Economic Growth

Social welfare and economic growth

By Ole Meldgaard

One of the hottest issues in the political debate is the link between economic growth and social welfare. Is economic growth and social welfare contradictory, so we have to choose? It has been debated for centuries and this question underlies also discussions today on long-term strategic challenges in welfare states economy. It is argued that we must cut social spending to expand economic growth.

The basic argument against tax based social welfare goes on incentives to work: any combination of taxes and social transfers is doubly costly. It erodes incentives to work, both for those being taxed and for those receiving benefits. For the former: why should they work harder to benefit others? For the latter: why should they work when they receive money from the government? Thus, in theory, social programs seem to subsidise leisure and not getting a job.

However, the Californian professor of economics Peter H. Lindert has explored the history of tax based social policy and redistribution since the eighteenth century, and in his book “Growing Public” from 2004, he concludes that contrary to traditional beliefs, the net national costs of governmental social programs are virtually zero. Social spending has contributed to, rather than inhibited, economic growth. Although it might seem obvious that social spending has a negative impact on growth and productivity, data refuses to confess that things work out that way.

Tax based social policy came lately into history. Before the end of the eighteenth century, no country spent even 3 per cent of its national product to redistributive social programs. People paid hardly any taxes for social programs. Today social spending has expanded to over one third in many countries. Over the last two centuries it was social spending that accounted for most of the rise in government’s taxing and spending as a share of Gross Domestic Product (GDP).

In the beginning of social spending there were only modest poor relief programmes and public schools. In the period 1880-1930, social transfer also included unemployment compensation, pensions, accident and disability compensation, public health and housing subsidies. The Scandinavian countries were the social-transfer pioneers. The real boom in taxation and social transfer came after the Second World War. Over two decades, social transfer rose as much as it had risen in all previous history. Now the expanding social programs drifted from being help the poor programs to being broad social safety nets that also returned benefits back to the income classes, who paid the taxes. Since 1980 social spending’s share of national product has risen very little, but not declined. This pattern happened to every OECD-country sooner or later, and Lindert expects it will happen to still other countries as their incomes grow.