Why Welfare States Are Important

This is an excerpt from a chapter 21 of the book "23 Things They Don't Tell You About Capitalism". It's discussing how a strong welfare state is beneficial to overall economic health as it makes workers more secure and leads to less need for trade protections for industries.

This book is very worth buying and reading. It's written so clearly and covers some of the most important economic issues affecting everyone now.

Let's look at the first bit:

What they tell you:
Big government is bad for the economy. The welfare state has emerged because of the desire by the poor to have an easier life by making the rich pay for the costs of adjustments that are constantly demanded by market forces. When the rich are taxed to pay for unemployment insurance, healthcare and other welfare measures for the poor, this not only makes the poor lazy and deprives the rich of an incentive to create wealth, it also makes the economy less dynamic. With the protection of the welfare state, people do not feel the need to adjust new market realities, thereby delaying the changes in their professions and working patterns that are needed for dynamic economic adjustments. We don’t even have to invoke the failures of the communist economies. Just look at the lack of dynamism in Europe with its bloated welfare state, compared to the vitality of the US.

This is the standard narrative on government pushed in the US. Nearly everybody who talks about the economy or government feels the need to acknowledge or reinforce this narrative.
How is this different or the same as the narrative about government in Taiwan?

What they don’t tell you:
A well designed welfare state can actually encourage people to take chances with their jobs and be more, not less, open to changes. This is one reason why there is less demand for trade protectionism in Europe than in the US. Europeans know that, even if their industries shut down due to foreign competition, they will be able to protect their living standards (through unemployment benefits) and get re-trained for another job (with government subsidies), whereas Americans know that losing their current jobs may mean a huge fall in their living standards and may even be the end of their productive lives. This is why the European countries with the biggest welfare states, such as Sweden, Norway, and Finland, were able to grow faster than, or at least as fast as, the US, even during the post-1990 ‘American Renaissance’.

How does this description of how welfare states work compare with Taiwan’s welfare state? Do you prefer this model or the Taiwanese model? What are the benefits to the Taiwanese model?

Korean youth and medicine as a profession
[In South Korea,] a survey done in 2003 revealed that nearly four out of five ‘top-scoring university applicants’ (defined as those within the top 2 per cent of the distribution) in the science stream wanted to study medicine. … The interesting thing is that, even though medicine has always been a popular subject in Korea, this kind of hyper-popularity is new. … What has changed?

What is driving this is the dramatic fall in job security over the last decade or so. After the 1997 financial crisis that ended the country’s ‘miracle years’, Korea abandoned its interventionist, paternalistic economic system and embraced market liberalism that emphasizes maximum competition. Job security has been drastically reduced in the name of greater labour market flexibility. Millions of workers have been forced into temporary jobs. Ironically enough, even before the crisis, the country had one of the most flexible labour markets in the rich world, with one of the highest ratios of workers without a permanent contract at around 50 per cent. The recent liberalization has pushed the ratio up even higher—to around 60 per cent. Moreover, even those with permanent contracts now suffer from heightened job insecurity. Before the 1997 crisis, most workers with a permanent contract could expect lifetime employment (as many of their Japanese counterparts still do). Not any more, Now older workers in their forties and fifties, even if they have a permanent contract, are encouraged to make way for the younger generation at the earliest possible chance. Companies cannot fire them at will, but we all know that there are ways to let people know that they are not wanted and thus to make them ‘voluntarily’ leave.
Given this, Korean youngsters are, understandably, playing safe. If they become a scientist or an engineer, they reckon, there is a high chance that they will be out of their jobs in their forties, even if they join major companies like Samsung or Hyundai. This is a horrendous prospect, since the welfare state in Korea is so weak—the smallest among the rich countries. … A weak welfare state was not such a big problem before, because many people had lifetime employment. With lifetime employment gone, it has become lethal. Once you lose your job, your living standard falls dramatically, and more importantly, you don’t have much of a second chance. Thus, bright Korean youngsters figure, and are advised by their parents, that with a licence to practise medicine they can work until they choose to retire.

But even I know that it is impossible for 80 per cent of the brainiest Korean kids in the science stream all to be cut out to be medical doctors.
So, one of the free-est labour markets in the rich world, that is, the Korean labour market, is spectacularly failing to allocate talent in the most efficient manner. The reason? Heightened job insecurity.

The welfare state is the bankruptcy law for workers
Free-market economists believe that any labour market regulation that makes firing more difficult makes the economy less efficient and dynamic. To start with, it weakens the incentive for workers to work hard. On top of that it discourages wealth creation by making employers more reluctant to hire additional people (for fear of not being able to fire them when necessary).
…The welfare state therefore makes things even worse. By providing unemployment benefits, health insurance, free education and even minimum income support, the welfare state has effectively given everyone a guarantee to be hired by the government—as an ‘unemployed worker’, if you like—with a minimum wage. therefore workers do not have enough incentive to work hard. To make things worse, these welfare states are financed by taxing the rich, reducing their incentives to work hard, create jobs and generate wealth.

Also, high taxes means that your wealthiest people will take their money out of your country and put it in offshore accounts, shifting the tax burden to the much smaller middle class tax pool.

Greater insecurity may make people work harder, but it makes them work harder in the wrong jobs. All those talented Korean youngsters who could be brilliant scientists and engineers are labouring over human anatomy. Many US workers who could—after appropriate retraining—be working in ‘sunrise’ industries (e.g. bio-engineering) are grimly holding on to their jobs in ‘sunset’ industries (e.g., automobiles).
The point…is that, when people know they will have a second (or third or even fourth) chance, they will be much more open to risk-taking when it comes to choosing their first job, or letting go of their existing jobs.
Do you find this logic strange? You shouldn’t. because this is exactly the logic behind bankruptcy law, which most people accept as ‘obvious’.

Bankruptcy, a generous second chance
Before the mid nineteenth century, no country had a bankruptcy law in the modern sense. What was then called bankruptcy law did not give bankrupt businessmen much protection from creditors while they restructured their business—in the US ‘Chapter 11’ now gives such protection for six months. More importantly, it did not give them a second chance, as they were required to pay back all debts, however long it took, unless the creditors gave them a ‘discharge’ from the duty. This meant that, even if the bankrupt businessman somehow managed to start a new business, he had to use all his new profits to repay the old debts, which hampered the growth of the new business. All this made it extremely risky to start a business venture in the first place.

Insofar as it gives workers second chances, we can say that the welfare state is like a bankruptcy law for them. In the same way that bankruptcy laws encourage risk-taking by entrepreneurs, the welfare state encourages workers to be more open to change (and the resulting risks) in their attitudes.

We can drive our cars fast only because we have brakes. If cars had no brakes, even the most skilful drives would not dare to drive at more than 20-30 miles per hour for fear of fatal accidents. In the same way, people can accept the risk of unemployment and the need for occasional re-tooling of their skills more willingly when they know that those experiences are not going to destroy their lives. This is why a bigger government can make people more open to change and thus make the economy more dynamic.