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Symposium 2008

Proposal - Globalization and the welfare state

The Challenge

What are the implications for welfare state eform? What constellation of welfare state policies enables us to compensate the losers from globalization without harming incentives to work and acquire ...

What are the implications for welfare state eform? What constellation of welfare state policies enables us to compensate the losers from globalization without harming incentives to work and acquire skills? What are the appropriate roles of the state, firms, housholds and civic organizations in the provision of welfare services?

How Globalization Transforms the Welfare State

Before responding to the specific questions raised for this panel, I think it is important to highlight three points:

First, the tendency in thinking about this topic is to focus on certain aspects of globalization: the globalization of the world’s labor market, such that low cost labor in low income and emerging market countries very much restrains wage demands and creates competitive pressure on labor markets in advanced countries; the potential for a “race to the bottom” on tax rates that at least may put limits on the potential for using certain tax instruments (particularly on capital goods) to mobilize government revenue; and the benign effect that integrating low cost labor into the global economy can have in restraining pressures for price increases. Yet there are other aspects of globalization that very much bear on this broader topic:

(i) the greater degree of interlinkage between economies, such that cyclical downturns in some of the larger economic blocs or unanticipated vulnerabilities in financial markets can impact on other economies much more substantially and quickly than in the past;
(ii) that growth in large emerging market economies is creating important pressures on resources that is fundamentally altering the relative prices of key commodities, with important effects on production decisions across the world ; and
(iii) that various real shocks can also quickly influence competitiveness in different sectors. All these aspects of globalization can also create sectoral adjustment problems and corresponding difficulties for many households that may require welfare-state type responses (at least of a social safety net nature) or affect the viability of current welfare state systems.

Second, it is difficult to focus on the impact of globalization in isolation from some other key structural factors that are influencing the possibilities for the welfare state. Most important, of course, is the impact of demographic trends, particularly the aging of industrial country populations due to reduced fertility and lengthening life expectancies. Even in the absence of the globalization, this demographic structural change would have required major adjustments in the welfare state. The effects of technology on costs in the medical sector is another factor that is having an impact on the design of the welfare state (though globalization may prove to contribute to ameliorating some of these effects).

Third, in addition to its effects on the welfare state of advanced countries, globalization will also affect how many middle-income and even some more advanced low income countries should approach the design of social safety net and social insurance policies. Competitiveness concerns and the experience of the industrial countries is likely to limit the generosity of new social insurance systems in these countries. Turning to the specific questions posed:

  1. Does the new wave of globalization require a reconstruction of welfare state provision and financing? It is not the new wave of globalization that will force modification of welfare state provision and financing, but rather the combination of the globalization that has occurred to date and underlying structural trends—in particular demographic trends in the industrial countries, emerging market, and low-income countries. The former will continue to put pressure on countries in terms of level of tax rates and competitiveness of industry. The latter will render existing welfare state promises unsustainable.
  2. How does globalization affect the welfare state? Does it reduce governments’ ability to impose taxes, while simultaneously creating more need for welfare state protection? Or does it benefit most segments of society, making welfare state protection less important with the passage of time? What are the policy implications?

One facet of globalization—the greater intensity of competition and the globalization of labor markets that allows for low-cost labor to be integrated into global production processes-- undeniably provides benefits to most segments of society through lower prices for imported goods and greater competitive pressures on domestic production. But this does not at all make welfare state protection less important over time—indeed, the latter need arises as much from relative income status within a society as it does from absolute income status. Globalization’s effect on the welfare state—and this applies across industrial countries, recognizing the significant differences in the character of the welfare states that one observes—is several fold:

(i) it limits the capacity of countries to raise tax rates or to maintain high tax rates, given competitive pressures, particularly on the taxation of mobile factors of production—viz., capital

(ii) it provides pressure for a restructuring of tax policies away from taxes on factors (particularly payroll taxes) and toward general sales taxes as a means of limiting the impact on employment; in this regard, it thus also creates pressures for changing the financing basis of welfare benefits away from those that are employment-linked. In a similar vein, it creates incentives for a restructuring of welfare policies to those which are of a personal account nature—e.g., defined contribution pension schemes, personal medical accounts. In the above context, and as noted above, one cannot ignore that these fiscal effects of globalization on the welfare state are occurring at the same time as the forces of demographic change will be independently pressuring the costs of the welfare state in industrial countries. Limits on the capacity to raise taxes at a time of growing social insurance burdens—particularly those faced by PAYGO systems—will force reforms that both contain benefit growth and put pressure to ensure an adequate safety net for the poorest of the elderly population.

(iii) globalization, combined with rapid technological change, accentuates the competitive pressures faced by domestic producers, with several important effects—restraining the capacity of labor to realize wage gains, maintaining pressure on producers for a lean labor force, and increasing the risk of unemployment. If anything, this accentuates the importance of social safety net policies—welfare and unemployment benefits—as well as policies to facilitate the more effective functioning of labor markets.

(iv) Another facet of globalization, which will only continue to be reinforced in the future, will be pressures for migration arising from the largely predetermined growth in the global labor force in coming years (despite the drop in fertility rates globally and the obvious aging of industrial country populations). Given the large disparity in incomes between aging industrial countries and less developed countries, and the labor force needs of industrial countries, pressures for migration will continue to be an important policy challenge in industrial countries. Such immigration pressures have been felt as a double edged sword by many industrial countries, providing some additional financial support for financially weak welfare systems but also raising questions as to the eligibility for benefits of these migrant groups.

(v) globalization has also enhanced the uncertainty and risk faced by domestic producers to global market changes. The last year has illustrated powerfully the way in which critical global commodity prices can be affected by supply and demand shocks as well as by speculative forces in the capital market. The ripple effects of such shocks can be transmitted quickly to local production markets, whether in low income or advanced economies. Witness the impact of high oil prices on the competitiveness of a whole range of industries in the United States, creating pressures on both established social insurance programs (unemployment benefits) and for relief outlays outside the formal welfare structure. (As an aside, out formal definition of the welfare state does not normally include the provision of financing to shore up financial institutions or strengthen deposit protection schemes, etc.). Also note the uncertainty created for producers who have created global supply chains as the cost of transport has risen sharply, rendering business models involving decentralized production processes less efficient. Such pressures could lead to greater competitiveness of domestic producers, either in advanced countries or neighboring countries whose labor costs may now be more competitive. The important point is that uncertainty may be heightened, increasing the returns to being able to flexibly respond.

(vi) One facet of globalization that has proved relatively efficient in the last decade has been the ability of capital markets to recycle capital from current account surplus to current account deficit countries. The recent pressures on commodity prices may have tilted current account surpluses to high savings rate countries, thus dampening global demand pressures and weakening growth prospects in many industrial countries. Higher rates of unemployment inevitably put pressure on welfare states that critically depend on maintaining relatively high employment rates (e.g., the Nordic countries). 3. What policies enable countries to reap the benefits from globalization while providing minimum levels of economic security, necessary to keep the citizens from voting for strongly protectionist policies? There is a conventional wisdom now on at least some obvious elements of the desirable policy response to the forces of globalization. In some respects, these are the same policies which would appear appropriate in sustaining rapid growth in a globalized policy environment, though not all are likely to be perceived as “favorable” by those likely to be sympathetic to protectionist policies. These include: -- achieving greater flexibility in labor markets to facilitate the reallocation of labor across sectors (reduced employment protection provisions, less burdensome unemployment insurance taxes and less generous unemployment insurance benefit provisions); greater portability in pension benefits; health insurance not tied to employment provision; life long education and retraining initiatives; enhanced efforts at fostering job placement and mobility to areas of high employment demand; --policies that provide incentives for research and innovation; --policies that foster enhanced investment in infrastructure, such as with respect to ITC; and --Policies that foster rapid adjustment of prices to market trends, facilitating adjustment by producers and factors of production. Having a basic social safety net—a combination of mean-tested welfare schemes and vigorous efforts at job retraining, placement, and possibly resettlement—may be a critical element of a package that limits support for protectionist policies.

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