From Welfare State to Welfare Planet
A talk to the Asia Society of Hong Kong
by
Jeffrey S. Lehman
November 3, 2006
Thank you, Ronnie, for that kind introduction.
I wanted to start by saying a little bit about my topic, and how it came to be. Just about four months ago, Ronnie kindly invited me to speak to this distinguished group, and I was delighted to accept. Almost immediately, I received a follow-up email from Gillian, asking me to suggest a topic.
I said, “Well, one topic that I know a lot about is Healthy Globalization and the Transnational Research University.” Gillian said, “Everybody talks about that. Try again.”
So I thought about it and decided to talk about a topic that I don’t know as much about. Or, I should say, it is a challenge that I recognize without being able to see my way to the solution.
So I thought that I would share with you my diagnosis of the problem and then talk about two potential paths to a solution that, I believe, ultimately will not work. If I’ve been successful, then we can all go home depressed. Or maybe one of you will be able to spot a solution and suggest it during the question and answer period.
Many of the biggest problems we face as a species are the product of our successes, the product of advances in science and technology. We would not be worrying about nuclear proliferation had it not been for the genius of Albert Einstein. We would not be worrying about global warming had we not figured out how to burn fossil fuels in ways that make our lives better.
The problem I want to talk about shares that feature. It is the product of our success. But not so much our scientific success as our social scientific success. Over the past fifteen years we have successfully crafted an interdependent global economy that engages a vastly larger portion of humanity than ever before, and that is well on its way to engaging virtually everyone on the planet. That development has meant that we have seen poverty rates fall faster than they have ever fallen before, and we have also seen virtually unprecedented rates of overall economic growth. People everywhere are living better because of globalization.
The problem I want to talk about has to do with the failures of the marketplace. Economic theory tells us that free markets sometimes do not work properly. And even though when they work properly they sometimes do not work humanely.
During the twentieth century, we solved this problem. Industrialized nation-states found a way to deal with most kinds of market failure. And they found a way to deal with the most egregious forms of market inhumanity.
But globalization has changed that. Global capital and labor markets mean that individual nation-states lack the capacity to do all that needs to be done. The challenge is what to do about it.
What are the particular problems that need to be addressed? Let’s begin with the standard list of market failures that lead to inefficiencies in the production and distribution of goods and services.
- You have the problem of asymmetric information, where one party to a sale knows something the other party doesn’t.
- You have the problem of externalities, where the costs of an activity aren’t borne by the same entity that reaps the benefits of that activity.
- You have problems of monopoly and oligopoly, where a seller of a good or service is able to extract a so-called rent on account of the lack of competition.
- You have the problems of so-called public goods, where many people are able to enjoy the benefits of someone else’s purchase without having to share in the costs.
- You have the problems of immature markets, where for any of a number of reasons the resources simply are not available to do things that make economic sense, such as borrowing against one’s future earning capacity.
The early twentieth century saw each of these kinds of market failure become significant causes of inefficiency in most industrialized economies, and what followed was the emergence of the regulatory state, or mixed economy, a system of legal rules and enforcement mechanisms designed to counteract them.
So monopoly and oligopoly problems yielded to antitrust and competition laws. Information issues yielded to the securities laws. Bargaining power issues yielded to the development of legally sheltered worker unions. Public goods were financed through public taxation and then produced either directly or through privatization. And new markets were created, often subsidized or insured by public funds.
It was, quite frankly, a very good run. And well-regulated mixed economies started to significantly outperform any of the alternative systems of production that were being offered up around the planet.
Over the course of roughly the same period we also found a way to deal with the problem of markets being inhumane.
What do I mean by markets being inhumane? Markets compensate people for producing something that others are interested in buying. But sometimes individuals lack the capacity to produce things that others want to buy.
Maybe they lack that capacity because they’re old. Or sick. Or feeble. Or because they invested heavily in mastering a skill that has suddenly become obsolete. There’s not a lot of demand nowadays for typewriter repair mechanics and even auto repair mechanics now find that computers and robots do a lot of their work much better. (As an aside, I sometimes ask myself how much of the work of lawyers and teachers, and especially law professors, might be headed for a similar kind of obsolescence.)
Sometimes this lack of market-valued capacity is temporary. Maybe I learned how to operate a computer punch-card machine, and that’s obsolete, but in only a few months I can learn how to operate a word processor and become marketable again. Or maybe I just had a baby and need to be home for a little while to care for it, but will be back in the paid workforce soon enough.
But sometimes the lack is permanent. Maybe I’ve suffered an injury that will keep me unemployable for the rest of my life.
Here the response of industrialized societies was to create what the Archbishop of Canterbury William Temple described during World War II as a “welfare state,” to be contrasted with Hitler’s “warfare state.”
The first elements of the welfare state were social insurance programs, which dated back to Otto von Bismarck in Germany. Additional elements were added in postwar England thanks to the leadership of people such as Temple, R.H. Tawney, T.H. Marshall, and William Beveridge.
We should appreciate here that while the problem was the same in every industrialized country – how to care for people who are not in a position to earn their way in the marketplace – each country developed its own version of a response. There was not just one welfare state, but many different varieties.
Some welfare states just tried to fill in the gaps, to catch people who fall through the cracks. These states emphasized means-tested programs. Others were more universal, offering programs of partial earnings replacement or even a flat benefit to all citizens, in an effort to bolster solidarity among all the citizenry on account of their shared participation in the system.
But, to one degree or another, all industrialized societies developed pension, disability insurance, health care, child care, and unemployment programs to care for their most vulnerable members. The inhumane corners were rubbed off the market economies. Poverty rates after taxes and transfers fell dramatically.
For present purposes, the most important distinction among welfare states has to do with how they paid for the benefits they provided. In particular, to what extent was the cost of the welfare state passed along to an employer as an add-on to the cost of paying a worker to perform a task? The cost could take the form of a direct payroll tax assessed against the employer. More subtly, it could take the form of a payroll tax assessed against the employee. Since such taxes meant that less of what an employer paid out ended up in the employee’s pocket for immediate expenditure, it ultimately was no different from an employer-directed tax. Or the cost could take the form of regulations that made it hard for the employer to fire an employee.
How else might states pay for their welfare states? Through income, wealth, or consumption taxes based on something other than wage income. But by and large, these mechanisms have not been used as much as one might have expected. Whether you are talking about America’s payroll taxes or France’s system of paid vacations, the costs of social protection schemes have tended to manifest themselves in the gap between an employer’s total labor costs and an employee’s weekly take-home pay.
Before globalization, wage-based approaches to financing welfare states were okay. They were a market distortion, in that they shifted the incentives to use capital as opposed to labor, but they were not a huge market distortion. As long as employers didn’t have a realistic way to leave the jurisdiction, they were all in the same boat. They weren’t going to be worse off in competition with other firms if everybody was stuck paying with the same extra costs, and everyone was enjoying the same collective benefits.
But we’re in a new world now. It has been called the third industrial revolution, as we’ve gone from manufacturing to services to knowledge industries. Comparative advantage is now much less about geography and natural resources than it is about man-made phenomena such as legal systems, knowledge networks, and concentrations of expertise. More and more jobs are, in Alan Blinder’s terms, impersonal and therefore tradable.
The barriers to capital mobility have come crashing down like the Berlin Wall. So have transaction costs of moving ideas and information and even people and goods. Businesses have learned that they can make the most efficient use of their capital by contracting with others for manufacturing rather than by doing it in-house.
The net result is the emergence of the global delivery model. Firms develop worldwide networks of production contracts that give them the ability to produce almost anywhere, and to change the location of production on just a moment’s notice.
This means that firms are then free to focus ruthlessly on the costs of production in different locales, and then, as one businessman told me in Shanghai last year, to keep “chasing down the price curve.” Today, employers can leave. And that means that nation-states are no longer free to act with impunity.
This has implications for governments.
The good news comes when we are talking about government activities that address market failures. Efficiency-enhancing activities (except, arguably, those that force the internalization of externalities) can be popular with investors. Globalization can inspire a race-to-the-top with respect to things like the rule of law.
The bad news has to do with government activities that make markets more humane. Arguably globalization creates a greater need than ever for governments to provide certain forms of social protection. Under Ricardian principles of liberal trade, national specialization along the lines of comparative advantage will create winners and losers within each country. Countries need to make heavier investments in such welfare state features as trade adjustment assistance if they are to keep their workers agile. And they need to be prepared for rising numbers of workers who are rendered technologically obsolete.
But here’s the rub. Governments that want their citizens to be employed have to worry about the ways in which their policies affect the cost of labor in their country to potential employers of that labor. They have to worry about doing things that might drive the potential employer to move to another jurisdiction.
For the past ten years, there has been a robust social science literature debating whether the data shows a causal connection between globalization and the shrinking social protection schemes in western societies. There are, of course, other reasons why countries have cut back on their social programs that have nothing to do with international competition to minimize labor costs.
But the most recent and most thorough analysis, by Razin and Sadka, concludes that, as we look to the future, the combined forces of demographic change and globalization will make it impossible for the welfare state to maintain itself on its present scale.
What is to be done?
There are certainly answers. But they seem to be partial answers at best.
For example, some welfare state investments enhance worker productivity. Those can be preserved if they are deemed worthwhile in the global investment markets.
More ambitiously, we could try to extrapolate from the way in which welfare states were constructed within nation-states. After all, those are quite large. But they sustained welfare states because they extended all the way to their borders. (Where they didn’t, as in the United States for example, the result was rather meager by most accounts.) The extrapolation would say that some institution of global governance would set worldwide baseline standards for social protection. In other words, they would create the terms on which we would move from a welfare state to a welfare planet.
Right now, there are institutions of global governance -- the WTO and the Bretton Woods organizations.
But among them only the WTO could arguably claim jurisdiction over such a topic, making social welfare rights a predicate for increased trade liberalization. And frankly, with the collapse of the Doha round, it seems somewhat laughable to think of the WTO system taking on anything as ambitious as a universal social welfare floor.
So let me conclude with the darkest possibility of all. Suppose it really is the case that globalization will, on a going-forward basis, continue to ratchet up pressures to shrink the welfare state. And suppose that it is also the case that, without stronger engagement by domestic governments, we will continue to see the phenomenon whereby median wages in advanced economies fall, sometimes even faster than prices are falling as a result of globalization.
Then it would seem that the most likely outcome is some kind of democratic protectionist uprising. Some kind of popular effort to put the breaks on globalization. And an end to the era which has done so much to alleviate poverty and suffering worldwide. And that may be the most depressing possibility of all.
So we have about 15 minutes now to fix this. Let’s figure out a way that globalization can coexist with a mixed economy in which the public sector rubs off the more inhumane corners of the market economy.
Then we can all go home happy.
Thank you.
