اثرات انبساطی دولت رفاه در یک اقتصاد کوچک باز

We examine the relationship between welfare state policies and economic performance in a small open economy with (i) free trade in final goods and international capital mobility, and (ii) aggregate increasing returns to scale. Contrary to the conventional wisdom, we find that a retrenchment of welfare programmes is not an inevitable consequence of economic integration. Instead, by improving the exploitation of aggregate scale economies, social expenditure policies and international openness complement each other in facilitating an improvement in economic performance that can sustain a more generous welfare protection.

The aim of this paper is to shed light on the contentious question of the compatibility between welfare state and globalisation which, despite its colossal policy importance, is still fairly unexplored at the theoretical level. In the last two decades, welfare state policies have come increasingly under attack by an emerging consensus that sees them as being inimical to economic growth and incompatible with successful participation in a highly integrated world economy. Two major arguments characterise this conventional wisdom: (i) the distortionary effects of redistribution policies and the taxation necessary to finance them translate into high firms’ costs—this is the ‘efficiency’ argument developed, for instance, by Alesina and Perotti (1997); and (ii) the revenue raising capacity of governments is hindered by increasing economic integration, thus making it more difficult for them to finance these policies. From a normative point of view, the main implication of this view is the inevitability of welfare state retrenchment. However, despite the rhetorical calls for change (which have not been limited to centre-right governments), there is very little evidence that the increased extent of goods and capital market integration during the last few decades has contributed systematically to the rolling back of mature welfare states, and reforms have generally been limited to a restructuring of expenditure.1 Furthermore, empirical evidence exists pointing to a positive relationship between welfare state and openness (Rodrik, 1998) and welfare state and competitiveness (De Grauwe & Polan, 2005). In this paper we develop a theoretical model that shows that international openness does not inevitably reduce the revenue raising ability of governments. Our framework is inspired by Alesina and Perotti's (1997) contribution; contrary to their findings, however, we show that openness can complement welfare state policies in improving economic performance and enhancing welfare. At the core of our argument lie the imperfectly competitive nature of markets and the fact that in a second best world economic policy can be used to correct the effects of market imperfections.2 As in Alesina and Perotti, our model is characterised by imperfect competition in the labour market (in the form of unionisation); however, the input–output structure with a monopolistically competitive intermediate sector assumed here gives rise to aggregate increasing returns to scale. We show that social security programmes can lead to higher levels of economic efficiency by improving the exploitation of potential aggregate scale economies.3 This channel is particularly relevant in mature industrial countries where unprecedented depths of the division of labour have resulted in highly complex economic systems and production externalities. We argue that the acknowledgment of these externalities – whose effects on the economy may not be easily predictable – is essential for any meaningful debate about the sustainability of social expenditure and welfare state programmes. Our findings challenge the view that free trade and capital mobility undermine governments’ ability to pursue income redistribution policies. We show that, by enhancing the exploitation of aggregate scale economies, a more generous welfare state increases overall welfare regardless of the tax instrument used to finance the policy, even when (in the presence of capital mobility) the policy is financed through an increase in capital taxation that may initially stimulate a capital outflow. The rest of the paper is organised as follows. Section 2 outlines the model, Section 3 describes the general equilibrium and carries out the policy analysis, and Section 4 draws some conclusions.

This paper has examined the role of economy-wide increasing returns to scale in shaping the relationship between welfare state policies and economic performance in a small open economy with free trade in final goods and international capital mobility. Contrary to the conventional wisdom, we find that a retrenchment of welfare programmes is not an inevitable consequence of economic integration. Instead, by improving the exploitation of aggregate scale economies, social insurance policies and international openness can complement each other in facilitating the provision of a more generous welfare protection. These findings – which are consistent with, and help to explain, the evidence that goods and capital markets integration has not led to significant reductions in welfare states and tax burdens in OECD countries – crucially rest on the imperfectly competitive nature of the labour market and the intermediate sector of the economy. In the former, unionisation results in equilibrium wages being positively related to the unemployment benefit and income tax rates. In the latter, the existence of monopolistic competition leads to the emergence of increasing returns to the range of available varieties of the intermediate input. As a result, the expansionary effects of higher unemployment benefits and wages trigger a virtuous circle of entry in the intermediate sector, greater aggregate productivity, and higher income. This virtuous circle occurs despite the free mobility of capital. Unions play a crucial role in the transmission mechanism between government policies and economic performance: with unionisation, welfare state policies have distortionary effects since unions transfer the burden of taxation on to firms via higher wages. We find, however, that even with the high degrees of distortion associated with non-internalising unions, increases in social protection can have positive effects on aggregate welfare. The reason for this is that unions’ rent-seeking activity contributes, by raising income, to the emergence of a virtuous circle that reduces the sub-optimality in the provision of intermediate varieties. This clearly suggests that encompassing unions – typical of corporatists industrial relations systems – are not (as is often suggested, e.g., Garrett, 1998) necessary to ensure compatibility between welfare states and high degrees of international openness, and that production externalities can severely influence the way different labour market institutions affect economic performance. It is important to stress, however, that the existence of unionisation is not necessary for the above results to emerge. Any form of labour market imperfection (e.g., efficiency wages) that gives rise to a positive link between wages and policy instruments would most likely lead to similar conclusions. Similarly, our conclusions do not crucially depend on the specific structure of the model we have used in this paper; it is not difficult to show that the fundamental forces at work are not altered when some of the assumptions – such as (i) small-open-economy, (ii) non-tradability of intermediates, and (iii) absence of unionisation in the final good sectors – are relaxed.17 Finally, it is also true that welfare state policies are not the only way by which governments may trigger the virtuous process of cumulative causation described above. One lesson of economic policy is that policy intervention should be applied as closely as possible to the desired target. Thus, given that in this case the market imperfection leads to a sub-optimal production of varieties, industrial policy may well be more effective in correcting the distortion. This consideration, however, does not diminish the relevance of our analysis whose aim is to question the generality of the existence of a conflict between welfare state and economic globalisation. The welfare state has played a specific social and political role in advanced industrial economies and various attempts to retrench it are being met by oppositions that could lead to a backlash against trade and capital markets liberalisation. Our concern in this paper has been to assess the extent to which openness and this type of policies are incompatible, and our findings suggest that they need not be.