The Social Insurance State, Economic Problems of the North Atlantic, Redistribution, and the Lesser Depression: Monday Focus: March 10, 2014
Back in the 1970s and 1980s I was told over and over again–by pundits, right-of-center politicians, political scientists, and not a few economists–that the source of the North Atlantic’s economic problems play in its overly-democratic politics. The argument went more-or-less like this:
Some voters want goodies; other voters want low taxes; politician satisfy them by expanding programs and cutting taxes, Producing debt. The debt must either be amortized through high taxes that discourage investment, entrepreneurship, and enterprise, or through printing money which produces inflation and also deranges the price system and slows growth.
Thus, I was told over and over again, the economic problems of the north Atlantic in the 1970s and 1980s–the productivity growth slowdown in the inflation of the 1970s–were the result of an overly-large welfare state produced by an overly-democratic government. Both of these, the argument went, needed to be fixed.
This never seemed to me to make quantitative sense…
The growth of welfare–or rather social-insurance–states in the post-World War II period had not produced an explosion of debt or a “fiscal crisis” of the state in any sense: debt-to-GDP ratios were, rather, at historic lows. The inflation of the 1970s had other causes than a government that didn’t want to pay its bills: (i) a Great Depression memory-fueledc overly-strong desire to delay resorting to unemployment to control inflation until it should become absolutely necessary, (ii) a productivity slowdown that reduced the warranted rate of real wage increase accompanied by a failure of labor to recognize this reduction, (iii) the fact that both the Arab-Israeli conflict and a lot of the world’s oil were located in the Middle East, (iv) Henry Kissinger’s strange belief that a high world oil price produced Cold War benefits for America, (v) the Iranian Revolution, etc. In all of these rising government spending relative to taxes was nowheresville, because the government’s debt-to-GDP ratio had not increased.
Similarly, the argument that the high taxes needed to finance the social-insurance state were discouraging entrepreneurship and enterprise was nowheresville: those same high marginal tax rates had not discouraged entrepreneurship and enterprise in the 1950s and 1960s, had they?
The argument seemed to be:
- Inflation is a bad thing.
- The productivity growth slowdown is a bad thing.
- The social insurance state is a bad thing.
They must be connected!
Never mind that what short- and medium-run fiscal problems we had were the deliberate creation of a Republican Party faction that thought very large deficits were politically useful. And never mind that what long-run fiscal problems we had were due to that same deliberate creation and to our failure to develop a plan for national health insurance that would keep our projected spending on medical care within our means. Rational argument was powerless against the belief that all bad things must have some common roots and common links.
And now I find the same current of thought is back: the financial crisis of 2007-2009 and our Lesser Depression of 2008-whenever must, the argument goes, be due not to bad deregulation that produced a financial house of cards and made our economy dependent on it and to failures of policymakers to understand what was necessary to restore aggregate demand but, rather, to the fact that our tax and transfer systems are too progressive.
Paul Krugman writes:
Paul Krugman: Redistribution and the Lesser Depression: “I’ve finally gotten around to a careful read of the new IMF paper on redistribution and growth…
which concludes that there is no negative effect of redistributionist policies, at least within the range we normally see, and quite possibly a positive effect from the reduction in inequality…. A quick-and-dirty piece of data analysis…. I found myself thinking about… the common trope on the right that the economic crisis is the result of overlarge welfare states… what do the data say?
There is a suggestion of a slight negative correlation, and if you fit a regression line it is indeed downward-sloping, although the slope isn’t significant. But you can see right away that this result is driven by the relatively good performance of Anglo-Saxon countries that arguably gain from not being on the euro. Suppose we restrict the sample to countries on or pegged to the euro (Denmark). It looks like this:
There is, it turns out, a fair bit of variation among euro area countries in the amount of redistribution — and there is actually a positive correlation between redistribution and growth over the post-crisis period, significant at the 10 percent level. Overall, the data offer no reason to believe that the economic crisis has something to do with the welfare state…