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Economics of the Welfare State Winter Semester 2010/2011 Prof. Dr. Christian Holzner

Economics of the Welfare State

Prof. Dr. Christian Holzner

Contact Details Room: 308b, Ludwigstr. 28, front building, level 3 Email: [email protected] Office Hours: Monday, 3.30 - 4.30 pm

1. Introduction


General Information: Lectures:

− 2 hours on Monday starting at 10.15 am − Exception: 4 hours on Oct. 25th and Nov. 8th starting at 8.15 am

Courses: 2 hours on Thursday starting at 2.15 am Course exercises:

− Group work, has to be handed in the following Monday at the beginning of the lecture.

− One group is selected to present the exercises on Thursday. − The selected group meets with Wolfgang Habla on Wednesday at ??? (room 316,

Ludwigstr. 28, front building, level 4).

1. Introduction


General Information: Literature:

− Handouts are available online: http://www.fiwi.vwl.uni-muenchen.de/lehre/vorlesungen/201011_pubeco/index.html

− Main books: o Nicholas Barr: The Economics of the Welfare State o Peter G. Rosner: The Economics of Social Policy o Friedrich Breyer and Wolfgang Buchholz: Ökonomie des Sozialstaats

The relevant chapters are available online. − The relevant literature is listed at the beginning of each chapter

Exam:

− Monday, 7th February 2011, from 10.00 until 12.00 am

1. Introduction

http://www.fiwi.vwl.uni-muenchen.de/lehre/vorlesungen/201011_pubeco/index.html

http://www.fiwi.vwl.uni-muenchen.de/lehre/vorlesungen/201011_pubeco/index.html


Chapter 1: Introduction Literature: Barr, Nicholas, 2004, The Economics of the Welfare State, 4th edition, Oxford University

Press, Oxford, Chapter 1-3. Lampert, Heinz and Jörg Althammer ,2001, Lehrbuch der Sozialpolitik, 6th edition,

Springer, Berlin, Chapter 3.

1. Introduction


First and Second Fundamental Welfare Theorems: First fundamental welfare theorem: If every relevant good is traded in a market at publicly known prices, and if households and firms act perfectly competitively, then the market outcome is Pareto optimal. Second fundamental welfare theorem: If household preferences and firm production sets are convex, there exists a complete set of markets with publicly known prices, and if every agent acts as a price taker, then any Pareto optimal outcome can be achieved as a competitive equilibrium if appropriate lump-sum transfers of wealth are arranged.

1. Introduction


1.1 The role of the state: Different Views Libertarian view: No state intervention − Natural-rights Libertarians: Nozick (1974)

1. Everybody has the right to redistribute the holdings acquired through earnings and inheritance (that was itself justly acquired).

2. Thus, it is unjust on ethical grounds (theft), if the state redistributes holdings. The government may only redistribute holdings acquired illegally.

− Empirical Libertarians: Hayek (1944)

1. Individual freedom is only possible in a free market economy. 2. The pursuit of equity will reduce or destroy liberty. 3. Any government intervention is unjust, since it reduces welfare. 4. The major function of the government is to protect freedom, to preserve law and

order, to enforce private contracts and to foster competitive markets.

1. Introduction


Liberal view: Redistributive role of the state − Utilitarianism:

1. The utilitarian aim is to distribute goods so as to maximize the total utility of all members of society, i.e.

2. If marginal utility is decreasing, u`(yi) < 0, more weight is given to low incomes.

=ii

1∑=

n

yuYU )()(max

3. Criticized, because it can justify harm to the least well-off, if this raises total utility. − Rawlsian thinking: Rawls (1972)

1. A society should decide on the distribution of goods (incl. liberty and opportunity) behind the veil of ignorance (before people know their position in society).

2. Each person has the right to the most extensive basic liberty compatible with a similar liberty for others (equal right to liberty including economic liberty).

3. Any government redistribution must also benefit the least well-off.

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Socialist view: State must enforce equality − Democratic socialists:

1. Private property and the market mechanism are useful, because they increase efficiency. Democratic socialists acknowledge that there is an efficiency-equity trade-off.

2. The focus shifted from redistributing wealth to redistributing opportunities. 3. The unjust outcomes of the free market can be corrected by social policy.

− Marxists:

1. Workers are forced to sell their labor, since they would otherwise starve. The resulting lower market power of workers allows capitalists to extract surplus value. By using the extracted surplus capitalists can control the state.

2. The welfare state was created to avoid revolution and to keep capitalists in power. 3. Since the market mechanism does not achieve equality, Marxists call for public

ownership and planning.

1. Introduction


1.3 This lecture addresses two questions: 1. What are the aims of policy? (normative question) 2. By what methods are those aims best achieved? (positive question)

1. Introduction


What are the aims of policy? A) Efficiency

Scarce resources should be used efficiently.

⇒ Market mechanism is neither “good” nor “bad”. It is useful in some instances (e.g. private market for food) and works less well in others (e.g. health care).

Where institutions are publicly funded, their finance and the structure of their benefits should minimize adverse effects on labor supply, employment and savings.

⇒ Public provision does not necessarily imply production by the public sector. (e.g. heath insurance in the UK is publicly provided, in Germany privately provided, although health insurance is compulsory)

1. Introduction


B) Supporting living standards

Poverty relief:

⇒ The definition of the poverty line is largely normative. The OECD defines the poverty line as 40 % of median income.

Insurance:

⇒ Unemployment, invalidity, sickness, disability, accidents, …

Consumption smoothing:

⇒ Institutions should enable individuals to reallocate consumption over their lifetime,

- pension schemes (from young age to old age), - benefits for families with young children (sandwich generation), - student loans (middle years to young age)

1. Introduction


C) Redistribution of inequality

Vertical equality:

⇒ The system should redistribute (from rich individuals) towards individuals or families with lower income:

- Means-tested benefits like social assistance, - Progressive income tax, inheritance tax, taxes on wealth - Non-means-tested benefits, whose recipients disproportionately have lower

income, e.g. unemployment insurance benefits. Horizontal equality:

⇒ Individuals with similar ability to contribute to the welfare state should pay similar amounts (e.g. single wage earners should pay higher taxes than single mothers with the same earnings).

1. Introduction


D) Social inclusion

Dignity:

⇒ Benefits should be delivered as to preserve individual dignity and without unnecessary stigma.

⇒ Compulsory insurance schemes allow individuals to get security not as a charity but as a right.

Social solidarity:

⇒ Benefits should foster social solidarity, i.e. they should be big enough to allow recipients to participate fully in the life of the society (broader aim than poverty relief).

1. Introduction


E) Administrative Feasibility

Intelligibility:

⇒ The system should be simple, easy to understand, and as cheap to administer as possible.

Absence of abuse:

⇒ Benefits should be as little open to abuse as possible.

1. Introduction


Which weights are given to these different objectives of the welfare state is a fundamental normative question that has to be answered by the society itself, i.e. in practice by policy makers. The second question

“By what methods are those aims best achieved?” is a technical question and will be our subject for the rest of the semester.

1. Introduction


1.4 The size of the welfare state

1. Introduction


Social expenditure in % of GDP in selected countries Source: Bundesministerium für Arbeit und Soziales (2009), Sozialbericht 2009, S. 325

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Social expenditure in % of GDP over time in Germany Source: Bundesministerium für Arbeit und Soziales (2009), Sozialbericht 2009, S. 276.

1. Introduction


Growth and the size of the welfare state Does the size of the welfare state influence the growth rate?

Study Time period Countries Result Landau 1985 1952-76 16 OECD incl. Japan not significant Korpi 1985 1950-73 17 OECD excl. Japan 0.9 percentage point

reduction Weade 1986 1960-82 19 OECD incl. Japan 1.0 percentage point

increase Sala-i-Martin 1992 1970-85 74 countries worldwide 0.6 percentage point

reduction Nordström 1992 1977-89 16 OECD 0.6 percentage point

increase Hansson and Henrekson 1994

1970-87 14 OECD incl. Japan not significant

Persson and Tabellini 1994

1960-85 13 OECD incl. Japan 0.3 percentage point increase

Source: Atkinson, Anthony, 1999, The Economic Consequences of Rolling back the Welfare State, MIT Press, Cambridge, Mass.

1. Introduction


Acceptance of the size of the welfare state

France Germany Italy Spain

Don’t know / no answer 19.1 % 6.5 % 16.1 % 27.7 % Of those who answered a) Less transfers / less taxes 35.0 % 26.9 % 42.8 % 15.9 % b) Maintain 51.2 % 59.1 % 39.7 % 53.2 % c) More transfers / more taxes 13.8 % 14.0 % 17.4 % 30.9 % Source: Boeri, Tito, Axel Börsch-Supan und Guido Tabellini, 2001, “Would You Like to Shrink the Welfare State? The Opinions of European Citizens”, Economic Policy 32, Tabelle 4.15.

⇒ The majority of citizens with the exception of Italy support the current size of the welfare state.

1. Introduction


Social expenditure by categories Source: Statistisches Bundesamt (2009), Sozialbudget.

Sozialbudget D 2008Sonstiges

26,88% Rentenversicherung32,26%

Krankenversicherung20,97%

Wohngeld0,10%

Pflegeversicherung2,51%

Kindergeld und Familienleistungsausgleich

4,80%

Kinder- und Jugendhilfe2,78%

Sozialhilfe3,06%

Erziehungsgeld / Elterngeld0,66%

Arbeitslosenversicherung4,51%

Unfallversicherung1,47%

1. Introduction


1.5 Content of the Lecture 1. Introduction 2. Arguments for redistribution and social insurance 3. Consumption smoothing: Old age pensions 4. Health insurance 5. Unemployment insurance 6. Systems competition (Is the welfare state sustainable?)

1. Introduction


1.6 The historical background Pre-industrial period: No welfare state existed

⇒ Self-insurance through families and communities ⇒ Poverty relief through Christian charity, churches and monasteries

In medieval times people belonged to a Lord

⇒ It was one of the Lord’s duties to care for his villains (poverty relief, insurance). Guilds provided insurance for its members

⇒ Health insurance, widow’s pension, support for job seekers

1. Introduction


The first welfare laws:

The 1530 Reich police edict in Germany and the 1601 Poor Law Act United Kingdom:

o Each community or town was responsible for its poor. o The old and the sick were accommodated in almshouses. o The able-bodied were given work in “houses of correction”.

The Speenhamland System in the United Kingdom:

o 1795 food shortage and inflation lead to working poor. o Aid was extended to people in work (allowance based on bread prices).

The Poor Law Amendment Act 1834 in the United Kingdom:

o Population growth and escalating costs made a reform necessary. o Eligibility criteria were tightened (the able-bodied had to live in workhouses

under repulsive conditions to discourage living on benefits). o Benefits recipients were stigmatized.

1. Introduction


The German welfare reforms under Bismarck: Intention: Bismarck saw the welfare state not only as an act of charity but also as means

to fight socialism.

1883: Health insurance for workers

o Free medical treatment, sick-pay, and support for women in bed o Financed through mandatory contributions (2/3 employees, 1/3 employer)

1884: Accident insurance for workers

o Life annuities for workers, who were unable to work after an accident. o Financed by employers

1899: Retirement and invalidity pension

o Retirement: Eligibility at the age of 70 and with 30+ years of contributions o Invalidity: Eligibility after 5 years of contributions o Financed through mandatory contributions (1/2 employees, 1/2 employer)

1. Introduction


The Liberal reform in the UK between 1904 – 1916: Intention: – Working class political pressure and change in attitude (“positive freedom”), – Increase the productivity of the workforce – German example.

1908: Old Age Pension Act:

o 25 pence per week for people over 70, whose income was below £31 per year o Financed through local funds, no contributions.

1911: National insurance Act: Unemployment and Minimum Wage:

o Limited scheme of unemployment insurance linked to job search assistance. o Development Fund would finance counter-cyclical public-works expenditure.

1911: National insurance Act: Health insurance

o Free medical treatment and sick-pay for breadwinners

1. Introduction


1. Introduction

Further welfare reforms in the United Kingdom and Germany

1920/27: Unemployment insurance in the United Kingdom

o 1920: Insurance is extended to more workers o 1927: Two-tier system is introduced

1927: Unemployment insurance in Germany

o Included insurance for all workers as well as job search assistance

1946: Health insurance in the United Kingdom

o Free medical treatment for all financed through taxes

1995: Long-term care insurance in Germany

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