Does globalization erode social safety nets?

Economic theory and intuition suggest that as economies become more globalized, the ability of governments to undertake redistributive policies and to engage in social spending erodes.  After all, a large part of the tax base--corporations, financial intermediaries, and skilled workers in particular--become internationally mobile and can evade taxes needed to finance those public expenditures. 

This is important because historically countries that are more exposed to international trade have actually had larger public sectors, in part to insulate their citizens from shocks originating from abroad.  This fact, along with the lack of an obvious decline in the overall tax take in major advanced economies, has led many observers to think that the hypothesized decline of the welfare state has not in fact taken place.

Giuseppe Bertola and Anna Lo Prete have now brought new evidence to bear on this question, and their findings bear out the simple intuition.  As they put it, "as technological progress and multilateral trade liberalisation have made borders less of a barrier to economic activity, the scope of redistribution policies has become smaller."  Here is the chart that goes along with their result:

Another interesting argument Bertola and Prete make is that private finance seems to have partly filled the whole left by public transfers.  The claim is that more developed financial markets are able to supply the insurance and consumption-smoothing provided traditionally by the welfare state in very open economies.  They use the share of house prices financed by mortgages as an indicator of financial development.

I am sure this argument made a lot more sense a year ago, when the authors were doing their original research, than it does now. It will take a while until we think of finance, and housing finance in particular, as a source of insurance and stability. 

Bertola and Prete are aware of this of course.  So they conclude thus:

Financial markets are indeed in trouble and, if our perspective on past developments is correct, their fragility does not bode well for globalisation. The breakdown of private financial markets excites calls for stronger redistribution. If redistribution is national (as it has to be as long as politics are national), it will only be sustainable if national borders become less permeable to economic activity.

Indeed. Welcome back to the political trilemma of the global economy.

Comments

[Rich C]

But is this really so? Looking at the graph, I count 12 countries as being above average in trade exposure, and above average in public social expenditure, but only 11 countries that are above average in trade exposure and below average in public social expenditure. There is also one country that is above average in trade and exactly average in social exp, and one that is exactly average in trade exposure and above average in social exp.

It looks like the apparent relationship is a consequence of three countries that are way above average in trade exposure, but well below average in public social expenditure. The whole rest of the data set otherwise seems to point to an inconclusive result.

If those three outlier countries have other things in common (like, say, being East Asian Industrial states), then rather than concluding that trade exposure reduces public expenditure, it may instead be that a particular historical configuration of economic and political institutions in one part of the world has produced an anomalous result.

[Tord Steiro]

I love your clear reasoning Dani, but I am not sure I am convinced about the conclusion - that globalization today means less ability for the state to provide safety nets. Scandinavian systems evolved under increasing globalization, and it is robust to increasing trade. Hence, globalized labour markets or globalized capital markets should be the problem here. The first have we barely seen at all, while the latter will surely be reversed in the near future, so I think your trilemma have to wait. But I could be wrong, of course.

[LMCinHK]

"After all, a large part of the tax base--corporations, financial intermediaries, and skilled workers in particular--become internationally mobile and can evade taxes needed to finance those public expenditures."

So the solution seems pretty simple. Global taxation. The US taxes its citizens no matter where they live.

- LMCinHK

[AMP]

I've noticed in my region of expertise, the Middle East, that liberalizing economies have continued to seek out new means to provide social welfare (albeit mostly to political supporters). Income tax as a proportion of total revenues is rising at the expense of taxes on trade, but so are revenues from general sales taxes. This has allowed governments to continue funding some of their traditional welfare programs. However, another source of "welfare" has come from private capital in the Gulf. In Jordan, for instance, many Gulf investors are buying former SOEs. The contracts are classified--generally because it is believed that they include provisions for certain wage and employment levels.

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The mirror side of this argument is that many governments want to lock up their constituencies in corals where they can tax them without having to worry too much about what they do with the tax revenue.

What come first? To raise taxes and give it to any government or to have good governments that knows how to earn the taxes, within their open borders, in a credible way? As a citizen I will always prefer the second alternative but, then again, I don’t work for governments.

To hold that “the ability of governments to undertake redistributive policies and to engage in social spending” depends on closing borders dooms us all to an incredible low bar in governance.

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I wonder if there is an underlying variable that affects both the dependence on trade and the social safety net. Perhaps some aspect of culture or geography might be responsible for both.

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"... private finance seems to have partly filled the whole left by public transfers." The whole? Or the hole? I'm confused.

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The graph is a scatter-shot plot with no clear trend. What's the r-squared of that "trend line?" 0.15? A very weak relationship, if any.

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