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Samenvatting - Economics of the Welfare State
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Summary for the Economics of the Welfare State course given at the VU
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Lecture 1Welfare State: A government that undertakes responsibility for the welfare of its citizens
through programs in public health, public housing, pensions, unemployment compensation,
etc.
History of the Welfare State
The welfare state was created just after World War II when there was high economic growth
and low unemployment. In the 1970s the growth of the welfare state continued despite lower
growth rates and substantial increases in unemployment
Current trends that (could) have an effect on the welfare state
! Question could be about which current/upcoming trends will affect the welfare state
● Globalisation: restricts the autonomy of countries to design their welfare states
independently because they must now consider global economic standards,
competition, and international regulations, which can limit the choices available for
domestic policy-making.
● Demographic changes: Demographic changes like the increase in life expectancy
and lower fertility rates lead to an ageing population. This may increase the demand
for health care and pensions, because if the fertility rates are lower this can result in
fewer workers to support the elderly through taxation.
● Changes in family structure/individualisation: : More single-parent families and
fewer children per household can change the types of support needed, such as
childcare services and financial assistance. As people focus more on personal goals
and less on traditional family roles, there may be increased demand for services that
support independent living.
● Changing structure of jobs:
- Skill bias: Jobs that require advanced skills and education are growing, while
low-skill jobs are declining. This can widen income inequality as those without
the necessary skills struggle to find good-paying jobs.
- Precarious and part time employment: There is an increase in part time jobs.
Part-time, temporary, and freelance work often lack job security, consistent
income, and benefits. This can lead to financial instability and a greater
reliance on welfare programs.
Main components of welfare state
1. The government is involved in providing welfare services.
2. Benefits provided by the welfare state can be in the form of direct money (like
unemployment benefits) or services (like healthcare or subsiding
Public Economics: Examines the role of the government in the economy
Categorisation of benefits with a social purpose
, Public Private
Mandatory Voluntary Mandatory Voluntary
Redistribution Benefits that everyone Optional public Benefits not provided by Benefits that are not
should participate in by benefits that have the the government but which obligated by law, but
law. goal to redistribute are mandatory by law. redistribute.
Example: Universal Example: Public Example: Disability Example:
health care or Child housing subsidies insurance paid by Tax-advantaged
benefits. (huurtoeslag) employer benefits
No Benefits that everyone Optional benefits from Benefits not provided by Optional benefits not
redistribution should participate in, nationally defined the government but are provided by the
but has not so much to contribution plans. mandatory by law. do government which
do with redistribution. are voluntary
Example: Basic Example: Example: Company Example: Voluntary
pensions (AOW in NL) Energy-saving pension plan pension plan policies
subsidies (Warmte for self-employed
pomp subsidie in NL) individuals
Epsing Anderson Model
The Esping-Andersen model is a framework that categorises welfare states into three types
based on their approach to social protection.
! Question could be about how the types of welfare states differ
1. Liberal
This type of welfare state emphasises individual responsibility and market efficiency. It
provides limited, means-tested benefits (only available to those who can prove financial
need) primarily for the poor. Benefits are modest with strict eligibility requirements and are
funded through general taxation.
● Countries: US, Canada, Australia, UK
● Coverage: The ones who are eligible for welfare benefits are very limited. Typically
only includes the poorest individuals.
● Entry conditions: The requirements to receive the benefits are very strict. They often
require to be incapable of work and to pass mean testing (proving low income and
lack of resources).
● Limitation of duration: The duration of how long benefits are received are strict.
● Level of benefit: The level of benefit provided is very low and minimal.
● Method of funding: Welfare programs are funded through general taxation, which
means that taxes are collected from the general public.
● Minimum wage: Minimum wage is either absent or very low.
● (Dis)incentives to employment of women: There are no specific disincentives for
women’s employment such as high maternity leave.
● Subsidised employment: Jobs that are partially funded by the government to
encourage employment are virtually absent.
, 2. Corporatist
This type of welfare state focuses on maintaining social stability and supporting employed
individuals. It offers selective, earnings-related benefits mainly funded through employer and
employee contributions, with eligibility based on employment history. The system
emphasises preserving traditional social structures and ensuring support for workers through
their professional affiliations.
● Countries: Japan, France, Germany, Italy
● Coverage: Coverage is selective and hierarchical, meaning it primarily includes
specific professional groups, such as public sector workers or those in particular
industries, rather than the entire population.
● Entry conditions: are fairly strict, requiring an employment history to qualify for
benefits.
● Limitation of Duration: Benefits are often actuarially determined, meaning they
depend on the amount of contributions made over time by employer and employee.
This could potentially be long.
● Level of benefit: Benefits are often high and based on previous wages.
● Method of funding: Benefits are funded mainly through contributions from both
employers and employees.
● Minimum wage: Minimum wage is high but may vary for different sectors.
● (Dis)incentives to employment women: There are many disincentives for women to
work, such as benefits favouring a single breadwinner in the family, generous child
allowances, and a lack of adequate childcare facilities.
● Subsidised employment: is limited, meaning there are some government programs to
support employment, but they are not widespread or extensive.
3. Social-democratic
This type of welfare state promotes social equality and high living standards for all. It
provides universal, generous benefits funded through general taxation and emphasises
extensive public services and support regardless of income. The philosophy is based on
social solidarity, aiming to reduce inequalities and ensure comprehensive social protection
for everyone.
● Coverage: Coverage is universal, meaning everyone in society is eligible for benefits.
● Entry conditions: Entry conditions are generous, meaning it is relatively easy for
individuals to qualify for benefits without strict requirements.
● Limitation of duration: There are no strict limitations on the duration of benefits,
meaning individuals can receive support for as long as they need it.
● Level of benefit: Benefits are high and provide a guaranteed minimum income
● Method of funding: Welfare programs are funded through general taxation, meaning
that taxes collected from the public are used to finance these benefits.
● Minimum wage: The minimum wage is high, ensuring that workers receive a
substantial baseline income.
● (Dis)incentives to employment women: Many incentives for women to work, such as
individual benefit entitlements and extensive childcare facilities.
● Subsidised employment: Subsidised employment is extensive and mainly public,
meaning the government heavily invests in programs to create and support jobs.
,First and second welfare theorem
! Question could be about how the two welfare theorems justify government intervention
and that we can not just rely on the market.
First welfare theorem:
The first welfare theorem states that under conditions of no externalities, perfect competition,
perfect information, and rational behaviour, market outcomes are Pareto efficient, meaning
that no one can be made better off without making someone else worse off.
→ Why does the failure of the first welfare theorem justify government intervention?
The ideal conditions of the first welfare theorem are rarely met in reality due to factors like
externalities and information asymmetry (moral hazard & adverse selection). The failure of
these conditions to hold in real-world markets justifies government intervention through
mechanisms such as regulations, Pigouvian taxes, and mandatory insurances.
Second welfare theorem
The second welfare theorem posits that any Pareto efficient outcome can theoretically be
achieved by appropriate redistribution of initial endowments using lump-sum taxes,
assuming no market failures.
→ Why does the failure of the second welfare theorem justify government intervention?
This theorem's fallacy lies in the impracticality of such ideal conditions, notably the lack of
perfect information and the challenges of implementing distortion-free taxes. This fallacy
justifies government intervention through distortionary taxation and other measures
Example: we have an economy where 50% of people can earn 100 euros and 50% are
disabled and cannot earn anything. According to the second welfare theorem, if the
government could perfectly identify who is able and who is disabled, they could tax the able
people 50 euros, regardless of whether they work or not, to support the disabled.
However, in the real world, the government can't easily tell who is able and who is disabled.
If they tax everyone 50 euros, including those not working, it could discourage people from
working. This creates distortions (unintended economic effects) and errors in the system.
Types of intervention
1. Regulation: This involves the government setting rules to ensure things work well and
fairly. For example, they set quality standards for products and healthcare to make
sure they are safe and good. They control how much of something is available, like
the number of school places. They also set price controls, like minimum wage laws to
ensure workers get paid fairly, and uniform premiums to keep prices stable for
everyone.
, 2. Finance: Through subsidies and taxes, the government can influence market prices.
Examples include subsidies for public transport and pharmaceutical products.
3. Production: The government may take over the supply side of the market in critical
sectors such as defence, healthcare (like the UK's NHS), and education (primary and
secondary schools). This control can ensure equitable access and maintain
standards of service across the population.
4. Income transfers: These are direct financial supports such as housing benefits, child
benefits, and other forms of social assistance aimed at redistributing income to
support the economically vulnerable sections of society.
Objectives of the welfare state (Barr) and three key functions
! Question could be about the objectives of the welfare state and the three key functions
--- = function of welfare state
1. Efficiency
This means that the welfare state should use resources in a way that maximises benefits
and minimises waste.
- Micro efficiency: welfare resources should be effectively and targeted allocated.
- Macro efficiency: the right amount of GDP should be spent on welfare without
excessive costs.
- Consumption/Income smoothing: policy should enable individuals to reallocate their
consumption over their life cycle to ensure they can maintain a stable consumption
level during both old age and young age.
● If everyone could predict their future perfectly and face no risks, people would
be able to manage their finances throughout their lives without needing much
help from the government. In such a scenario, government intervention would
only be necessary for those who are poor throughout their entire lives
("lifetime poor").
- Risk-sharing: policy should use insurance to pool risks across a large number of
individuals (law of large numbers), which helps protect against involuntary significant
drops in living standards due to factors like unemployment and health issues. Private
insurance markets do not always work therefore government intervention is needed
(see next lecture).
- Incentivises: which should lead to no adverse effects on labour supply or savings.
2. Equity
, - Poverty relief: there should be no household that falls below a minimum standard of
living.
- Reducing inequality
● Vertical: system should redistribute resources from rich households to lower
income households.
● Horizontal: system should ensure that individuals with similar ability to
contribute should pay similar amounts.
- Social inclusion: The welfare state should provide policies that promote a sense of
unity and ensure that everyone can participate fully in society.
3. Administrative feasibility
The system and policies implemented must be understandable and designed in a way that
prevents abuse.
Issues with poverty relief objective/function of the welfare state
- What is the threshold?: At what point is a household considered poor? Should this be
based on an absolute standard (like a fixed income level) or relative to the average
income in society?
- Assistance in transfers or in kind?: should help be given as direct money transfers
(cash) or as goods and services (like food or housing).
- What information is used to determine eligibility?: what data or criteria should be
used to decide who qualifies for poverty relief, such as income levels, family size, or
health status.
- Rely on voluntary redistribution?: Should poverty relief depend on voluntary
donations and charity from others or if it should be managed and funded by the
government through taxes.
Should redistribution be in cash or in-kind?
"In kind" refers to the distribution of goods and services directly to beneficiaries, such as
healthcare, education, or subsidised housing, rather than giving them cash.
1. In kind may override consumer preferences: When the government provides goods
or services (like food stamps or housing) instead of cash, it may not align with what
individuals actually want or need. This can limit people's ability to make their own
choices about how to use resources.
2. Consumer info may be poor (paternalism): The government might choose to provide
goods or services instead of cash because they believe that people may not always
make the best decisions with money due to a lack of information or experience. This
paternalistic approach assumes that the government knows better what people need.
3. Consumers may have unequal power: In-kind benefits might be necessary when
there's a concern that giving cash could leave vulnerable people at a disadvantage,
such as in situations where there is unequal bargaining power or market access.
Providing specific goods or services ensures that everyone gets what they need,
regardless of their ability to negotiate or access markets.
MVPF
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