The Welfare State and Economic Performance: Quantiles and Nonlinearities

This study examines the relationship between the welfare state and aggregate macroeconomic performance for a sample of OECD countries over the period 1980-2013 based on data for social spending and output. We provide a descriptive statistics and econometric analysis of the former relationship in order to investigate the following hypotheses: a) the evolution of public social spending depends on the income level of countries; b) the relationship between social spending and output depends on the size of the welfare state; and c) the relationship is non-linear and depends on the associated welfare state regime. In addition to descriptive statistics based on quantile techniques, econometric methods suitable for the analysis of non-stationary series (DOLS) and a model with thresholds (Hansen, 1999) are applied. The descriptive statistics analysis supports the first two hypotheses for the whole sample of 25 OECD countries and for the groups obtained by dividing the sample according to either output or social expenditures quantiles. This analysis also points to a non-monotonic relationship between social spending and output—positive for the whole sample but negative for high values of output and social expenditures-, although in the latter case applying only to a small number of observations. Accordingly, we next applied econometrics methods suitable for non-stationary series to assess whether the relationship is spurious. The regression results with the DOLS model confirm that there is a positive long-term relationship between output and social expenditures regardless of the distribution considered for the identification of the country groups. Therefore we were not able to provide evidence supporting hypothesis (b). Additionally, we identified three welfare state regimes that have associated a tenuous “law” of diminishing returns to social spending.