poor more likely to

become rich?• Perception and reality• Is American society more socially

mobile than European ones?

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II. Political Explanations

1) The electoral systems

Proportional electoral systems are associated with larger transfer spending programs in OECD countries. The US and the UK have two of the least proportional electoral systems. Northern European countries have very proportional systems.

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Transfers/GDP vs. Log (Proportionality)OECD countries

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2) Lack of a strong socialist/communist party in US history

The strength of socialist parties is strongly associated with the expansion of the welfare state

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3) Role of the judiciary system and the Supreme Court

Special role of US Supreme court. Throughout US history at least until the mid part of the past century, Supreme Court always rejected welfare legislation arguing that it would go against private property. A famous case was the rejection of a federal income tax in 1894.

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Side question: why have the US and “Europe” chosen different

institutions?

• Proportional representation is recent :a conversion to proportional representationhappened mainly between 1917 and 1920• Proportional representation reflected the growing power of labour movement and socialist parties.

1) Proportional representation

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• Also, in the United States proportional representation was considered too favourable to minorities like Blacks and recent immigrants.

• Conservative forces within the US were too powerful to allow a reform of that magnitude.

• The United States did not get proportionalrepresentation because the socialist partywas much weaker.

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2) The lack of an American Socialist party: why?

• Racial fragmentation

• Density and size of the US

• The role of wars

• Ideological “biases” of US Trade Unions

• Economic opportunities

• Political institutions and electoral rules: the President, the Senate, the Supreme Court

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3) The stability of American Constitutionalism

• Old versus new constitutions

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III. Behavioral and sociological explanations

1) Perceptions of poverty

Americans believe that the poor are lazy;Europeans believe that the poor areunfortunate.

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According to the World ValueSurvey, 71 per cent of Americans versus 40 per cent of Europeans believe that the poor could become rich if they tried hard enough

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Social Spending/GDP vs. Mean Belief That Luck Determines Income

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• Protestant ethic

• Racial fragmentation

2) Why these differences?

A large body of evidence shows thatthe white majority does not want to redistribute to the poor because the latter are perceived as “different” ethnically or racially.

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• Self-selection of immigrants:

The US is a nation of immigrants.Those who choose to move from theirown country may be those more likely to believe that one can escape povertyby taking risks.

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3) Implications for Western Europe

• The more Western Europe becomes racially mixed because of immigration from north Africa and Asia the more the welfare state will feel the same kind of “racial pressure” felt in the US

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4) What are the effects of these different beliefs?

• “Sense of justice”: if you believe that luck (or inherited wealth) determines differences in income, you are more favourable to redistribution.

• If you believe that individuals’ effort and ability determines income, you are less favourable to redistribution

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Individual survey evidence: those whobelieve that society is fair, i.e. peopleget what they deserve, are less favourable to redistribution

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2) Differences in European Social Models

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1) Standard classification:

• Nordic• Anglo-Saxon• Continental and Mediterranean

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• Nordic: highest level of social protection and universal welfare provision; extensive fiscal intervention in labor market (very generous unemployment compensation) but low firing costs and labor market mobility

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• Anglo-Saxon: social assistance of the last resort, not as generous in terms of pensions and unemployment subsidies

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• Continental and Mediterranean: concentration on pensions; heavy intervention in the labor markets with regulation, such as very high firing costs

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2) Comparisons

Nordic and Anglo-Saxon are normally considered superior to the other; one much more expensive than the other, but more egalitarian. But: incentive effects?

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Mediterranean and Continental tend to:

• be inefficient in redistributing resources from the very rich to the very poor

• create pockets of privileged, old workers, insiders in the labor markets versus unemployed and young workers

• create incentives to retire early, make pension systems unsustainable

• create obstacles to reform because of power of the insiders

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At risk of poverty before and after social transfers

  Before After Year

Germany 24 16 2004

Italy 23 19 2004

Greece 20 20 2004

France 26 14 2004

Sweden 30 11 2004

Netherlands 23 11 2002

Denmark 31 11 2004

UK 29 18 2003

Norway 26 11 2004

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3) Can the Nordic system be exported? Probably No.

• First it is very expensive. Mediterranean and continental countries may not be able to afford it given the size of their public sector and the pension bill in particular

• Nordic system successful in small, relatively homogenous countries and countries with very high degree of “trust” and social capital

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• the Nordic countries are the “heroes” of the European left, but their degree of success is somewhat exaggerated (remember the crisis of the nineties), and it is quite unclear that their system can be easily exported.

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3) What choice for Eastern and Central European countries?

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• Collapse of communism can in principle cause two types of reactions of how individuals look at the role of states: a continued demand for a very intrusive and paternalistic state; or “ultra-liberalism”, i.e. a complete rejection of the state altogether

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• evidence shows a bit of both depending on the country

• reunification of Germany provides a very useful policy “experiment”

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• East Germans remain very strongly “married” to the view that the state has to provide a list of services, social insurance, jobs, etc.

• major “political shock” in Germany that will make free market reforms harder to come by

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Germany: “The state should be responsible for the following areas”

 

Year AreaWest

SampleEast

Sample

1997

Responsibility for the financial security when unemployed 63.24% 78.85%

 Responsibility for the financial security when sick 34.50% 52.76%

 Responsibility for the financial security of the family 32.78% 49.06%

 Responsibility for the financial security when old 38.46% 56.09%

2002

Responsibility for the financial security when unemployed 65.33% 76.64%

 Responsibility for the financial security when sick 40.01% 51.81%

 Responsibility for the financial security of the family 32.10% 46.65%

 Responsibility for the financial security when old 36.70% 48.51%

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• whatever the Central and Eastern European citizens may want, their only option is an Anglo-Saxon system, for several reasons

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• First, they cannot afford a Nordic system and they do not have the characteristic of homogeneity and social capital that makes that system operate

• Second, the adoption of Mediterranean/Continental system is not only expensive but very likely to interfere with the process of “catch-up” of these countries vis-à-vis western Europe

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Conclusions

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• Western Europe has gone too far in the direction of providing social protection which is also often done in very inefficient ways

• The economic shock of the seventies and eighties plus increasing international competition have created much strain on these systems; in turn the latter have interfered with microeconomic adjustments to these shocks

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• Within Europe especially inefficient and costly systems are the Continental/Mediterranean ones

• The Nordic systems are very expensive and can function most likely in relatively small and homogenous countries with a high degree of social cohesion and social capital

• Countries of Central and Eastern Europe have no choice other than adopting a “light” welfare state in the Anglo-Saxon tradition.