June 6, 2016

How Our Broken Welfare System Threatens Economic Growth



As the head of the Niskanen Center’s new Poverty and Welfare program,  I look forward to discussing the relative merits of a basic income and wage subsidies, how the current patchwork of welfare programs creates a crushing regulatory burden on the poor, and the ways well-designed public assistance can boost autonomy rather than create dependency.

First, however, I want to talk about growth.

Even though the annual real growth rate of the U.S. economy has slowed, hovering near 2 percent the last I checked, the economy is still expected to double every 35 years or so. On a per-capita basis, that means roughly $1,000 more in productive output is created each year than the year prior for every person in the United States.

Let that sink in. While top economists are rightfully worried that we have entered an age of economic stagnation, they do so against the backdrop of continuing exponential increases in wealth and income. The world we live in today is orders of magnitude richer than the world of our ancestors, and with any luck, so too will our present world look orders of magnitude poorer to future generations.

But what does this have to do with poverty and welfare? Everything.

A welfare policy that does not begin with this basic fact, (what Deirdre McCloskey calls “The Great Enrichment”), is deaf to history and blind to the very foundations of social justice. Economic growth, driven by innovation and expanding markets, has been the number one poverty-fighting tool in human history. And to the extent that certain groups fall through the cracks, growth is also responsible for generating the surplus required to finance a safety net in the first place.

As my colleague Will Wilkinson recently wrote:

When we effectively coordinate our efforts, we produce gains over and above what we could have done acting independently. Those gains are the “surplus” of cooperation. Enrichment—that is to say, economic growth—is about creating ever more and ever larger surpluses from cooperation. But whenever we produce a surplus there’s always the question of how to divvy it up. If it’s a question about how to divide it fairly—about who ought to get what, rather than about who has the power to snatch the most—then it’s a question of “distributive justice.”

The philosopher John Rawls, whatever his deeper legacy, understood this point well. His “difference principle,” which stipulates that economic inequality is justified to the extent that the least well off in society benefit, is often characterized as excessively egalitarian. Yet on the contrary, his central innovation was to orient questions of distributive justice to the guiding star of expanding output. I have my own problems with Rawls, but he is a reservoir of sanity compared to “thinkers” who treat income as manna from heaven, independent of the basic economic rights, institutions and cultures that give rise to wealth creation from the bottom up.

Securing Cooperation, Present and Future

As the economist (and Niskanen Center advisor) Tyler Cowen once pointed out, defenders of the welfare state portray their position as pro-poor, but if applying distributive justice comes at the expense of doubling future production possibilities it surely “harms the interests of future generations and foreign citizens, and in this regard it does not help the poor more generally.”

I’d like to suggest that the reverse is also true:  if we take questions of distributive justice too lightly, and allow economic growth to become captured in part or in whole by an exclusive group—what, in general, might be called “rent seeking”—this harms growth as well. Growing our cooperative surplus, in short, demands continued cooperation, and the semblance that everyone’s station in life is secure if not improving.

Consider that if two people engage in a cooperative venture only to discover that just one of them will be remunerated, the uncompensated party will, the next time around, in all likelihood choose to decline his or her services. In the same way, despite it being true that the net gains from technological change and globalization are in principle sufficient to compensate the losers from creative destruction and trade liberalization, if we refuse to do so in practice, don’t be surprised when the country’s reactionary elements are eventually inspired to “Make America Great Again.”

Finding the right mix of compensatory social insurance, tax rates, property rights and social norms that maximize society’s dynamism and future growth potential is a challenge, a kind of balancing act for which there is no static solution. And yet something tells me we are currently to the left of the optimum point when it comes to what you might call just compensation. Wages have stagnated or declined, while federal social programs have either been eroded in real terms by inflation (like TANF), or devolved to states which then target the spending on the non-poor.

When economic growth was roaring near 4% in the late 1990s, there was a better argument—an appetite, really—for welfare reform that cut cash transfers and attached penalties on not seeking work. Yet a safety net is mainly for when the trapeze fails, not for when it’s at its most robust. And when it hadn’t failed in a while, those in control of the purse came to believe maintaining the net was nothing but a costly waste. In fact, the economy was so strong that poverty rates fell at first following the 1996 welfare reform, before climbing again in the 2000s. Then the Great Recession happened and revealed in an undeniable and tragic fashion how mammoth the holes had become.

The answer, however, is not to return to the system before 1996. A social insurance system that allows creative destruction to go unimpeded and creates buy-in for free trade and liberalization needs to be reconciled with the unique needs of the contemporary engines of growth.

Put differently, we should think of the those pushing to unionize the gig economy, say, and those seeking a revival of ‘90s era punitive work requirements, as each being backward looking in their own, uniquely horrible ways. Now is the time to start thinking hard about a welfare reform for the 21st century, because if we sit back and wait for the next big wave of technological change and dislocation to occur it may end up being the last.