Scholarly Evidence Against the Welfare State

Vermont socialist Sen. Bernie Sanders, left, and former Secretary of State Hillary Clinton, right. (Photo: AP)

I repeatedly try to convince people that the welfare state is bad for both taxpayers and poor people. Sometimes I’ll add some more detailed economic analysis and explain that redistribution programs undermine growth by reducing labor supply (with ObamaCare being the latest example).

And I’ve even explained that the welfare state has a negative impact on savings and wealth accumulation (these dramatic charts show Social Security debt in America compared to ever-growing nest eggs in Australia’s private pension system). But if new research from the European Central Bank (ECB) is any indication, I should be giving more emphasis to this final point.

Culling from the abstract, here’s the key finding from the working paper by Pirmin Fessler and Martin Schürz.

…multilevel cross-country regressions show that the degree of welfare state spending across countries is negatively correlated with household net wealth. These findings suggest that social services provided by the state are substitutes for private wealth accumulation and partly explain observed differences in levels of household net wealth across European countries.

Here are details from the study.

We regress net wealth on income…and add welfare state country level variables. …The main result of these hierarchical linear models is that pension and social security expenditure measured as shares of GDP show significant and negative correlation with household net wealth levels. …We regard this as evidence that welfare state expenditures indeed act as substitutes for private wealth accumulation and explain partly observed differences in household net wealth among euro area countries. A larger and more active welfare state leads to less need for private households to accumulate private wealth.

Here’s a pair of graphs from the study, showing the negative relationship between government-provided pensions and private wealth.

Now here’s the part that should make honest leftists more open to entitlement reform.

The data show that the welfare state increases inequality!

The effect of a 1 percentage point increase in state pension expenditure as a share of GDP on net wealth is a decrease about 20% less wealth for households around the 10th net wealth percentile. The size of the negative impact is smaller for wealthier households, but remains at above 10% of net wealth. Social security expenditure shows a similar but somewhat weaker effect, ranging at around 10% at the 10th net wealth percentile and coming close to zero for the wealthiest. …we see a decrease in net wealth of 47% for the low wealth household, of 16% for the middle wealth household, and 8% for the high wealth household. These numbers are roughly in line with our results… Additional welfare state spending is negatively associated with all wealth levels but decreasing in size relative to wealth across the full net wealth distribution. …this mechanism would lead to increased observed inequality of private net wealth given an increase of welfare state activity.

Those are some damning results.

And the numbers might be even worse in the United States since many minorities already are screwed by Social Security because they have shorter lifespans.

P.S. Since we’re on the topic of inequality, regular readers know that I think the issue as a complete red herring. Simply stated, the goal should be faster growth and it doesn’t matter if some people get richer faster than others get richer (assuming, of course, that the rich are earning their money and not getting subsidies, bailouts, and other forms of unearned wealth).

That being said, if somebody had asked me whether there had been a significant increase in inequality over the past couple of decades, I would have guessed – based on all the feverish rhetoric from our statist friends – that the answer is yes. So I was very surprised to see this chart from Mark Perry at the American Enterprise Institute.

Source: AEI

In other words, the politicians who are talking about a supposed crisis of growing inequality are spouting nonsense. And I’m ashamed I didn’t know their rhetoric is a bunch of you-know-what. That being said, if their concern about inequality is legitimate and not just for purposes of demagoguery, I expect them to read the ECB working paper discussed above and add their voice in support of a smaller welfare state and in favor of Social Security reform.

P.P.S. If the New York Times can support private retirement savings (albeit by accident), then other leftists should be able to do the same thing.

[mybooktable book=”global-tax-revolution-the-rise-of-tax-competition-and-the-battle-to-defend-it” display=”summary” buybutton_shadowbox=”true”]