HIAS-E-30

Real and Imagined Threats to the Welfare StatePeter H. Lindert
University of California - Davis and NBER

June 2016

Hitotsubashi Institute for Advanced Study, Hitotsubashi University
2-1, Naka, Kunitachi, Tokyo 186-8601, Japan
tel:+81 42 580 8604
http://hias.ad.hit-u.ac.jp/
HIAS discussion papers can be downloaded without charge from:http://hdl.handle.net/10086/27202
https://ideas.repec.org/s/hit/hiasdp.html

All rights reserved.

“Real and Imagined Threats to the Welfare State”1
Peter H. Lindert
University of California – Davis and NBER
ABSTRACTThe traditionally, and wrongly, imagined vulnerabilities of the welfare state
are economic. The true threats are demographic and political.
The most frequently imagined threat is that the welfare state package
reduces the level and growth of GDP. It does not, according to broad historicalpatterns and non-experimental panel econometrics. Large-budget welfare statesachieve a host of social improvements without any clear loss of GDP. The paper
elaborates on how this “free lunch” is gained in practice.
Other threats to the welfare state are more real, however. Two demographicpolitical clouds loom on the horizon in the twenty-first century, though neither
cloud reveals an economic flaw specific to the welfare state. One cloud is the rise ofanti-immigrant backlash. If combined with heavy refugee inflows, this could destroy
future public support for universalist welfare state programs, even though they
seem to remain economically sound. The other, and more certainly rain-bearing,
cloud is that population aging poses a serious problem for financing old age, either
publicly or privately. Pension deficits threatens to crowd out more productive social
spending. Only a few countries have faced this issue very well.
JEL codes: H10, H50, N32, N34

1 This working paper draws in part on two previous presentations. One is a Levine

Family Lecture on “Can the Welfare State Survive in a Global Economy?” given at UC
Davis. The other is a chapter in the University of California Press book on How Big
Should Government Be? (Lindert 2016).
1

I. The big picture
A. Adam Smith was on the right track
Adam Smith wrote his famous defense of the free market in an age in whichgovernments were still tiny by today’s standards, and there was nothing even close
to a welfare state. Yet he devoted considerable thought to the proper role ofgovernment. Those who cite him as the ultimate champion of tiny government haveoverlooked, knowingly or not, much of what he wrote on this. They might want togive fresh attention to passages like this one from the 1766 edition of his Lectures on
Jurisprudence -‘We may observe that the government in a civilized country is much more
expensive than in a barbarous one; and when we say that one government ismore expensive than another, it is the same as if we said that the one country
is farther advanced in improvement than another. To say that the
government is expensive and the people not oppressed is to say that thepeople are rich. There are many expences necessary in a civilized country forwhich there is no occasion in one that is barbarous.”2
In that 1766 lecture, the necessary expenses he had in mind were what we would
call infrastructure, both civilian and military. Within ten years, however, his Wealthof Nations had added a case for tax-funded primary education.3 His case rested on abasic point echoed in today’s economics: If individuals failed to capture all the social

2 Smith (1766, pp. 530-531). I am indebted to Barry Weingast for bring this passage

to my attention.
3 Smith (1776, 130-134, 420-434, 443). He was certainly prescient on taxpayer
financing of the bulk of primary education. Every educationally leading country
followed the same formula of launching its rise of mass schooling primarily withlocal taxes.
Thomas Jefferson agreed with Adam Smith about the need for taxes tosupport public schooling (Butts (1978, 26-28). So did Milton Friedman, in his
Capitalism and Freedom (1962).
2

gains from providing these things, then individuals could not be relied upon toprovide enough of them:[An essential] duty of the sovereign or commonwealth is that of erecting andmaintaining those publick institutions and those publick works, which,though they may be in the highest degree advantageous to a great society, are,however, of such a nature that the [social] profit could never repay the
expence to any individual or small number of individuals, and which it,
therefore, cannot be expected that any individual or small number ofindividuals should erect or maintain….
When the institutions or publick works which are beneficial to thewhole society, either cannot be maintained altogether, or are not maintained
altogether by the contribution of such members of the society as are mostimmediately benefited by them, the deficiency must in most cases be madeup by the general contribution of the whole society.4
This is not to say that Smith liked taxes and big government for their own
sake. On the contrary, he saw waste in much of the government spending of his day,especially in the subsidy to unproductive high offices handed to political favorites.
He railed at length against tariffs on imported goods, such as England’s infamous
Corn Laws. Yet he clearly understood that external benefits could justify tax-basedsocial expenditure.
Remarkably, government expense has risen far above anything that had been
experienced in human history up to Smith’s lifetime. And, as he perceived even then,the places with the highest government spending were exactly those “civilizedcountries” that were “farther advanced in improvement”. In the ensuing centuries,
the enormous expansion of government has been dominated by civilian social
spending, the kind he barely touched on when making his case for tax-based fundingof universal primary education. The rising social expenditures are defended ashaving the same beyond-private benefits as the ones Smith envisioned for “those
4 Smith (1993 (1776), 413, 443).

3

publick institutions and those publick works”. Yet the rise in tax-based social
expenditures remains controversial, in a world of clashing self-interests. This paper
weighs the evidence regarding their effects on national economic growth.
B. A preview of verdicts
Since World War II, about a dozen rich countries have channeled more than afifth of national product into social transfers, and about a quarter of national
product if we include public education as part of social spending.5 Those countries,
in order of their social transfer share of GDP in the first decade of this century, areFrance, Sweden, Austria, Belgium, Denmark, Germany, Finland, Italy, Portugal, andSpain, with Norway, Netherlands, and the UK near the margin. Contrasting theirexperience with that of other countries provides a historical test case for the effectsof tax-based social spending. That historical case seems to have delivered these six
clear verdicts:(1) One imagined threat rejected by the historical facts is the widespread
suspicion that the welfare state package reduces the level and growth of GDP. Global
5 This paper defines “social transfers” as taxpayer-funded government expenditures

on health care, pensions, family assistance (Americans’ “welfare”), unemployment
compensation, active labor-market spending (retraining, etc.), and public housing
subsidies. My definition of social transfers nearly matches the official OECD
definition of “public social expenditure”. The main difference between the two isthat I would, whenever the data permit, exclude the pension benefits paid to public
employees. These are part of a labor contract, comparable to private labor contracts,
and not redistributions from the rest of society. OECD allowed such a separation inits social expenditure series for 1960-1981, but not for its current series starting in
1980.
I define “social expenditures” as these social transfers plus public spending
on education. This broader definition matches the definition used by Garfinkel et al.
(2010).
My arbitrary definition of the “welfare state” is any democratic country forwhich social transfers, and the taxes implicitly paying for them, exceed 20 percent of
GDP. Had I defined the welfare state as any country devoting more than 20 percent
of GDP to social spending, including public education spending à la Garfinkel et al.
(2010), it would have been easier to show (as they do) that the welfare state is not
bad for economic growth. For rhetorical purposes, I prefer the more stringent test
focusing on social transfers, which are more controversial, and less obviously
productive, than public expenditures on education, which I separate from mydiscussion of the “welfare state”.
4history does not show any clear overall negative effect of larger tax-financed socialtransfers on national product. The widespread belief in large GDP costs of the highbudget welfare state is based on theory and inappropriate tests. The real world neverran the kinds of experiments that so many have chosen to imagine. The best statisticaltests underline a “free lunch puzzle”: Europe’s large tax-based social budgets haveapparently not lowered GDP.
(2) That “free lunch” has taken the form of several fundamental human gains
reaped by large welfare states. The larger welfare states have achieved lower income
inequality, lower gender inequality, lower poverty rates, and longer life, again without
any clear loss in GDP. Nor do they suffer any other often-imagined side effects. The
large welfare states, particularly in Northern Europe, have some of the world’s cleanest
and least corruption governments, with lower budget deficits than the United States,
Japan, and other rich countries. And, for what it is worth, their populations express
greater happiness in international surveys of public opinion.
(3) What made that possible? The “free lunch puzzle” of the welfare state is easily
understood when one examines how actual practice has evolved. Both sides of theAtlantic have made some mistakes when trying to draw an efficient border between
governments and markets. The main mistakes on the American side relate to insufficientanti-poverty programs, inefficient health insurance, underinvestment in mothers’
careers, and the under-taxation of addictive goods (tobacco, alcohol, and gasoline).
(4) Neither the timing nor the geographic location of the “European” economiccrisis starting 2007 relates to the welfare state as such. The main causes of crisis in the
not-so-welfare-state Mediterranean and Ireland since 2007 have been the real estate
bubble and under-regulation of finance. The main institutional mistakes inMediterranean Europe relate to excessive protection of vested interests against
competition in product and labor markets, not the welfare state.
(5) Other threats to the welfare state are more real, however. One can see
two demographic-political clouds on the horizon in the twenty-first century, thoughneither cloud reveals an economic flaw specific to the welfare state. The first cloudis the rise of anti-immigrant backlash. This could destroy future public support foruniversalist welfare state programs, even though they seem to remain economically5sound. Such a retreat from the welfare state is a threat mainly to Sweden andGermany, i.e. to those welfare states that continue admitting large refugee flows
while refusing to discriminate against immigrants in providing social services.
(6) The other, more global, cloud is that the rapid acceleration of population
aging poses a serious problem for financing old age, either publicly or privately.
Only a few countries have addressed this issue with major reforms so far.
The remainder of this paper summarizes the evidence regarding these six
verdicts. We turn first to the traditional imagined threat related to the welfare state,
and then to the two real threats. The wrongly imagined threat is economic. The real
threats are demographic and political.

II. An imagined threat:
Isn’t the welfare state bad for growth?
If having generous social insurance programs reduces the level and growth ofGDP, then sooner or later this negative effect should cause a decline of the welfare
state. Such a fear underlies the many books and articles written in the latetwentieth century about the “crisis” and “demise” of the welfare state – that is, aboutan even that has still not happened. Let us survey the evidence on this imagined
threat.
A. No, the data show a “free-lunch puzzle”(1) History shows no correlations pitting the welfare state against growth. For
at least three centuries many conservatives have insisted that taxed-based social
spending cuts jobs and output. So strident is the opposition that one would expect it
to have resulted from looking directly at some glaring evidence from history. If thenegative effects of welfare state programs were so clear, then perhaps even the raw
data should have shown it on a huge I-Max screen.
No such glaring evidence has ever appeared. An obvious starting point
would be to glance at the broad sweep of the history of national product, which

6should have been lower where tax-based social spending was higher. The glance,
however, yields the big-screen evidence shown in Figure 1. Most of world history
has languished in the lower left-hand corner, with poverty and no social help to thepoor, the sick, or the elderly. This is the dreary world that Adam Smith called“barbarous”. In the two and a half centuries since Smith wrote, a few dozen
countries have taken off into prosperity, as illustrated in Figure 1 by four of Smith’s
civilized countries – the UK, the US, Sweden, and Japan. While prospering, they alsochanneled a greater and greater share of their national product into taxes spent onsocial programs. Yet they continued to prosper. One who believes that the social
programs destroy initiative and progress might claim reserve causation: Perhaps itis the prosperity that bred the wasteful social spending. Yet if the social spending is
nothing but a rich country’s bad habit, like obesity or recreational drugs, why don’t
we see any easy evidence of its dragging down GDP per person?
One would rightly demand a closer look than this glance at the broad screen.
Sticking to raw correlations for the moment, we may ask whether looking at all
countries and over shorter periods of time shows a negative relationship between
their growth experiences and their use of welfare state expenditures. Table 1 shows
the results for as many decades (10) and as many countries (19) as provide
systematic long-term data. As reported there, history again provides nosignificantly negative relationship between the start-of-decade social spending
share and either the growth or the level of GDP per person. If we had included themany poorer countries that failed to report social spending because they had little
or none of it, there would be more chance of a positive correlation across history, as
Figure 1 has already hinted. From all the correlations we cannot infer such a
positive causal influence of social spending on economic growth. Yet any claim of anegative historical relationship is even easier to doubt.
Within nations, as well as between them, we find no secure negative
correlation between local governments’ social transfers and either the level or
growth of product per capita. For all the conservative media anecdotes aboutcompanies fleeing high-tax states for low-tax states, there is no net result showing
any damage to the higher-taxing and higher-welfare localities. The only time that7

the anti-government Southern states in the United States rose toward the national
average income per capita was in the period 1940-1973 when the South reaped
disproportionate benefits from government military and aerospace spending. Such
spending not only created jobs and income within the South, but it also raisedSouthern pay rates by attracting Southern workers to Northern and Pacific Coastcities. Since the rise of welfare payments and other social spending in the 1960s and1970s, there has been no erosion in the relative incomes of such larger-transfer
states as Connecticut and California. There is no outward evidence of massive tax
flight, no “race to the bottom.”(2) Nor is there any econometric evidence revealing any net GDP costs. One
should deeper if possible, into statistical tests that really hold other things equal.
We know well that both social transfers and national product have many separate,though overlapping, causal determinants. Surely social spending is not just theresult of being a rich country, and a country’s prosperity depends on many morethings than just social spending and the incentives it may create.
Since around 1990 economists have poured great effort into developing truly
randomized trials, like those now proliferating in medical science. These arestatistically superior to testing from historical experience, since the randomly
selected “treatment” group of observations is subject to influences clearly notexperienced by the “control” group. The history of entire nations is not a
randomized trial, however. It does not offer a treatment group of dozens ofsocieties that were beset by welfare-state policies imposed on them by completely
outside forces, forces not experienced by a large control group of otherwise similarsocieties. A few econometric studies have been lucky enough to find “naturalexperiments”, in which history imitates the random-trial laboratory. Yet for large
complex forces like the welfare state, no such randomized historical experiment isavailable.
Lacking truly random trials, economists are forced to extract what causal
insights they can from a messy panel of human experiences over time and space, apanel in which both the determinants or social spending and the determinants of
GDP might be disentangled even though they overlap and are confounded by a host8

of other forces. Elsewhere, I have surveyed the econometric studies available as of adecade ago. None has even found a significant negative effect of the whole welfare
state package on GDP, at least not any that has used sound techniques and has madeits underlying data available to others.6 Even the few that announced negative
effects yet hide their data have failed to show negative effects large enough to imply
the major economic damage imagined by some theorists, journalists, and politicians.
The lack of clearly negative effects of tax-based social transfers on the leveland growth of GDP is all the more remarkable because the tests typically hobble thewelfare state variables with two devices that should have shown a negative effect.
The first is a handicap that this author has also adopted, in order to toughen the test:
Exclude public spending on education from the “welfare state” bundle. Public
expenditures on education have such clearly positive effects that omitting themraises the odds of finding against the welfare state.7 Second, all the tests on
historical time-space panels hobble the welfare state with a reverse-causation bias.
Safety net programs, such as family assistance or unemployment compensation, aredesigned so that they pay out more when GDP and jobs have slumped – and pay out
less when the economy improves. Thus transfer spending will appear guilty of
causing slumps, and cutting that spending will be credited with causing the recovery,
unless one somehow perfectly identifies the macro-economic shocks causing any
movement in GDP. The false guilt is analogous to blaming hospitals for causing
deaths because so many people die there.8 Given these two handicaps, it is all the
6 See Lindert (2004, Chapters 10 and 18), and the downloadable data sets available

either from Cambridge University Press (see the book’s preface) or from theauthor’s home page.
7 For a review of rates of economic return on education around the world, see
Psacharapoulos and Patrinos (2004a, 2004b), and the earlier studies cited there.
8 This second bias shows up even in the set of econometric panel tests that seems
the best candidate for an objective discovery of negative growth effects.
Overlapping studies by Kneller, Bleaney, and Gemmell (1999) and by Gemmell,
Kneller, and Sanz (2011). The authors did not put any weight on the negative result
about social spending, but that negative implication from their study should betaken seriously. With their help, I have found that even their best-practiceeconometric test has trouble identifying the shocks that we know were there, given
our reading of recent history. For example, we know that at the start of the 1990s9more remarkable that social transfers and other measures of the welfare state do
not show clearly negative effects on jobs or growth.
(3) Achievements other than GDP. While not paying any clear net cost in termsof GDP, the large welfare states achieved many other things with their socialtransfers.9 Here is a quick list of social goals they have served at least as well asother rich countries on the average:(1) They have consistently enjoyed a more equal distribution of incomes.10(2) They have lower shares of their population in poverty, whether thepoverty line is defined as a share of median income or as an absolute level ofconsumption per person.11(3) The welfare states tend to have longer life expectancy than other OECD
countries at similar income levels. How this might relate to public health care isreviewed in Section III below.
Finland suffered a major macro-shock from the collapse of its main trading partner(the Soviet Union) and from mistakenly keeping the Finnish Mark pegged to thesoaring German mark. Yet these authors’ tests have no way of picking up suchidiosyncratic large macro-shocks that are neither time-fixed effects for all countries
or fixed county effects for all times. The result is a misleading correlation between
Finland’s huge safety net expenditures and the plummeting of Finland’s GDP. I
thank Richard Kneller for making their underlying data set available.
9 Here is a rough quantification of the points listed in this section. Data from 23

countries circa 2007 show that the share of social transfers in GDP, our welfare state
indicator, has these correlations with social achievements: (a.) a negative 0.56 withthe share of households having less than 40 percent of median household income;(b.) + 0.39 with life expectancy, (c.) + 0.21 with Transparency International’s clean
government indicator, and (d.) no overall correlation (0.01) with government
budget surplus in 2007-2009. Correlations (a.) through (c.) were statisticallysignificant at the 5 percent level. The sources are those cited elsewhere in thissection.
10 See Wang et al. (2012) on OECD countries’ inequality in 2004. For a readable andbalanced summary of the definition of equality in terms of “vertical equity” and thecase for progressivity in redistribution, see Slemrod and Bakija (2004), especially
Chapter 3.
11 On the poverty shares relative to median incomes, see OECD, Growing Unequal(2008, p. 127). International comparisons of absolute poverty are found in studies
by the Luxembourg Income Study: See Smeeding et al. (2000), and Scruggs and Allan(2005).
10

(4) The welfare states have some of the world’s cleanest and least corrupt
governments, despite what some might have predicted from the large amounts
passing through government hands.12(5) Welfare states do not run large budget deficits. There is no correlation at
all between the GDP shares of social transfers and the net budget deficit.13(6) Finally, for what they are worth, international polls of public opinion findhigh average expressions of personal happiness in the high-spending welfare
states.14
B. Some reasons why
What has made this possible? How could the large welfare states haveavoided any of the imagined net cost in terms of GDP, while making progress on somany social concerns? A balanced tentative answer seems to be that the few ways inwhich large tax-based social transfer programs reduce GDP are balanced by ways inwhich they raise GDP. The heaviest weight on the negative side of the scales seems
to be unemployment compensation. Even allowing for some statistical biases
against such programs, the empirical literature seems to say that more generous
unemployment compensation does indeed reduce jobs and output somewhat. This
negative effect, however, is offset by several GDP-enhancing effects of the way inwhich the welfare state has worked in practice. We turn next to three such effects.
(1) An efficient tax and transfer mix. While a critic might choose to imagine afoolish hypothetical welfare state riddled with bureaucracy, initiative-discouraging
taxes, and transfers that subsidize a lifetime of laziness, no such fiscal system has
ever prevailed in a welfare state. On the contrary, real-world welfare states havefeatures that make their tax-based social programs less bureaucratic, less expensive
12 For Transparency International’s index of clean government, called its“Corruption Perceptions Index”, http://www.infoplease.com/world/statistics/2007-transparency-international-corruption-perceptions.html.
13 On government budget surpluses as shares of GDP, 2007 and 2009, see IMF
eLibrary.
14 On international differences in expressions of happiness, see the World Values
Survey; e.g. http://www.nationmaster.com/graph/lif_hap_net-lifestyle-happinessnet.
11

in administrative terms, and less in conflict with economic theory than many haveimagined.
One such feature is that universalism is efficient on the expenditure side.
Universalist expenditure programs, to which everybody is entitled, are cheaper toadminister because there is less bureaucratic need to investigate who should be
excluded from the benefits.15
In the case of health insurance and health care, for example, comparative
studies have consistently found that administrative costs are a lower share of thehealth care delivery expenditures in the more public programs of Canada andEurope.16 Universalist public insurance and public provision is less bureaucratic
because it does not need to spend so much resources denying coverage to patientsthat might prove expensive for one reason or another. Universalist health coverageis also cheaper than means-tested coverage for the poor because it avoids having toinvestigate the legitimacy of poverty pleas. Similarly, tax-based public assistance tothe poor is in turn cheaper than private charities’ administrative expenses forraising donations.17
Similarly, on the tax side, broader taxes are also cheaper to administer. As
countries develop and prosper, they tend to shift toward the broader kinds of taxes
that economists consider more efficient. The typical shift was away from customs
duties and other narrow taxes that might greatly disrupt choices (taxes on highelasticity activities) toward broad taxes on all of a person’s income or consumption.
Across the first half of the twentieth century, the shift was toward broad income
taxation; after that, the shift has been more toward VAT (value added taxation, a flat
consumption tax) and sin taxes on addictive products causing external damages.
The same tax shift affected all prospering countries, whether they became
welfare states or not. It is something that happened as government got bigger.
Indeed, the tax shift helped them become bigger. Setting aside for the moment the
15 For a general discussion of this point, see Lindert (2004, Chapters 4, 10 and 12)

and Pestieau (2006, pp. 81-83).
16 See, for example, the studies by Reinhardt (2000), Woodlander et al. (2003), andKotlikoff and Hagist (2005).
17 Lindert (2004, Ch. 3; and 2014).
12

incentive effects of this shift, we merely note here that a broad tax treating
everybody similarly, and every source of income similarly, is easier and cheaper toadminister. Figure 2 shows the dramatic decline in the administrative costs ofcollecting taxes in Britain since the 18th century and the United States since the 19th.
Broader taxation reaps economies of scale to such a degree that today the Internal
Revenue Service spends on administration only half a percent of the amountcollected. 18 Welfare states have reaped similar economies as their budgets
expanded on the basis of broader forms of taxation.
In addition, the tax mix used by welfare states looks more efficient even inconventional theory. Relative to the smaller –government rich economies, such as
Canada, the United States, and Japan, the large-budget welfare states of Northern
Europe get a greater share of their tax revenue from broad consumption taxes andsin taxes on harmful-addiction products such as tobacco, alcohol, and gasoline.19
Canada, Japan, and the United States, by contrast, get a greater share of their tax
revenue from direct taxes on income and wealth. Conventional economics favors
broad sales taxation and sin taxes, and the sin taxes draw added support from thoseconcerned with public health and environmental quality. While we lack reliableeconometric evidence that this kind of tax mix is really better for economic
growth,20 conventional economists and economic conservatives believe that it isbetter. Ironically, then, conventional theory favors the kinds of taxation used as amoney machine for large welfare states.
(2) More efficient health care. More efficient public health care systems ofhealth insurance and health care provision might have made people live longer inother countries than in the United States. Three international contrasts about
health insurance and health care delivery provide some circumstantial evidence
favoring the performance on countries having a more universal and publically18 This omits, of course, the resource cost to taxpayers themselves of preparing theirtax returns.
19 See Kato (2003) and Lindert (2004, Chapter 10).
20 The closest thing to econometric support for this conventional hunch is the resultof Kneller and co-authors (1999, 2011) to the effect that indirect taxes are better for
growth than direct taxes.
13funded health system. Two of these three facts are unknown to the American
general public, while the third has received a great deal of media attention. The
first fact, generally unappreciated, is one already cited above: America’s mixed
private-public health insurance has higher bureaucratic administrative costs that auniversal government “single payer” scheme of health insurance (e.g. Canada,
Germany) or a system dominated by government provision of health services (e.g.
England and Wales). The second under-appreciated fact is about popular beliefs
themselves. While people in all countries have complaints and fears about theirhealth care systems, Americans for decades have had a lower opinion of theirsystem than do people surveyed in other countries.
The third fact, given more media attention, is that the United States ranks
behind at least a dozen other countries in life expectancy. The pattern is not a
simple one relating to social spending. The world leader in life expectancy is Japan,
a country with relatively modest social spending, though Japan’s social spending
does tend to tilt toward public health. Still, it is true that people tend to live a bit
longer in the average welfare state than in the United States. The media have said so
repeatedly, and have pointed out that a significant part of the difference in life
expectancy comes in the first year of life: American babies do not survive as well as
those in over a dozen other countries.
Before reviewing the troubled history of American health care, we need tostress two cautionary points about the international contrasts in life expectancy.
The first is that they do not just reflect the performance of the health care system.
As best one can tell, the differences in survival are not due as much to differences inhealth care systems as to differences in life style. The slight shortening of life in
America versus other rich countries is due primary to sedentary lifestyle and diet.
Second, the international contrasts are not between public and private systems, or
between large-spending and small-spending countries. Rather they relate to apeculiarly vexed history of health insurance in the United States, a country that
actually spends about as much publically, and spends much more privately, on
health care than other rich countries.

14

At the center of America’s health insurance problems is a pair of historicalwrong turns that left the United States with too strong a reliance on voluntary
employer-based health insurance. The first wrong turn came in World War II andthe 1950s. Employer-based plans gained popularity in World War II, when wage
controls prevented employers’ competing for scarce workers by offering higher
straight pay, but allowed them to offer attractive fringes. Then came a tax policy,
enacted in 1943 and solidified in a 1954 Supreme Court ruling, that exempts
employer contributions to employee health plans from taxation, either as corporate
income or as employee income. Thus one major reform left undone by theCongressional fight of 2010 is to remove the special subsidies on employer-based
health coverage, and to push the industry toward offering plans that are more
portable from job to job.21
Our second costly wrong turn was taken in 1965, when the passage ofMedicare confined public (alias “socialized”) health insurance to those over 65 (plusthe military). The second wrong turn was caused in part by the first. The passage ofMedicare in 1965 was targeted at the elderly because they rightly feared facing
costlier health care with no job to offer them coverage. Some have tried to reduce
this elderly bias by extending Medicare to all age groups. In 2010, The Affordable
Care Act succeeded in extending insurance toward the young, with extensions ofMedicaid and the State Children's Health Insurance Program. It thus made partial
steps toward making coverage more universal, while proceeding slowly enough tohonor (to “grandfather”) existing insurance arrangements. Yet one’s 65th birthday
still brings a jump in coverage, and this country’s deficit in life expectancy among
OECD countries is still worse before the age of 65 than after that birthday22. The
health insurance trap, then, was specific to the United States, and not to all countries
with smaller social budgets.
(3) Better development of mothers’ human capital. The welfare states also
gain jobs and productivity through public policies that invest in career continuity
and skills accumulation for mothers. This matters a lot, now that such a large share
21 Thomasson (2002, 2003).

22 Eggleston and Fuchs (2012).

15

of women’s adulthood is career-oriented. Welfare states provide paid parental
leaves and public day care with qualified providers. While the underlying rules arecomplex and hard to summarize, the policy differences among OECD countries areapparent in the fiscal efforts to work-life balance for parents, especially mothers, ofnewborns and infants. Welfare states spent 3-4 percent of GDP on supporting worklife balance for new mothers, whereas the United States, Japan, and others spend
less than half this share.23
Does the extra support for mothers pay off? While it is not easy to estimate
the gains in productivity from micro-data, there is at least one aggregate sign ofstrong gains: Women in such countries have market wage rates that are much closer
to male wage rates than do women in the United States or Japan, as shown for 19672006 in Figure 3. While it is possible in principle that the higher female/male wage
ratio in the Nordic countries and Australia might have reflected forces that lower
male earnings, this seems very unlikely. Rather the differences appear to be inpolicies that gave mothers the extra human capital that comes from not losing acareer when a baby arrives. Indeed, other data show that the wage gap between
males and females is specific to policy environments and to marital status: Single
women are very close to single men in their rates of pay, whereas married women,
mostly mothers, are paid less in countries that support them less.
The benefits of real-world government interventions on these welfare-state
fronts, combined with the better tax mix of the high-budget welfare states, may help
to explain why the statistical evidence has not turned up any negative effect of socialtransfers on GDP.

III. An imagined threat:
What about “Europe’s” economic crisis since 2007?
23 See, for example, the international data in the OECD Family Database,

http://www.oecd.org/social/family/oecdfamilydatabase.htm#public_policy. For
other summaries of differences in parental leave laws and public infant care, see
Lindert (2004, vol. 1, 252-257 and 282-287).
16

Since today’s high-budget welfare states are European, a natural mistake
would be to attribute any success or failure of any European country to the“European welfare state”. Such sloppiness in the use of correlations often occurs.
Thus when several European economies have slumped seriously since theAmerican-led recession since 2007, some commentators tied the problems to thewelfare state. We should therefore quickly note some ways in which the recession
seems to have been quite detached from welfare state spending.
The recession burst upon Europe after the private real estate market bubble
burst loudly in the US, Iceland, Ireland, Spain, and Portugal. Nothing about thewelfare state caused this. The bursting of the real estate bubble exposed systemicrisks that had been building in financial markets since the late 1990s.24 Underregulated private financial markets crashed first in the US and Iceland, later in
Cyprus. The spread of the recession popped real estate bubbles, especially in
Ireland and Spain, and triggered large deficits in Mediterranean countries. The
leading welfare states such as the Nordic countries and Germany, however, kept
their budgets under control, helped by the fact that their financial sectors had not
lunged into the same financial-derivative-based systemic risks taken on by others.
The closest approximation to a link between financial disaster and a welfare
state has been apparent in the case of Greece. For Greece, the problem has indeed
centered on the public sector, which spent unwisely on pensions and the Athens
Olympics. Yet Greece, like bankrupt Iceland, has never had a welfare state and does
little for the poor, as we shall note again below.
The spread of the recession throughout the Mediterranean raises anotherpoint often missed. There is a separate reason why the Mediterranean countries
have such high rates of unemployment. All Mediterranean countries, here includingFrance, have over-protected their established senior workers with tough anti-firinglaws since the 1960s. Initially, in the late 1960s and the 1970s, these employee
protection laws (EPLs) may have prevented unemployment by protecting
24 See Madrick (2011, esp. pp. 286-404).

17

established workers against dismissals, and may even have induced firms to invest
more in the further training of the “insider” workers they were committed to retain.
Yet soon the firing problem became a hiring problem. Firms became increasingly
reluctant to hire new workers who might not prove so productive, or whom they
could not dismiss in a slump. Over the last quarter of the twentieth century and into
this century, the share of “outsiders” in the population of labor-force age kept rising.
More and more of that population lacked the insiders’ careers and theirimprovements in pay and training. More unemployment, less investment in human
productivity. This problem has loomed larger in the Mediterranean than in
Northern Europe, where similar-looking worker rights are modified into more
flexibility in job turnover and retraining.25 Yet again, the defects of EPLs are quite
separate from the level of government spending.

IV. Real demographic-political threat #1:
Rising immigration and political backlash
To see the real threats to the future of the welfare state, we need to look at
demographic trends and their relationship to politics. One ominous demographic
trend is the continued inflow of immigrants. This section begins with a frequently
asserted economic effect, namely that immigrants are a fiscal burden, for which thealready-arrived “native” population must pay. Such a fiscal burden is not entirely
absent.
The net fiscal effects of extra immigrants depend on time horizon. Table 2
summarizes this dependence conceptually, and Figure 4 quantifies the dependence
using a plausible simulation run by Ronald D. Lee and Timothy Miller in 2000.
Suppose we take a very short-run view, in the top row of Table 2, asking “Aretoday’s extra immigrants a net drain on government budgets in this same year?”
They could be, since extra immigrants’ families typically are a net drain through the
25 Lindbeck and Snower (1988, 2001), Flanagan (1988, 1999), Allard and Lindert

2007.

18

host country’s child-related social programs such as education. If this drain isgreater than the tax revenues collected from adult immigrants, helping to pay forpensions and other public programs, then immigrants do indeed cause a net fiscal
drain this year. The Lee-Miller simulation in Figure 4 shows that the short-run fiscal
effect is indeed negative, as summarized by the thick black “Total” line. A typicalmix of immigrant age groups is so tilted toward the young that the costs of childcentered social programs yield a negative net result for the first 12-15 years after animmigrant arrival.
If one then takes a somewhat longer view, asking about the net fiscal effects
over the whole lifetimes of the first generation of new immigrants, the answer ispositive overall, as shown again by Figure 4’s thick black line. True, the immigrants
in old age probably get a net transfer from others, because the U.S. Social Security
System is designed to be progressive, giving a high rate of return to lower-income
earners, such as first-generation immigrants. Yet while that first generation is aging,its children have already become productive adults, paying positive taxes instead ofneeding school money.
Finally, when we consider the whole lifetimes of not only the extra
immigrants but also their children and grandchildren, the net fiscal effects become
clearly positive, as again suggested in Table 2 and quantified in Figure 4. We knowthat the eventual fiscal results are clearly positive, because in the long run theimmigrants and their descendants pay more in taxes than they get in targeted
transfers, just like the rest of society. So the long-run fiscal effect of extra
immigration is clearly positive.26
Nonetheless, these positive fiscal effects may be politically trumped bynegative perceptions, especially in the wake of a large influx of refugees. Prevailing
opinions can still be negative about the same fiscal effects, and about the truly
negative effects on some native workers’ earning power, not to mention cultural
26 Estimates based on data from several countries around the turn of the century

yield net fiscal benefits from migrants that tend to be near zero, with more positive
net results than negative ones. See OECD (2013, Chapter 3) for the assumptions andtime horizons used. Note that the simulations run by Lee and Miller do not refer to alarge refugee influx, since their parameters were drawn from calm time periods.
19

phobias and fears of terrorism. That kind of backlash has been increasingly evident
in Europe and the United States, where the new nativism rides the wave of antiimmigrant sentiment. Figure 5 shows the recent rise in their vote shares in Europe
since the turn of the century. There is a fair chance that coalitions of such nativist
parties and more established conservative parties could take power in several
countries.
Will immigration backlash undermine the welfare states? The threat seems
real, yet the mechanism is not so obvious. The outcome will surely depend on theform that the backlash takes. Let us first consider three kinds of cases in which there
would be little threat to social spending on natives. Consider first the possibility that
immigration is simply blocked. In such a case, immigrants will cease to be abudgetary burden, aside from the cost of enforcing the barriers at the border. In
such a case, social spending on the native population can continue as before. A
second, and nearly equivalent, possibility is that the government reacts to the antiimmigrant spirit with a combination of blocking boat people and over-border
refugees, yet continues to admit the highly skilled. Such a combination is being
practiced by such non-welfare-states as Australia and Switzerland. Here again,
there is little threat to social programs for established citizens, since the skilled
immigrants passing through the filter will quickly become net taxpayers. A third
possibility is that immigrants are still allowed to enter, but the government
discriminates against them in its provision of social services. If such discrimination
were practiced, then social services could resemble Jim Crow schooling by race inthe US South, or schooling by race under South Africa’s apartheid, -- or China’s
hukou passport system, as practiced in the major eastern cities. The discrimination
would make it easier to avoid dilution of benefits for natives. Thus far, however,countries accepting immigrants have been unwilling to saddle themselves withimmigrants who are not entitled to basic social services.27
27 A near approach to this case of receiving immigrants while denying them basic

services threatened to arise when Californians passed Proposition 187 in 1994. The
proposition called for denying public K-12 education and other public services tothe families of those non-US-citizens who had entered the state without legal
20

The countries most likely to translate heavy immigration, plus strong
opposition to that immigration, into a reduction of universal social entitlements
would be the welfare-state countries that absorb large numbers of refugees, without
skill requirements, yet remain unwilling to discriminate against them in theprovision of basic social services. The highest likelihood of such a dilution of
welfare state benefits seems to face Sweden and Germany since the mass influx of
Syrian, Iraqi, Afghan, and other refugees in this decade, especially since 2014. In
these two prime-target countries, a visible strain on social entitlement standards
may soon appear.
The issue has already achieved prominence in Sweden. On the one hand,
Sweden’s conservatives deny that cutting the welfare state is their object, knowingthat the welfare state remains popular. In February 2011 the leader of Sweden’s
Right-Wing “Sweden Democrats” Party, not to be confused with the Social
Democratic Party that has governed Sweden most of the time since 1932, wasexplicit about this: “We believe in the welfare state”, while also voicing suspicions
about Sweden’s mosques and Islamic community groups. Still, there are hints thatbeing impacted by local immigration undercuts people’s support for universal social
insurance. In Sweden, communities receiving a large exogenous immigrant shock
have become more inclined to doubt the viability of universal safety nets (Dahlberg
et al. 2012). Thus the threat is real, though no reduction of universal benefits has
yet occurred.
V. Real demographic-political threat #2: Aging and “gray power”
A. The curse of long life: Something has to give
Something has to give in pension policy in the twenty-first century, as many
have long warned. Those over the age of 65 will go on rising as a share of the adult
population, just as they have done over recent centuries. The ratios of the elderly tothose of working age are rising most ominously in East Asia and Italy, but nodocumentation. However, Proposition 187 was struck down by the state’s Supreme
Court, and has never been implemented.
21

country is exempt. The main cause is simply the upward march of senior life
expectancy. The natural solution of having people work to later ages, to hold fixed
the share of their adult lives spent at work, has been undermined by a decline in the
average age of male retirement, though this has historically contributed less to thelengthening of retirement than has the improvement in life expectancy.28
Today for every 100 Americans of working age (18-64 years) there are 21
elderly Americans (65 and up), most of them retired. By the year 2050 there will be
36 elderly for each 100 Americans of working age, assuming today’s rates of birth,migration, and survival. The balance between people paying into retirement andpeople drawing on it is shifting. So we are warned in the media every week. In thecontext of Social Security, 85 percent of economic experts agreed in 2009 with thestatement “The gap between Social Security funds and expenditures will become
unsustainably large within the next fifty years if current policies remain unchanged”.
Actually, the ratio is likely to shift even faster than that, because of a newly
documented “longevity transition”: The life expectancy of seniors is shooting up
rapidly, presenting all pension calculations with a possible curse of unexpectedly
long life.29
This demographic fact of life has a clear implication for setting pensions:
As the share of elderly rises, their annual benefits past the age of 65 absolutely
cannot rise as fast as the average incomes of those of working age.30
This clear warning is both softer and louder than it may sound at first. Softer, in thesense that it does not mean your pensions have to drop in real purchasing power.
Pensions should still keep up ahead of the cost of living – it’s just that they cannot
28 For historical retirement trends from the United States see, for example, Costa(1998) and Lee (1998, 2001). One should also note that the trend toward earlier
male retirement has reversed itself in many OECD countries since 2000.
29 On the recent acceleration of senior survival rates, see Eggleston and Fuchs(2012).
30 This result is derived from a budget balancing equation in Lindert (2004, vol. 1,
pp. 195-196).
22

grow as fast as earned incomes per person of working age, which historically growat about 1.8 percent a year, adjusting for inflation.
Yet the warning should sound louder when one realizes that it applies to the
future of any kind of provision for old age, no matter how private or public. The
curse of longer life is not specific to Social Security or other public pensions. It is thesame even if you rely only on your own savings for old age. To plan ahead, if youlive to age 65, you are likely to live to 85 even at today’s survival rates. Your
grandfather only had to plan on living about 14 years more, if he were to reach age
65. Even in such an individualist calculation, your annual consumption inretirement has to be a lower share of annual earnings than in the past, because
you’ll live more years. So it’s not a problem of government pensions, but a problem
facing any pension plans, be they individual savings, private job-based pensions, orSocial Security.
Thus as long as pension subsidies per elderly person keep in step with wage
and salary rates, population aging threatens to raise the share of GDP devoted tosubsidizing the elderly. To avoid paying for this with an upward march in tax rates,
or with cutbacks in public spending on more productivity investments in the young,society needs to trim the relative generosity of pension subsidies. That, however, is
not the current direction of movement.
B. Mission drift toward an elderly bias
Since about the 1960s, the further expansion of government social budgets
has changed focus, drifting away from those human investments having the greatest
GDP gains and toward support for the elderly and the middle classes.31 Curiously,
the shift has occurred mainly in countries that are not welfare states. This section
charts the mission shift, first viewing where it occurred, then examining its
fingerprints in terms of social expenditure behavior, and finally conjecturing about
its efficiency consequences and implications for the future.

31 For an in-depth history of the politics of the postwar drift toward the elderly andtoward less progressive social spending, see Baldwin (1990).

23

Since the 1960s, poverty rates have been reduced much more successfully
for the elderly than for children or persons of working age. So say the averages overgroups of OECD countries.32 In large groupings of OECD countries, we see a clear
divide around age 50. All age groups up to 50 years of age experienced an increased
poverty share relative to the population as a whole, while those above 50 shifted outof poverty faster than the whole population. In the United States, for example,
poverty declined dramatically for those over 65 but not for children between 1959
and 2010. Over this half-century, the poverty share fell from about 34 percent of theelderly population to 9 percent, whereas it fell only from 28 percent to 22 percent
among children.33
The drift toward lowering poverty rates more for the elderly than forchildren and those in working age is clearly tied to a bias in expenditure policy,
particularly in certain countries. To show this, one needs to avoid just examining
social expenditures as shares of GDP, which can be driven by the age group shares of
total population. A more telling kind of expenditure measure is the percentage bywhich poverty for each age group has been reduced by net transfers fromgovernment. Figure 6 contrasts the international patterns in such net transfers by
age group.34
As far as aiding the elderly is concerned, OECD countries have generally done
their job, cutting the poverty shares of their elderly populations by better than half
in almost all countries, as shown in Panel A of Figure 6. So say the OECD estimatesfor most countries in both 1995 and 2005, the exceptions being the reported
retreats from pension subsidies in Ireland and Finland between these two years.
32 OECD, (2008, chapter 5, Figure 5.5), updated 12 September 2008. In all that

follows, the concept of transfers toward the elderly, or “pension subsidies,” shouldbe thought of as being measured by only the non-contributory part of pension
benefits.
33 See http://www.census.gov/hhes/www/poverty/data/ historical/people.html,
as accessed 31 December 2011.
34 For alternative measures of the elderly bias in social expenditures, 1985-2000,
see Lynch (2001, 2006). Her measures compare support ratios in the form of (social
expenditure benefits / person in the age range) for the elderly versus those ofworking age.
24

Countries differed far more in their willingness to cut poverty among
younger groups, both in 1995 and again in 2005, according to the remaining panelsof Figure 6. Unlike the similar of all OECD countries in their pension subsidies(again, Figure 6A), the age pattern reveals the wide gap in poverty reduction for
those of working age (Figure 6B) and for children (Figure 6C). By the turn of the
century, the poverty-cutting results were dramatically lower for Japan, the UnitedStates, and other non-welfare-states than for the Nordics and the Czech Republic.
Particularly striking is that Italy, whose large share of social spending in GDP would
qualify for welfare-state status under the 20-percent rule, has directed so little of its
social budgets toward cutting poverty. Again, as elsewhere in the Mediterranean(and in South America’s Southern Cone), social transfers go to the elderly, largely
those with privileged occupations in their earlier careers.
Has favoring the support of the elderly, and investing less in those under theage of 65, been something costly in terms of GDP? The answer depends on thesocial-budget counterfactual one chooses to pose. Here are the two leading
candidates:
Counterfactual A: Take some of the government money spent on the elderly,and shift it toward the leading kinds of social programs for children and those ofworking age (education, preventive out-patient health care for the children, worker
retraining, etc.).
Counterfactual B: Privatize pensions, reducing taxes and mandating
individual savings accounts for old age.
Thus far, the text has implied that we are comparing actual practice withCounterfactual A, and for this comparison the answer is clearly yes, the bias in favorof the elderly is clearly costly in terms of GDP. That is evident from the simple factthat investing in human development brings a higher return, the earlier the stage ofcognitive and career development. The importance of this point has recently been
underlined in the writings of Pedro Carneiro and James Heckman, among others,25finding that even among children, the rate of return seems higher, the earlier thechild age at which parents and society intervene.35
By contrast, comparison of actual practice with Counterfactual B suggests noclear difference in GDP. For all we can tell from twentieth-century data, individual
saving and tax-financed saving can yield the same GDP result with appropriate
adjustments of parameters in programs targeting the elderly. One might note that
universal programs like Social Security in the United States are administered withlower bureaucratic costs and lower default risk than private pension plans or
individual investments. On the other hand, there is reason to fear that the politicalprocess would underfund public pensions. Twentieth-century panel data have notallowed us to deny that there is a zero net effect on GDP from choosing public
pensions over mandated private individual pensions. Thus the historic drift toward
funneling tax money to the elderly either has cost GDP or not, depending onwhether one wants to consider Counterfactual A or Counterfactual B.
If there is no clear gain in GDP from shifting social insurance and assistancetoward the elderly, why have so many societies done it? The answer seems to begray power. In the postwar democracies, an ever-greater population share consistsof the elderly plus those approaching old age, and the elderly have a relatively highparticipation rate in politics. They have succeeded in gaining intergenerationaltransfers, with or without a net effect on GDP.
C. Formulas that have worked for Social Security
Fortunately, there are broad formulas that can adjust our pensions to longer
life spans. Here are three formulas that would make Social Security sustainableindefinitely, formulas that private savings plans should also try to emulate.
The first formula is one on which the United States has already done its
homework quite well, and just needs to follow through. The formula is this:35 Carneiro and Heckman (2003), and the sources cited there.

26

Keep the share of adult life spent on Social Security from rising, by extending
the working age for each benefit rate in proportion to adult life expectancy.
The United States has already taken steps down this path, thanks to the 1983
Greenspan Commission on Social Security Reform. We have advanced the age of“full” retirement benefits from 65 to 67 for those born after 1960. The gradualformula adopted in 1983 wisely follows the strategy of “grandfathering”, by nothitting those of middle age with a shock to their life plans.
Yet the news about accelerating senior longevity means we must continue.
Seniors are increasingly healthy, and the share of them in poverty has declined, so it
is not unreasonable for them to receive full Social Security benefits only if they work
the same share of their adult lives as did their parents. Fixing the share of adult life
at work would mean something like this: To receive the year 2007’s retirement
benefit as a percentage of average earnings at any given age, one must work 51.6
percent of one’s life expectancy for males, and 41.5 percent for females, as we did in
2007. America’s progress along this path needs to continue, with more age
adjustments.
The second formula builds in an automatic adjustment of the workretirement balance to the longevity trend. Borrowing from the “notional defined
contribution” pension reform that Sweden set up in the 1990s, the formula is this:Index the retirement benefits for each cohort to life expectancy at age 60.
That is, while every individual’s annual pension benefits are still tied to his or her
lifetime earnings history, they are indexed to the senior survival odds of everybody
in his or her birth cohort. Thus if you were born in 1980, and you worked from2000 to 2045, your annual Social Security benefits would be tied to your earnings
over those years divided by an index that is tied to the age-60 life expectancy
calculated from survival outcomes around the year 2040. The longer your cohort ofpeople is expected to live, the less your benefits each year, though of course your27

benefits are likely to continue for more years. This helps maintain aggregatebalance in the pension budget.
The third formula is also patterned after Swedish practice since the 1990s:
Index annual pension payouts to recent GDP per working-age person.36
Pensioners’ benefits from Social Security should share in the fortunes of theeconomy. When there is a boom, pensioners share in it, by automatic formula. By
the same formula, pensions share the pain of a recession as much as others. In an
unlikely Great Depression extreme, their ultimate safety net would be the same as
for the young: Public support for the poor plus medical care.
Pre-commitment to such pre-determined formulae could remove the pension
parameters from the political arena. Of course, social contracts can only makepolitical pre-commitment easier. They cannot guarantee it. Even Sweden softened
its pre-set formula very slightly in response to the 2008-2009 slump. Under theoriginal formula, the government was obligated to cut benefits for the two years
2010-2011. Afraid to follow through on the cuts in 2010, an election year for
Parliament, officials changed the formula to stretch the reductions out over more
years. Yet the system remains intact, and it still works.
Nonetheless, in pensions as in human investments in health and mothers’
careers, welfare state Sweden stands out as a leader in rational solutions to social
concerns.

VI. Conclusion

36 I have oversimplified Sweden’s system, which is well described in Knuse (2010).

Instead of an index tied to GDP per working-age adult, Sweden uses two other index
factors that yield a similar result. The economic aggregate is wages and salaries per
employed person, not GDP per person 18-64. And Sweden backs up its pension
stability with an additional trigger that goes off whenever the pension fund’s“Balance ratio” BR = capitalized assets / capitalized obligations drops below 1.
28

The imagined economic threats to the welfare state have not materialized. No
welfare state has become poor. Nor has there been any international “race to thebottom” in taxes and social spending. Productive people and their wealth did notflee from the welfare state, any more than productive people prefer a low-tax
neighborhood over one with higher taxes, better schools, and more public services.
The welfare state looks like a Darwinian survivor in the global economy.
As we have seen, this favorable economic outcome did not just emerge from astatistical black box. There are plausible reasons for expecting such an outcome,and real-world governments have appreciated that broad safety nets and investingtaxpayers’ money in human development will raise human productivity. They havefinanced the universal social programs with broad taxes, at low administrative cost,using a mix of taxes that conventional economics would have preferred.
In the process, the large-budget welfare states are world leaders in achieving
an egalitarian society with lower income inequality and lower poverty, while
maintaining social peace. Perhaps one key to this peaceful egalitarian achievement
is the fact that their progressivity was achieved not through friction-causing steeply
progressive taxes but through universalism in their social expenditures. The lowerand middle-income classes that most favored social insurance in fact paid for muchof it by themselves.
The real threats to the welfare state are not economic, but rather arise aspolitical responses to demographic movements. One real threat is that politicalbacklash against a rising influx of refugees could bring a retreat from universalist
welfare programs. This threat is probably confined to countries like Sweden andGermany, i.e. countries that are welfare states and accept large refugee inflows andrefuse to discriminate against immigrants in the provision of social services.
The other, more global, threat is one that is moving toward all developed
countries, whether they have large or minimal government budgets. The
accelerated aging of the adult population in all OECD countries means a strain onplanning for old age, with or without the reliance on tax-based pensions and longterm care. The Nordic welfare states, like the United States since the 1980s, are29

world leaders that have already begun doing their social homework to meet theelderly tidal wave.
References
Allard, Gayle J. and Peter H. Lindert. 2007. “Euro-Productivity and Euro-Jobs sincethe 1960s: Which Institutions Really Mattered?” In Timothy J. Hatton, Kevin
H. O’Rourke, and Alan M. Taylor (eds.), The New Comparative Economic
History: Essays in Honor of Jeffrey G. Williamson. Cambridge MA: MIT Press, pp.
365-394.
Baldwin, Peter. 1990. The Politics of Social Solidarity and the Bourgeois Basis of theEuropean Welfare State, 1875-1975. Cambridge: Cambridge University Press.
Blau, Francine. 2012. The Economics of Women, Men, and Work, 6th edition.
Englewood Cliffs, NJ: Prentice-Hall.
Butts, R. Freeman. 1978. Public Education in the United States from Revolution to Reform.
New York: Holt Rinehart and Winston.
Carneiro, Pedro and James Heckman. 2003. “Human Capital Policy.” In James
Heckman and Anne Krueger (eds.), Inequality in America: What Role for
Human Capital Policies? Cambridge, MA: MIT Press.
Cutler, David M. and Dan P. Ly. 2011. “The (Paper)Work of Medicine: Understanding
International Medical Costs.” Journal of Economic Perspectives 25, 2 (Spring):
3-25.
Dahlberg, Matz, Karin Edmark and Heléne Lundqvist. 2012. “Ethnic Diversity andPreferences for Redistribution”. Journal of Political Economy 120, 1(February): 41-76.
Dahlberg, Matz, Karin Edmark and Heléne Lundqvist. 2013. “Ethnic Diversity andPreferences for Redistribution: Reply.” Research Institute of Industrial
Economics (Stockholm), IFN Working Paper No. 955 (February).
www.ifn.se/wfiles/wp/wp955.pdf.
Eggleston, Karen N. and Victor R. Fuchs. 2012. “The New Demographic Transition:
Most Gains in Life Expectancy Now Realized Late in Life.” Journal of Economic
Perspectives 26, 3 (summer): 137-156.
Flanagan, Robert J. 1988. “Unemployment as a Hiring Problem,” OECD Economic
Studies, 11 (Autumn): 123-154.
Flanagan, Robert J. 1999. “Macroeconomic Performance and Collective Bargaining:
An International Perspective.” Journal of Economic Literature 37, 3(September): 1150-1175.
Friedman, Milton. Capitalism and Freedom. Chicago: University of Chicago Press,
1962.
Garfinkel, Irwin, Lee Rainwater, Timothy M. Smeeding. 2010. Wealth and WelfareStates: Is America a Laggard Or Leader? Oxford: Oxford University Press.
Gemmell, Norman, Richard Kneller and Ismael Sanz. 2011. “The Timing andPersistence of Fiscal Policy Impacts on Growth: Evidence from OECDCountries”. Economic Journal 121 (February): F33–F58.
30

Joshi, Heather and Pierella Paci, with Gerald Makepeace and Jane Waldfogel. 1998.
Unequal Pay for Women and Men: Evidence from the British Birth Cohort
Studies. Cambridge: MIT Press.
Kato, Junko. 2003. Regressive Taxation and the Welfare State: Path Dependence andPolicy Diffusion. Cambridge: Cambridge University Press.
Kotlikoff, Laurence J. and Christian Hagist. 2005. “Who’s going Broke? Comparing
Healthcare Costs in Ten OECD Countries.” NBER Working Paper 11833(December).
Kneller, Richard, Michael Bleaney, and Norman Gemmell. 1999. “Fiscal Policy and
Growth: Evidence from OECD Countries.” Journal of Public Economics 74, 2(November): 171-190.
Knuse, Agneta. 2010. “A Stable Pension System: The Eighth Wonder”. In Tommy
Bengtsson (ed.), Population Ageing - A Threat to the Welfare State? Berlin and
Heidelberg: Springer-Verlag, pp. 47-64.
Lee, Ronald D. and Timothy Miller, 2000. “Immigration, Social Security, and Broader
Fiscal Impacts," American Economic Review 90, 2 (May): 350-354.
Lindbeck, Assar and Dennis J. Snower. 1988. The Insider-Outsider Theory of Employment
and Unemployment. Cambridge: Mass.: MIT Press.
Lindbeck, Assar and Dennis J. Snower. 2001. “Insiders versus Outsiders”. Journal of
Economic Perspectives 15, 1 (Winter): 165-188.
Lindert, Peter H. 1994. “The Rise of Social Spending, 1880 - 1930,” Explorations in
Economic History 31, 1 (January): 1-37.
Lindert, Peter H. 2004. Growing Public: Social Spending and Economic Growth since
the Eighteenth Century. Two volumes. Cambridge: Cambridge University
Press.
Lindert, Peter H. 2014. “Private Welfare and the Welfare State”. Chapter 14 involume 2 of Larry Neal and Jeffrey G. Williamson (eds.), The Cambridge
History of Capitalism. Cambridge: Cambridge University Press.
Lindert, Peter H. 2016. ““Are Government Social Programs Bad for Economic
Growth?” Chapter 2 In Jon Bakija et al. How Big Should Government Be?
Oakland CA: University of California Press, pp. 34-66.
Lindert, Peter H. and Jeffrey G. Williamson. 2016. Unequal Gains: American Growthand Inequality since 1700. Princeton NJ: Princeton University Press.
Lynch, Julia. 2001. “The Age-Orientation of Social Policy Regimes in OECDCountries”. Journal of Social Policy 30, 3: 411–436.
Lynch, Julia. 2006. Age in the Welfare State. Cambridge: Cambridge University Press.
Madrick, Jeff. 2011. Age of Greed: The Triumph of Finance and the Decline of America,
1970 to the Present. New York: Knopf.
OECD. 2008. Growing Unequal? Income Distribution and Poverty in OECD Countries.
Paris: OECD.
OECD. 2013. International Migration Outlook 2013. Paris: OECD.
Pestieau, Pierre. 2006. The Welfare State in the European Union: Economic and Social
Perspectives. Oxford: Oxford University Press.
Psacharapoulos George, and Harry Anthony Patrinos. 2004a. “Returns to Investment
in Education: A Further Update.” Education Economics 12: 2 (August): 111 134.
31

Psacharapoulos George, and Harry Anthony Patrinos. 2004b. “Human Capital andRates of Return.” In Geraint Johnes and Jill Johnes (eds.), International
Handbook on the Economics of Education. Cheltenham: Edward Elgar, pp. 1-57.
Reinhardt, Uwe E. 2000. “Health Care for the Aging Baby Boom: Lessons from
Abroad.” Journal of Economic Perspectives 14, 2 (Spring): 71-84.
Scruggs, Lyle and James Allan. 2005. “The Material Consequences of Welfare States:
Benefit Generosity and Absolute Poverty in 16 OECD Countries”. Luxembourg
Income Study Working Paper No. 409 (April).
Slemrod, Joel and Jon Bakija. 2004. Taxing Ourselves: A Citizen’s Guide to the Debate
over Taxes. 3rd edition. Cambridge: MIT Press.
Smeeding, Timothy M., Lee Rainwater, and Gary Burtless. 2000. “United States
Poverty in a Cross-National Context”. Luxembourg Income Study Working
Paper No. 244 (September).
Smith, Adam. 1978 (1766). Lectures on Jurisprudence. Edited by R.L. Meek, D.D.
Raphael, and P.G. Stein. Oxford: Clarendon Press, 1978.
Smith, Adam. 1993 (1776). An Inquiry into the Nature and Causes of the Wealth of
Nations. Edited by Kathryn Sutherland. New York: Oxford University Press.
Thomasson, Melissa A. 2002. “From Sickness to Health: The Twentieth Century
Development of U.S. Health Insurance.” Explorations in Economic History 39,
3: 233-253.
Thomasson, Melissa A. 2003. “The Importance of Group Coverage: How Tax Policy
Shaped U.S. Health Insurance.” American Economic Review, 93, 4 (September),1373-1384.
Wang, Chen, Koen Caminada and Kees Goudswaard . 2012. “The Redistributive
Effect of Social Transfer Programmes and Taxes: A Decomposition acrossCountries”. International Social Security Review 65, 3: 27-48.
Woodlander, Steffie, Terry Campbell, and David U. Himmelstein. 2003. “Costs ofHealth Care Administration in the United States and Canada”. New England
Journal of Medicine 349, 8 (August 21): 768-775.
World Economic Forum. 2012. The Global Competitiveness Report 2012–2013.
Geneva.

32

Figure 1. The Welfare State is Young and Rich

33

Figure 2. Tax Collection Costs as a Percentage of the Amounts Collected
By Central Governments, US and UK 1787/96 - 201134

Figure 3. Female-Male Wage Ratios in Selected Countries, 1967 – 2006

35

Figure 4. The Present Value of Annual Fiscal Impacts of One Immigrant,
Admitted to the United States in 1998
(The immigrant in 1998 is a composite of different age and education groups.)

36

Figure 5. Vote Shares Received by Nativist Political Parties since c2000

37

Figure 6. Poverty Reduction Achieved through Fiscal Net transfers, 1995 and 2005
A. For the elderly (ages 66 and up)

38

(Figure 6, continued)
B. For those of Working Age (18-65 years)

39

(Figure 6, continued)
C. For Children (0-17 years)

40

Sources and notes to figures:
Figure 1: The real GDP per capita series up to 2007 is from the Angus Maddisoninternet site: http://www.worldeconomics.com/Data/MadisonHistoricalGDP/
Madison%20Historical%20GDP%20Data.efp. The social transfer shares of GDP on
the vertical axis for 1880-1930 are from Lindert (1994), and those for 1960-2007
are from the OECD’s Socexp series downloadable from OECD iLibrary.
Figure 2:
The administrative cost share of tax collections are documented in Lindert, Growing
Public (2004, Volume 1, Chapter 12), and updated in the IRS Data Book
(http://www.irs.gov/uac/Tax-Stats-2). I am indebted to Joel Slemrod for his
directing me to the updated IRS series.
Figure 3:
The source is Blau (2012, p. 372), citing International Labour Organization,
LABORSTA Internet database, http://laborsta.ilo.org.
Note: For Denmark, Finland, Norway, and Sweden, figures for 1990 and before arefor the manufacturing sector. For Germany, figures prior to 2000 are for West
Germany. Data for Germany for 2000 and on are for the manufacturing sector.
A new series starts for France, Japan, and Switzerland in 2000.
Figure 4: The source is Lee and Miller, 2000.
Figure 5: See Milanovic (2016), Figure 4.11 and the sources cited there.
Figure 6:41

Table 1. How Social Transfers as a Share of GDP Correlate with
Growth and Prosperity in 19 OECD Countries, 1880 - 2000

Time
period1880-1890
1890-1900
1900-1910
1910-1920
1920-1930
1960-1970
1970-1980
1980-1990
1990-2000
2000-2010
Simple averageof these correlations

The coefficient of correlation between theinitial share of social transfers in GDP and(a) the growth(b) the levelof GDP/capita
of GDP/capita
0.10
-0.18
0.34
-0.05
-0.23
0.09
0.12
0.31
-0.24
0.49
-0.16
-0.24
0.34
-0.09
-0.07
0.09
-0.11
-0.04
0.12
-0.19
0.02

0.02

None of the correlations is statistically significant.
Notes and sources for Table 1:
Social transfers/GDP for 1880-1930: Welfare, unemployment, pensions, health, andhousing subsidies, as given in Lindert (1994, Table 1).
Social transfers/GDP for 1960-1980: OECD old series (OECD 1985); 1980-present:
OECD new series (OECD 1998).
Real GDP per capita: Penn World Table 7.1, downloaded 1 April 2013.
The 19 countries are Australia, Austria, Belgium, Canada, Denmark, Finland, France,
Germany, Greece (1960s on), Ireland (1960s on), Italy, Japan, Netherlands, New
Zealand, Norway, Sweden, Switzerland, the United Kingdom, and the United States.

42

Table 2. The Fiscal Effects of an Extra (U.S.) Immigrant
Depend on the Question You Ask about Them
The question
you ask
The “pay as you go” question:
Are today’s immigrants a net
burden on native taxpayers,
right now, “pay-as-you-go”?
The “one lifetime” question:
Is one wave of immigrants a net
burden on native taxpayers overthe life span of the immigrants
and their descendents?

The “many generations” question:
Are today’s immigrants, plus theirchildren and grandchildren to 2100,
a net fiscal burden?

Social Security
effects

Public-schooling
effects

No, immigrants
pay for natives’
Soc Sec. since
about 1980.

Yes, immigrantchildren subsidized
by native taxpayers
since about 1980.

Yes, if immigrants
have lower lifetime
earnings, they getan above-averagerate of return on the
Soc Sec, at expenseof other taxpayers.

No, immigrants’ kids
repay the rest of society
in productivity
and taxes.

No, they become
heavy net taxpayers,
like others.

No, they become
heavy net taxpayers,
like others.

43