Assessing the Impact of the Welfare State on Economic Growth: A Survey of Recent Developments

From the mid-1980s to the late-1990s a considerable number of empirical studies investigated the impact of the Welfare State (WS) on economic growth with no definite conclusions on the sign, transmission mechanisms and direction of causality of the relationship. More recently, globalization, population ageing and the public fiscal sustainability crisis experienced by many European countries brought the WS to the forefront of the debate on Government retrenchment. Some authors argue that the WS makes economies less productive and competitive, and thus hampers economic growth since its funding consumes scarce resources and introduces distortions in economic activity through disincentives embedded in the structure of the WS. Yet other authors call our attention to the fact that WS interventions have the potential to generate economic externalities that can outweigh their (potential) distortions. The opposing arguments on the impact of the WS on economic growth thus seem to claim for more empirical research on the subject. This paper provides a survey of the recent progress in the applied literature on the relationship between the WS and economic growth. The survey highlights that most empirical studies focus on testing the impact of social expenditures on the level or the growth rate of output ignoring the institutional features of Welfare State interventions. In turn, this leads to econometric specifications that make it difficult to interpret the observed aggregate relationships and derive meaningful and useful policy implications. The unresolved key issues that remain concerning conceptual, measurement and methodological issues call for more work on comparative analysis of WS size and composition and the respective impact on economic growth before a consensus can be reached.