Welfare States and their associated institutions serve unique public interests and purposes that the market cannot provide. The ‘free’ market was never ‘self-regulating’ by its own existence but was supported, regulated, and molded by non-contractual social ties and traditions within pre-modern and pre-industrialising societies. The involvement of the state in the late to early 19th Century forcibly broke these local and regional social bonds in the interest of the market.
Yet through the process of Creative Destruction, the economies of old were creatively destroyed in place of new industries. This, as theorised by Joseph Schumpeter, has lasting dire consequences on society as a whole most notably the Right-Wing Populist movements of the 20th century reacting against capitalism’s destructive potential. These vast economic improvements came at the cost of mass social dislocation and eventually contradictions that oversaw the rise of these movements. Developed nations soon realised that this economic transformation came at such a cost: labour cannot be entirely separated from pre-existing social arrangements. In years post-WW2, developed countries crafted their own systems of social protection in the form of the modern welfare state that combated such sentiment and alienation.
Creative Destruction did not end in the 20th Century; we are still feeling it today. Globalisation saw huge dispersed gains in wealth across the world but very concentrated losses in incomes across the Developed world leading to a so-called ‘China-Shock’ with the admission of China into the WTO in 2001. Automation and technological innovations are (unsurprisingly!) going to cause greater Creative Destruction.
This transformation requires a greater understanding of our Welfare State and the reasoning behind it. Even further reason is that the Welfare State does not retard innovation, efficiency, income, and freedom but rather improves them.
In the market, resources, goods, and services are distributed based on the marginal productivity of each unit factor of production (FoP). In much simpler terms, those employed within the labour market are the only people who are those who are only paid (regularly). However, around 51% of the American population gets paid a market wage rate and the remaining 49% of Americans do not receive any market wage rate. A moral ‘distribution-based’ argument then appears. Should those — the elderly, the sick, the young, students, careers and the disabled (86% of the non-working population) — be either forced to join the labour market to earn a wage, provided relief by private charities which lack the scale and efficiency to provide for such amount of people, or rely on a Welfare State which redistributes income to the non-working population? As poverty disproportionately affects non-workers, with a large majority of those being people who should not work, it seems clear that the solution to poverty should be a welfare state the provides to these people.
Contrary to the conservative mantra that welfare increasing state-dependency and other inefficiencies, welfare states actually help improve economic efficiency and correct market failures. Welfare allows for the pooling of risk giving people the chance to take more entrepreneurial risks and thereby have far more efficient labour-matching. More comprehensive social insurance allows workers to look for better jobs. If social insurance is provided, people can have higher job mobility by having the time to reduce their ‘search costs’ for a better job. If losing your current job means loss of most-all of your income without the guarantee of social insurance, then one would be more hesitant to find a better job. Unemployment insurance for instance can produce long-run productivity gains due to this reasoning.
The conservative argument that welfare disincentives work by incentivising people to live off welfare is not borne out empirically. In a comprehensive program-by-program study researchers Shalon, Moffit, and Scholz found that the work disincentive effects of welfare have a “basically zero” effect on the overall poverty rate. Furthermore, welfare benefits instead of being allocated to those too ‘lazy’ to be in the labour market, are mainly allocated to the elderly, disabled, or working population. In fact, around 90% of all entitlement benefits are allocated to these groups according to the Center on Budget and Policy Priorities.
Similar logic can be applied to entrepreneurship. Welfare and Social Insurance can safeguard entrepreneurs from risks if their venture/business fails. Such a comprehensive Social Insurance system provides a safety net for up-and-coming businesses and makes the prospect of just starting less riddled with risk. This can be highlighted empirically with Gareth Olds “Food Stamp Entrepreneurs” study stating that welfare increases the level of entrepreneurship. Indeed income security which is provided by welfare is directly positively correlated with “economic freedom”.
Incentivising private savings in order to allow for these risk-riddled ventures may be another solution. Yet saving is not efficient over a long period of time. If there existed a situation where everyone saved enough for retirement, entrepreneurial ventures, the risk of unemployment or disability, this would mean that one would save for the highest amount of years that one could be out of work to compensate for all of these risks. This is inefficient as people would save an absurdly high amount as much of this saving would be rendered unnecessary as people would not have all these risks compounded on them. Essentially people will inefficiently over-save. On the other hand, younger individuals also do not have enough time to save for a potential risk coming their way. The Welfare State must be there to provide some form of social insurance.
Welfare obviously serves the purpose of redistributing income from those in upper-income brackets to lower-income individuals. Younger and lower-income individuals have a higher marginal propensity to consume — a dollar is worth more to a younger poor person than a rich person. A welfare state would redistribute money towards those who are more likely to get more utility out of it. Even further reason is that the bottom 80% turn over their wealth in annual spending “three or four times as fast as the top 20%”. Essentially, if wealth is more broadly (re)distributed, more spending and thereby greater wealth accumulation would occur.
Also along the lines of the reasoning of more efficient labour matching, welfare, in general, can maximise freedom. The more money one haves, the more one can choose what to do generally. However, this effect is much more pronounced for those in lower-income levels rather than higher-income levels. Giving someone in a lower-income bracket greatly increases the options they have to choose what to do in life such as improving their housing, food, or basic income.
Giving the option for those to be freer may ruffle some feathers— alluding to the stereotype that welfare incentivises mothers to not marry and instead rely on it instead. The ability of single women to sustain themselves without marriage increases the incentive for single-motherhood which is seen as bad on communities and children. Yet the relationship between increased single-motherhood and increased entitlement is spurious. Regions with more single-mothers are more likely to grant more entitlements to single-mothers and regions with cultures that are more accepting of single-mothers are more likely to pass more generous benefits to single-mothers. Welfare itself may not be the cause of single-motherhood rather they both may be caused by the same underlying reason.
In the study “Welfare in America: is Welfare the answer or the Problem?”, researchers showed that instead welfare did not play a role in rising single-motherhood. Rising wedlock births from the 1970s-80s corresponded with declining welfare benefits in the same timeline. Another study by Hillary Hoynes called “Does Welfare Play Any Role in Female Headship Decisions?” saw that welfare does not increase the number of single-mothers for both White and Black families even controlling for migration. Instead, people who are more likely to become single mothers move to states with greater welfare benefits rather than causing single-motherhood.
Welfare, most importantly, has clear empirical effects on declining rates of poverty. Higher welfare and social spending are strongly negatively correlated with post-tax-and-transfer poverty as shown below.
In the US, welfare spending already reduces those in poverty from the distribution market-income to those in poverty post-tax-and-transfer — the distribution of disposable income. According to Census data, a previous 24% market income poverty rate is reduced to a 13.1% disposable income poverty rate — US welfare programs cut the amount of market poverty by 46% as shown below (!).
Yet as stated by Matt Bruenig, the poverty-gap — how far households are from the poverty line on market income and disposable income — is even more reduced by the welfare state. As per the graph below, the US welfare program cut the poverty gap by 66%, or a collective $173 billion.
As illustrated below we see that the US (highlighted in grey) has a pre-tax and transfer poverty rate at the mid-to-higher-end of OECD economies yet is the highest in terms of post-transfer poverty out of all OECD countries. The US lacks a comprehensive welfare state which holds it back relative to other countries. This does not discredit the fact that welfare programs have not contributed to a reduction in poverty in the US e.g Social Security in the US already lifts 14,810,000 elderly people out of poverty benefitting 21,661,000 overall including those below 65+¹.
Social Security is great at reducing both headcount poverty and the aforementioned poverty gap. Social Security, both provided to the elderly and the disabled reduce the poverty gap by 40% and 20% respectively with the former decreasing poverty by 28% for the senior population.
The Welfare State also serves a socio-political purpose of preventing Reactionary backlash arising from Creative Destruction. The disintegration of traditional societal protections brought about by economic liberalism increasingly saw the need for something that provides strong social ties. The continuous interchange between liberal markets and the need for social protection soon ended in the socio-economic catastrophe that was the Great Depression. Fascism was the radical reaction to the societal alienation that was brought by the Depression. The Welfare State can help buffer against this reactionary threat. Safety Nets can develop stronger social ties between people, prevent income shocks and thereby create greater solidarity: this would prevent reactionaries from coming into power.¹⁴ Arguably a universal (Social-Democratic) welfare state is largely more effective in bringing both the poor and middle-class away from reactionaries (this may be discussed in a later article!).
The Welfare State serves a function that nothing else can do as effectively. It increases efficiency, income mobility and, productivity and decreases income inequality, poverty and, the negative effects of Creative Destruction. The recognition of the social, political and economic benefit of a Welfare State is not the end of the conversation. How do we structure welfare payments? How do we pay for this welfare state? Progressive or broad-based regressive taxation? Who is welfare for? Means-testing or universality? Is decommodification ideal? These are all major questions in Political Economy that cannot be answered that sincintly in such an article. Hopefully, I would try to unveil these issues in later articles!
