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Economic Growth, Income Inequality and Welfare States
Dissertation by Niko Gobbin
Public defence on 24/01/2005 at 17u00
Het Pand, Zaal Rector Vermeylen, Onderbergen 1, Gent

In the past years an increasing number of economists have started questioning the desirability of an extensive welfare state. Employers’ federations, popular media and politicians have picked up their arguments and are increasingly calling for a roll back of the social security safety net. They argue that the expansion of the welfare state has gone too far. European economies are caught in excessive government intervention. Workers are incited to shirk, as they can always fall back on the unemployment benefits. For the same reason, the unemployed have no reason to actively look for a job. Firms are discouraged to innovate as their profits are pruned away by the government. An example of how things should be done, can be found on the other side of the Atlantic. Economic agents in the United States are not impeded by high taxes and social security-induced disincentives. Hence, they are able to swiftly accumulate wealth while European economies are stagnating.

If this dismal description is true, why then have welfare states grown that large? Before the end of the eighteenth century no country had even 3 percent of its national product devoted to redistributive social programmes. In 1930 social transfers amounted to only 2.59% of the national product in Sweden, which is currently the prototype of the extensive welfare state. By the end of the 1990s that figure had grown to over 30%.
Moreover, the general statement that the United States have outpaced all welfare states is not supported by the data. The correlation between the size of the welfare state and economic growth is very weak.

There are some objective reasons for a re-examination of the welfare state. These reasons do not question the welfare state itself, but are linked to its long run feasibility. Social and economic circumstances have changed enormously since social security programmes were first introduced (e.g., globalisation, European integration, …). Many different issues will have to be addressed in the debate concerning the future of the welfare state. In the dissertation I focus on one of those issues: the trade off between income equality and economic growth. The dissertation bundles 4 contributions that are somehow related to the following question: “Would rolling back the welfare state automatically stimulate economic growth?”. The dissertation contributes to the literature on inequality, redistribution and economic growth in developed countries. It contains a state of the art of both empirical and theoretical work on the subject. Moreover, it presents a thorough examination of data and methodology. I also identify and remedy some weak spots in the literature.

In the first contribution I deal with the channels through which the welfare state interacts with economic activity. Theory does not predict that a larger welfare state necessarily hurts growth. Potential costs of the welfare state might be neutralised by equal gains. Moreover, “the” welfare state does not exist. The way in which redistribution affects economic activity depends on many factors (e.g., eligibility criteria, tax design, institutions, …).
The three remaining contributions highlight the empirical relationship between income inequality and economic growth. I argue that existing evidence is unreliable due to flaws in the estimation methodology and a lack of consistent data. Hence, I present a new data set and use an alternative estimation technique. I also show that even in the absence of the perfect income inequality data, one should be able to discover the correct inequality-growth relationship as long as methodological problems are overcome.

The estimates indicate that inequality negatively affects investment in human capital. Even in rich OECD countries with well developed capital markets, government support for human capital investment makes sense. The results also indicate that rolling back the welfare state will not necessarily improve economic growth.

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