American Economist| March 22, 1997 | Lindbeck, Assar |
The modern welfare state and full employment policies have common intellectual roots. In the 1930's and 1940's, Keynesian visions of full employment and Beveridge-inspired ideas of a universal welfare state grew up in about the same intellectual environment. Both ideas emphasized a government's responsibility for the welfare of its citizens. The two ideas were also projected by approximately the same individuals.
From the very beginning, welfare-state arrangements and full-employment policies were regarded as strongly complementary. Both were designed to improve the economic security of the individual, although welfare-state arrangements deal largely with life-cycle considerations, while full-employment policies focus on the situation at a given point in time. They were also believed to support each other. Not only would high aggregate employment help finance the welfare state by boosting the tax base and keeping down the number of beneficiaries. A reverse causation was also assumed: various welfare-state arrangements were often asserted to contribute to full employment. Hence a virtuous circle was postulated between the welfare state and full employment. Governments also constructed specific institutional arrangements and regulations that were explicitly designed to strengthen the consistency and complementarity between the welfare state and full employment job policies.
Actual economic and social developments during the first decades after World War II seemed to support the view of a harmonious, indeed symbiotic, relation between the welfare state and full-employment policies. It turned out to be possible to combine full employment with high economic security and a gradually more even distribution of income, which are important ambitions of the welfare state.
Exactly what, then, were the asserted complementarities between the welfare state and full-employment policies, and why do these complementarities look less convincing today?
I would like to organize the discussion of these questions around four issues: (i) the influence of welfare-state arrangements on short-term macroeconomic stability, (ii) the long-term incentive effects of welfare-state arrangements, and related taxes, on aggregate employment and unemployment; (iii) the role of explicit administrative measures to boost aggregate employment in the long run; and (iv) the employment consequences of various labor-market regulations designed to fulfill much the same purposes as traditional welfare-state arrangements. The paper concludes with (v) a discussion, using a simple macro model, of how various welfare-state arrangements affect the contemporary employment crisis in Western Europe.
(i) The welfare state and macroeconomic stability
Assertions that comprehensive welfare-state arrangements contribute to the short-term macroeconomic stability are built largely on the Keynesian "automatic fiscal stabilizer", which maintains the disposable income of households in business downturns via government budget deficits. Indeed, this is perhaps the most obvious example of complementarities between the welfare state and full-employment policies - a point emphasized in Tony Atkinson's Award Lecture last year (Atkinson, 1995, pp. 8-9).
It is tempting, then, to hypothesize that macroeconomic stability will be greater, and the possibilities of avoiding heavy unemployment better, the more comprehensive and generous the welfare state becomes, and hence the more sensitive the budget deficit is to macroeconomic fluctuations. The entire issue is much more complex, however. An important reason is that budget deficits in recessions may not be balanced, even approximately, by budget surpluses in booms. One explanation is simply a "technological" asymmetry: there are stricter limits to increased capacity utilization in booms than to reduced capacity utilization in recessions. Another explanation is political: when tendencies towards large budget surpluses emerge, the political pressure for increased spending or lower taxes is often irresistible.
What, then, would be the disadvantages of a rapid long-term increase in government debt, as a share of GNP? One trivial but important problem is that a dramatic and sustained increase in the interest burden of the public sector tends to crowd out other types of public-sector spending. During the last few decades, this has been the case in high-debt countries such as Belgium, Finland and Sweden, where the nominal interest payments of the government have recently approached and/or exceeded 10 percent of GNP. This has induced governments to cut welfare-state spending; the welfare state has become a victim of galloping public-sector debt.
Other well-known problems of galloping government debt are, of course, redistributions of income to the disadvantage of future generations, and increased risks of higher inflation as the government may want to inflate away the real value of the deficit and the debt. Though the magnitude of these problems is sometimes exaggerated in the political discussion, it would be wrong to deny that these problems are genuine drawbacks of a large and galloping public debt.
Another problem, which has come to the forefront in recent years is that galloping government debt may generate destabilizing expectations among private agents - households as well as institutional lenders; see, for instance Giavazzi and Pagano (1996). Multiperiod theories of household saving (consumption) predict that increased public-sector deficits will raise the household saving rate, provided households take their knowledge of the government's intertemporal budget constraint into account in their own microeconomic behavior. More specifically, people have reasons to expect that benefits will be cut or taxes raised in the future as a result of a budget deficit today. As a consequence, households are likely to increase their saving today to counteract the effects of expected government budget policies on their future resources. As we know, economists have expressed serious doubt regarding a strong version of this theory, according to which the rise in desired household saving would be exactly as large as the fall in public-sector saving - so-called "Ricardian equivalence". There are, however, exceptional situations when this may be the case, and when the household saving rate may increase even more than predicted by the theory of Ricardian equivalence.
One such situation arises when galloping government debt during deep recessions generates a drastic increase in the uncertainty among households about social-security entitlements (though increased uncertainty about future taxes may have the opposite effect). As a result, households may cut their consumption to a larger extent than predicted by consumption theories where such uncertainties are not explicitly considered. Such negative effects of increased uncertainty about future social-security entitlements on private consumption may in some cases dwarf the "traditional" positive effects of the automatic stabilizer which boosts disposable income. It may also dwarf the "normal" ambition of households to smooth their consumption path over the business cycle, as described by standard life-cycle theories of saving. Uncertainties of these types are often believed to be an important explanation …
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