23 Things They Don't Tell You About Capitalism

Over time, people came to realize that the lack of a second chance was hugely discouraging risk-taking by businessmen. Starting with Britain in 1849, countries have introduced modern bankruptcy laws with court-granted protection from creditors during initial restructuring and, more importantly, the power for courts to impose permanent reductions in debts, even against the wishes of the creditors. When combined with institutions like limited liability, which was introduced around the same time (see Thing 2), this new bankruptcy law reduced the danger of any business undertaking and thus encouraged risk-taking, which has made modern capitalism possible.

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. Because they know that there is going to be a second chance, people can be bolder in their initial career choices and more open to changing jobs later in their careers.

Countries with bigger governments can grow faster

What about the evidence? What are the relative economic performances of countries that differ in terms of the sizes of their welfare states? As mentioned, the conventional wisdom is that countries with smaller welfare states are more dynamic. However, the evidence does not support this view.

Until the 1980s, the US grew much more slowly than Europe despite the fact that it had a much smaller welfare state. For example, in 1980, public social expenditure as a share of GDP was only 13.3 per cent in the US, compared to 19.9 per cent for the EU’s fifteen countries. The ratio was as high as 28.6 per cent in Sweden, 24.1 per cent in the Netherlands and 23 per cent in (West) Germany. Despite this, between 1950 and 1987, the US grew more slowly than any European country. Per capita income grew at 3.8 per cent in Germany, 2.7 per cent in Sweden, 2.5 per cent in the Netherlands and 1.9 per cent in the US during this period. Obviously, the size of the welfare state is only one factor in determining a country’s economic performance, but this shows that a large welfare state is not incompatible with high growth.

Even since 1990, when the relative growth performance of the US has improved, some countries with large welfare states have grown faster. For example, between 1990 and 2008, per capita income in the US grew at 1.8 per cent. This is basically the same as in the previous period, but given the slowdown in the European economies, this made the US one of the fastest-growing economies in the ‘core’ OECD group (that is, excluding the not-fully-rich-yet countries, such as Korea and Turkey).

The interesting thing, however, is that the two fastest-growing economies in the core OECD group during the post-1990 period are Finland (2.6 per cent) and Norway (2.5 per cent), both with a large welfare state. In 2003, the share of public social spending in GDP was 22.5 per cent in Finland and 25.1 per cent in Norway, compared to the OECD average of 20.7 per cent and 16.2 per cent in the US. Sweden, which has literally the largest welfare state in the world (31.3 per cent, or twice as large as that of the US), at 1.8 per cent, recorded a growth rate that was only a shade below the US rate. If you count only the 2000s (2000–8), the growth rates of Sweden (2.4 per cent) and Finland (2.8 per cent) were far superior to that of the US (1.8 per cent). Were the free-market economists right about the detrimental effects of the welfare state on work ethic and the incentives for wealth creation, this kind of thing should not happen.

Of course, by all this I am not suggesting that the welfare state is necessarily good. Like all other institutions, it has its upsides and downsides. Especially if it is based on targeted, rather than universal, programmes (as in the US), it can stigmatize welfare recipients. The welfare state raises people’s ‘reservation wages’ and deters them from taking low-paying jobs with poor working conditions, although whether this is a bad thing is a matter of opinion (personally I think the existence of a large number of ‘working poor’, as in the US, is as much of a problem as the generally higher unemployment rates we see in Europe). However, if it is well designed, with a view to giving workers a second chance, as it is in Scandinavian countries, it can encourage economic growth by making people be more open to changes and thus making industrial restructuring easier.