Is the Welfare State Sustainable?

Charles N. Steele
 
Issue CCXXXVI - February 20, 2010
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Is the welfare state sustainable? I don't think so.  And it should make us leery of most of the current proposals for health care reform, and especially the grossly misnamed "single payer" scheme.
 
Sustainability is something of a buzzword in common usage, but in environmental economics it does have a relatively precise definition.  In its weakest form, it refers to a pattern of resource use compatible with future generations achieving a living standard at least as high as that of the present.  This in turn means that the current pattern of resource use is not depleting the total stock of natural and physical capital.
 
With this in mind, consider the economy as an ecosystem (perhaps this isn't really a metaphor, as "an economy" seems close to some definitions of ecosystem).  Let's focus on "physical" (manmade) capital alone, for now.  A sustainable economic system is one in which (1) there's production of valuable goods (defined very broadly to include whatever it is that people value), (2) of this production, enough is set aside to at least replenish the capital stock, and (3) the amount not set aside (consumed) is sufficient to induce people to keep the system going.
 
A progressive, growing economy, as laid out in Adam Smith's Wealth of Nations, is one that successfully meets these criteria, and exceeds the minimum on (2), i.e., it accumulates capital and increases future productivity.  It's sustainable.  The Soviet economy had great difficulty with (1), in that much of its production met no one's needs, putting (2) and (3) in doubt.  What growth it did have came not from increasingly effective use of resources, but from mobilizing resources.  Unsurprisingly, the system was unsustainable.  So how does the welfare state fare in sustainability?
 
The "social safety nets" of modern welfare states are largely pay-as-you-go programs in which current benefits to one group are paid by current taxation of another, or by borrowing (i.e., future taxation of another group).  The disconnect between program benefits and program costs drives a wedge into the decision-making process; political entrepreneurs (a nice term for politicians) can exploit this to increase their political support.  They can gain votes by increasing benefits; they can also gain votes by deferring costs to the future.  There's an inherent incentive in these systems, then, to expand benefits and to borrow or tax without any careful consideration of costs.  This dynamic tends to push the welfare state towards unsustainability.  I think this dynamic helps explain why so many Western European countries are facing debt problems, and it's the story behind the U.S. debt problem as well.
 
Today's welfare states, including the United States, are on tracks that fail to satisfy (2).  Over the longer run, our entitlement and interest burdens grow faster than our economies.  For the United States, even with conservative assumptions, the burden exceeds any reasonable projection for the federal budget.  We pay by borrowing or by taxation, but either way we reduce resources available for augmenting the capital stock.  Borrowing is likely to be especially pernicious in this regard, since the ultimate tax burden is hidden.
 
Sustainable?  No.  It's a formula for unsustainability.


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