Download w S /w U

Ec426 Public Economics
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Can welfare states compete in a global
economy?
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Plan of lecture
1.
2.
3.
4.
5.
Globalisation as threat to the welfare state
Impact of globalisation on non-welfare state (“US”)
Impact of globalisation on welfare state (“Europe”)
A richer model
Importance of institutional structure: unemployment
benefits
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1. Globalisation as threat to welfare state
“The panoply of social programs, benefits and protections
designed to cushion Europeans from the harshest effects of their
capitalist economies have become enormously expensive and, in
some cases, their consequences extremely perverse”
(Newsweek, 20 December 1993).
Argument A: Tax Cost
Two different arguments
That welfare state has too high a tax cost.
Argument B: Specific effect
That welfare state benefits have negative effects on economic
performance.
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Tax cost argument
Tax as % GDP =
Replacement rate x dependency rate
+
Other government spending/GDP
+
Cost of tax expenditures/GDP
+
Cost of debt interest/GDP
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Specific cost argument
Globalisation (G)
Economic performance (EP)
Welfare state (WS)
∂EP/∂G < 0
and
∂2EP/∂G∂WS < 0
Need to examine economic impact of globalisation, first in
absence of WS.
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2. Impact of globalisation on non-welfare
state (“US”)
Open economy:
Assume goods and services traded (with zero transport
costs), but that factors immobile. Immobility reasonable
first assumption for labour, on which focus to begin with, as
literature has highlighted labour market and the differential
impact on skilled and unskilled workers. Cause of increased
wage dispersion in US.
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Re-label GE two factor
model:
X/Y
skilled and unskilled labour
Domestic demand
Assume small
country: facing
given world
relative price
for output
Trade: import of
X, export of Y
Production
wS/wU
pX = cX(wS,wU); pY = cY(wS,wU)
Pricing
Eg Cobb-Douglas case
pX= wU wS
α
(1-α)
; pY =
wUβwS(1-β)
pX / pY = [wS/wU]β-α
X is intensive in use of unskilled labour if α > β
pX/pY
wS/wU
Assume X
more
intensive in
unskilled
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labour
Effect of increased
competition in production
of X by NIC
X/Y
Effect of
globalisation
Skilled wage
premium rises
and trade
increases
pX/pY
wS/wU
Pricing
wS/wU
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Different where
specialisation.
X/Y
Effect of
globalisation
Cobb-Douglas case
wS/wU
wS/wU =
[(1-β)/β
/LS/LU]
unaffected by
global
competition
■
●
■
●
●
wS/wU
“Supply”
curve
pX/pY
Pricing
where
both
goods
produced
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Country faces offer curve
Export X
X/Y
Domestic
demand
Domestic +
Foreign
demand
Trade in
balance
wS/wU
Import X
pX/pY
Pricing
wS/wU
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Effect of globalisation where
country faces offer curve
X/Y
Effect of globalisation on final
demand (domestic + foreign)
Skilled
wage
premium
rises and
pX/pY falls
wS/wU
pX/pY
Pricing
wS/wU
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Implications for personal income distribution
It is not just a matter of ws/wu. The personal distribution depends on the
numbers of skilled and unskilled workers. There are LS with wage wS, LU
with wage wU. Denote ratio wS/wU by ω, and ratio LS/LU by ℓ. Then total
income is wU (ωLS+LU) and share of unskilled is 1/[1+ωℓ].
Gini coefficient is equal to the difference between population share and
income share, which is
[ω-1]ℓ/[(1+ℓ)(1+ωℓ)]
Depends on ω but also on ℓ.
“Trade” explanation of
increased earnings dispersion.
Lorenz
curve
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3. Impact of globalisation on welfare state
(“Europe”)
Krugman (1994 and Brookings Papers on Economic Activity,
issue 1, 1995) argued that Europe differently affected by
globalisation on account of welfare state.
Welfare state here represented by unemployment benefit at
rate b (in real terms), financed by a payroll tax levied on
workers at rate tS or tU, so that the net wage becomes w(1t).
BUT
First have to ask: why is there unemployment?
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Unemployment benefit and reservation wage
In the textbook Krugman model, the only cause of unemployment is that
unemployment benefit causes there to be a reservation wage that is (1+η)
times the benefit level. In particular,
(1-t)wU ≥ (1+η)b π
where π is an index of consumer prices. If we assume that demands are
Cobb-Douglas, with all income (and all government revenue) being spent a
fraction μ on good X and a fraction (1-μ) on good Y, then price index
π = pXμ pY(1-μ)
With Cobb-Douglas cost functions (see slide 7), and ω = wS/wU
pX = wU ω(1-α); pY = wU ω(1-β) Hence π = wU ωζ where ζ= μ(1-α)+(1-μ)(1-β)
The ceiling on the skilled wage premium therefore becomes
(1-tU)wU ≥ (1+η)b wU ωζ or ω ≤ [(1-tU)/(b(1+η))]1/ζ = ω*.
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Higher
unemployment
X/Y
Effect of
globalisation
Effect of wage
premium ceiling
Supply where full
employment
wS/wU
●
●
pX/pY
ω = ω* =
[(1-tU)/(b(1+η))]1/ζ
Wage premium ceiling
Cobb-Douglas case
●
wS/wU
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X/Y
●
●
Unemployment
rises
U/LU
Effect of
globalisation
●
●
Determination of
unemployment rate
Unemployment
Determined
rate of
by ω*
unskilled
workers
How to cut unemployment in this model?
pX/pY
• allow ω* to rise by cutting b
• allow ω* to rise by cutting tU
• raise LS/LU
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Implications
Globalisation causes increased wage dispersion in US but unemployment in
Europe.The distributional consequences need to be analysed with care.
In the “European” case there are LS with wages (1-tS)wS ,(LU –U) with wages
(1-tU)wU, and U with benefit income b. Need to distinguish between:
• distribution of earnings
• distribution of market income
• distribution of disposable income
Earnings: mean rises, causing both
slopes to fall, and proportion of
unskilled workers falls.
Lorenz
curve
What happens to the distribution of
market income and disposable income?
Effect of globalisation in
“European” case
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BUT
• (1) Underlying model is Arrow-Debreu (perfect competition
and fully clearing markets), with no unemployment in
absence of unemployment benefit;
• (2) Economic model is inconsistent and omits key features
(Section 4);
• (3) Treatment of unemployment benefit ignores important
institutional aspects (Section 5).
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4. A richer model
• Inconsistent: Do not have parallel universes; Europe and US are
trading in same world, so cannot have both pX/pY fall (and
increased wage dispersion in US) and pX/pY constant (and
European unemployment); need as a minimum 3 country model
(US, Europe and NIC);
• Need to relax tight link between product prices and factor
prices; introduce non-traded sector (e.g. personal services,
sector Z).
• Model lacks capital and intermediate goods
• 2 country x 2 good x 2 factor model not adequate.
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A richer 3 country (Europe, US and NIC) x 3 sector (intermediate
good, final output, and personal services) x 3 factor (skilled labour,
unskilled labour and capital) model
Capital Labour
Sector X
(intermediate good)
Sector Y
(final good)
Sector Z
(non-traded
personal services)
Input
Intermediate
good (X)
Unskilled
labour
Output
Skilled
labour
Input
Unskilled
labour
A B Atkinson, “The economics of the welfare state in today’s world”,
International Tax and Public Finance, 2008, vol 15: 5-17.
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Main conclusions from richer model
• In this model, wS/wU may be fixed in Europe, but not
determine wage ratio in US;
• Globalisation can lead to unemployment of unskilled workers
in Europe but increased wage dispersion in US;
• Effect of globalisation is moderated in both cases by expansion
of service sector employment;
• Globalisation may cause de-localisation of capital from X
sector in Europe to either NIC or US;
• Welfare state is less exposed the higher the LS/LU ratio;
investing in skills is advantageous.
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5. Importance of institutional structure
The standard treatment by economists assumes that unemployment benefit is
paid unconditionally to all those unemployed. Such a treatment ignores
important institutional features.
Hypothetical
Typical real-world UI
(unemployment insurance)
Typical real-world UA
(unemployment assistance)
Benefit paid irrespective of
reasons for entering
unemployment.
Benefit refused where a person enters
unemployment voluntarily or as a
result of industrial misconduct.
As UI.
Benefit is paid for all days of an
unemployment spell.
Benefit may not be paid for an initial
period.
As UI.
Benefit is unlimited in
duration.
Limited duration and rate of benefit
may decline over time.
As hypothetical.
No condition of job search is
imposed.
Benefit conditional on being available
for work and engaging in job search.
As UI.
There is no penalty for refusal
of job offers.
Refusal of job offers may lead to
disqualification from benefit.
As UI.
There are no contribution or
income conditions.
Benefit depends on satisfaction of
contribution conditions.
Amount of UA depends on other
income and on assets via a
means test.
Eligibility for benefit is not
affected by income of other
family members.
As hypothetical.
Amount of UA is affected by
income and assets of other
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household members.
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Implications of institutional structure
• Some of the unemployed may not receive benefits: in 2005 in the EU
40 per cent of those unemployed 1-3 months did not receive any
benefit (UI, UA or sickness benefits), 29 per cent of those unemployed
for 4-6 months, and 42 per cent of those unemployed for 7-12 months.
• Benefit conditions need to be taken into account in economic
models: for example, job search models of unemployment assume that
a person can reject job offers without any risk of losing benefit,
whereas they may be disqualified;
• The “shirking” model of efficiency wages assumes that a person
dismissed for shirking would receive benefit, whereas they may well be
disqualified;
• Contribution conditions mean that new entrants cannot receive UI;
• Contribution conditions mean that there is a link between payroll
taxes paid and benefits received.
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Conclusions
• Distinguish two concerns: (a) tax cost of welfare state and (b) its impact
on working of the economy;
• In absence of unemployment benefit, globalisation can lead to widening
wage dispersion, but not where economy specialised;
• Unemployment benefit leads to restricted wage flexibility, and hence
unemployment, intensified by globalisation;
• But we need a model where there is rationale for unemployment benefit
(e.g. search model);
• Analysis needs to be extended to allow for 3 countries (and 3 goods and 3
factors);
• The standard treatment of unemployment benefit by economists assumes
that it is paid unconditionally to all those unemployed. Such a treatment
ignores important institutional features.
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