Welfare states as investments

Tim Worstall points to the likely high earnings of successful Olympians such as Victoria Pendleton and says: "Stop subsidising the training.It’s just stealing money from the poor so that a gilded few can get ever richer." But there's a different way of looking at this.

It's that such subsidies are a form of investment in human capital. In subsidizing training, the government helps to raise athletes' earnings and it gets a return on this in the form of higher tax revenues.

Granted, the additional tax alone doesn't recoup the spending on elite sport. But it is only a fraction of the financial payback; for example, there's also lower health spending, to the extent that lardies are inspired by Olympians to get fit.

What's true for sport funding is more true for welfare spending generally; it's a form of investment which helps raise peoples' earnings and tax revenue. To this extent, the welfare state pays for itself. For example:

- Health spending patches people up and gets them back to work

- Education spending raises our earnings; if I hadn't had a state education, I'd be struggling to hold down a minimum wage job. As it is, my higher earnings have repaid the cost of my schooling many times over.

- Welfare benefits don't just keep people alive whilst they wait to get a job. They can give people time to find the right job, which raises their future earnings. And they can subsidize writers and musicians whilst they hone their craft; if it hadn't been for the dole (and an Arts Council grant), we might not have the Harry Potter books and JK Rowling's large tax payments.

You might ask why, if such spending pays for itself, the private sector does not do it, as Hopi suggests? One reason is that there are large costs of identifying the profitable investments such as those children who would benefit most from schooling. Venture capitalists find it hard enough to spot profitable companies, let alone profitable people. Another, bigger, reason is that private contracts to hand over 40%+ of one's future income are unenforceable. Only the state has the power to extract returns on investments in education and health.  

So much for intuition. What of the evidence? Here are three things:

1. Between 1830 and 1870, when the UK's welfare state was minuscule, real GDP per head grew by just 1.4% a year. Between 1945 and 1985, when it grew rapidly, real GDP per head rose 1.9% per year.

2. Nordic states have for years combined large tax-funded welfare states with good economic outcomes, which suggests that big welfare states in themselves are not bad for economies.

3. Peter Lindert's research suggests that the welfare state is a free lunch. He says (pdf): "There is no clear net GDP cost of high tax-based social spending."

I say all this because the welfare state is often seen as a cost. It's not. It's also an investment and perhaps a profitable one.

Comments

[Anonymous]

Thanks for saying these unfashionable things.

It is surprising to find Tim Worstall siding with the poor given his social Darwinian agenda which would have the weak, the vulnerable and the poor go to the wall and left to die. His agenda is that markets should be used to penalise the weak and the poor so as to achieve his Darwinian end of survival of the fittest. Or as Adam Smith put it "Devil take the hindmost". Murder by stealth may not be too fanciful a description that underpins Mr Worstall's philosophy.

In a study of 15 EU countries there was a positive correlation between social spending and employment levels. In other words, on average, the higher a county's social spend the higher that country's employment level was. Of course the relationship is not exact - the correlation coefficient comes out at about 0.5 with 15 countries included in the study. Nor does it imply causality - just that the two variables are positively associated with each other. What the study does show, however, is that high spending does not impede high employment levels. Ot put another way, high social spending does not incentivise workers to be unemployed.

In the study, the UK was a bit of an outlier - it had high employment levels (at the time of the study) and a low social spend. Denmark had the highest social spend and the highest employment level. Employment levels and social spends were expressed as percentages and hence controlled for size.

[Anonymous]

"You might ask why, if such spending pays for itself, the private sector does not do it"

The answer may be due to the existence of merit goods - goods for which the social benefit is higher than the private benefit. These goods will be under supplied if left to "free markets" because "free markets" fail to price these goods correctly at their true value.

[Bialik]

Why doesn't the private sector do it? Reminds me of the sub-plot of Kenneth Fearing's 'The Big Clock' http://en.wikipedia.org/wiki/The_Big_Clock which never ties up with the main plot as far as I can tell; there must be another reason for it being there.

[Luis Enrique]

so the impact upon output hinges on whether the investment-like characteristics (which I agree are typically completely over looked) outweigh the disincentives to work (which can't be denied, if properly conceived of as applying only to a sub-set of recipients) and I suppose the distortions involved in raising the taxes to fund the transfers.

but, as you know, whether the welfare state is a good idea or not depends on more than its net impact on aggregate earnings.

[how would a private sector "investor" in the welfare state capture the returns? free rider problem]

[Anonymous]

@Luis

A private sector investor in the welfare state would be unable to capture the social return. So yes, there is a kind of free rider issue here.

Market distortion can correct market failure and hence may be a good thing. The transaction costs from tax and spend are likely to be outweighed by the financial and social benefits of social spending.

The research does not support the hypothesis that social spending produces disincentives to work.

[Frances Coppola]

I suspect that much of the reason why the private sector doesn't do it is the very long time horizon, particularly in education and training. Would private sector investors be prepared to wait 20-30 years for their investment in education to generate a return? Plus the laziness of corporations that expect to be provided with a fit, healthy labour force fully skilled to perform the functions they require.

With health care there is the additional problem that the largest users of state health care provision are the elderly - who generally are not being patched up so they can return to work, but so they can continue living on their savings and the taxes of others. So I'm not sure why a private sector provider would be remotely interested in health care for the elderly.

[gastro george]

Isn't it rather interesting that the free-marketeers are all over the impossibility of the ability of government to "pick winners" and, yet, in Olympic sport, that's exactly what several quasi-governmental sports bodies have been exactly able to do.

[Igor Belanov]

There do seem to be distinct wings within the right between those who are quite willing to wave the flag and get all jingoistic about Olympic medals, and those who regard current sport policy as rather too close to those of countries such as the Soviet Union, East Germany or China.
It is interesting how the political significance of sport changes over the years. Politicians these days are all over sport like a rash, fabricating an interest in order to bask in the reflected glory of medal-winning and celebrity sportspeople. If you think back to the Thatcher era, sport was either ignored or treated as some sort of pariah activity.

[Andrew]

Very interesting point about the state having unique powers to enforce longer term contracts and thus may be a uniquely valuable market participant.

I find this blog a heady mix of intellectual stimulation and complete mental fail (witness the absolute stock market return advantage of 2-5% for the intelligent being a "paltry" return below.)

[Martin Freedman]

What happened in the UK after 1985, why did you chose that date to to compare to your previous data point?

[Walter W]

The size of the welfare state is properly measured by the difference between the welfare being received and the taxes being paid. The poor in the US receive relatively less in welfare and also pay relatively less in taxes. In comparison, in Nordic countries, the poor get more in welfare and pay more in taxes (particularly, in value-added taxes). My guess is that there is not much difference on average between the US and the Nordic countries, but this is just a guess. In any case, it is interesting that as the government grows, there is a larger incentive for it to have an efficient tax system, with reasonably similar taxes on all goods and income. So the Nordic countries may be on to something.

[Anonymous]

@Walter W

So if 100& of tax paid is spent on welfare then the size of the welfare state is zero?

Perhaps I have misunderstood but your method of measuring the size of the welfare state seems incorrect.

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[Zorblog]

Thanks for letting the Continent know about Victoria Pendleton. Her fame hadn't reach us so far. You have to believe that all those (continental) journalists who were covering the Olympics aren't any more competent than their economic counterparts.

[Will]

Very interesting, thanks Chris. I've always wondered why the investment argument is accepted so much more readily for capital projects. Is the evidence better?

I blogged about the same thing here a few days ago http://www.community-links.org/linksuk/?p=3493