Don't fret about "Big Welfare"
Social democracy vs. neoliberalism showdown
After provoking the left, I’m now going to be upsetting some of my economically liberal friends from the US. Sorry! Here it goes: I think social democratic capitalism is more desirable than outright neoliberal capitalism, at least as traditionally defined. Economic freedom is overall a good thing, but if we’re being somewhat selective with it, society can be even better.
In making my case, I’m leaning on the wonderful work by sociologist Lane Kenworthy, especially his book Social Democratic Capitalism. And I’m mostly going to be presenting stylized facts, not rigorous and endogeneity-robust causal estimates, so keep that in mind. Where possible, though, we’ll discuss a bit of causality too.
Defining social democracy
What even is social democratic capitalism? Kenworthy defines it with reference to six nonexclusive clusters of traits:
1. Political democracy (liberal democracy)
2. Private ownership and markets (capitalism)
3. Basic education (good-quality K–12 schooling)
4. Expansive, generous public insurance programs
5. Employment-oriented public services
6. Some, but only modest/moderate, regulation
If a (developed) country scores high on all these traits simultaneously, it has a high degree of social democratic capitalism. If it scores high on only some of them but low on others, it has a low degree of social democracy.
Upon hearing this definition, some will no doubt protest. How can the absence of strict regulation (that is, relative economic freedom on the regulatory dimension) have anything to do with social democracy? Isn’t this more like neoliberalism? My response is three-fold.
First, Kenworthy is at least partly looking at actually existing societies that most people would tend to call social democratic and then enumerating their characteristics. So, if the poster boys for social democracy – the Nordic countries and certain other European societies – have only modest-to-moderate regulation, then this can reasonably form one pillar of our definition of social democratic capitalism.
Second, modest regulation on its own might not a flagbearer of social democracy – it would have more to do with traditional neoliberalism if looked at in isolation – but when mixed with the other five traits, it can make sense to include it in the definition of social democratic capitalism. This is especially so when you realize that regulation is actually made up of several relatively distinct subcomponents that can be mismatched (more about this at the end).
Third, I don’t really care what we call the system Kenworthy is proposing. We can call it social democratic capitalism, or “neoliberalism-lite”, or “System X”. What I know is that the system that combines the 6 enumerated clusters of characteristics (1) can and does exist in reality, and (2) is desirable. If you don’t like “social democracy”, fine. Nothing substantive hinges on the moniker.
Does it really work, or at least not hurt?
With this out of the way, why would we think social democratic capitalism is desirable or better than one notable alternative, namely, neoliberal capitalism? Well, causality is hard, and I won’t be really able to establish it here, but even basic descriptive statistics can still be illuminating to some extent. Consider the following.
1. Less poverty and hardship
Countries with more generous public insurance have significantly lower rates of relative poverty and material hardship. In Kenworthy’s data, the share of households in Denmark struggling to afford food or housing is just 5%, compared to 15% in the United States.
2. More economic security
What happens if you lose your job or get sick? In the U.S., a 20% drop in individual earnings leads to an average household income decline of a whopping 28%. In social democratic countries like Denmark or Sweden, that drop is closer to 10%.
3. More actual freedom and opportunity
Critics claim big government crushes freedom. But when people are asked if they are “satisfied with your freedom to choose what you do with your life,” a higher share say “yes” in countries with bigger welfare states. By providing services like affordable early education and healthcare, these systems reduce people’s dependence on their boss, spouse, or parents.
4. More happiness
Being higher on the social democratic capitalist index translates to higher levels of reported happiness, and it does so even if we removed Nordic countries from the analysis. The bivariate correlation is extremely strong (0.72), although obviously no causality can be inferred here.
Here are a few other simple correlations at a glance, indicating that bigger welfare need not even come at the expense of growth or innovation.
Or look at how America’s poorest (thick line) are faring in comparison to the poorest in social democracies.
But there must be some trade-offs
Based on the data, Kenworthy argues that there doesn’t seem to be a lot of them. At least not at the descriptive level. However, he rightly points out that households at the top of the income ladder in social democratic countries have lower post-tax cash incomes than their American counterparts. That seems to be a real trade-off and it might be off-putting to some. But I admit it isn’t to me, given all the other potential social benefits.
But surely higher taxation hurts economic growth while tax cuts would boost it? According to a recent meta-analysis, which is actually the first of its kind, corporate tax cuts aren’t related to economic growth once researchers correct for publication bias. There’s slightly more evidence for the conventional wisdom found in this meta-analysis on size of government and economic growth. But even here, researchers warn that the negative link cannot be interpreted causally:
Our findings in this study indicate that government size is more likely to be associated with negative effects on per-capita income growth in developed countries. They also indicate that the medium-sized adverse effects in developed countries may be biased due to endogeneity and reverse causality problems, which are either unaddressed in a large segment of the evidence base or the instruments used to address these problems are weak or both. Therefore, we call for caution in establishing casual links between government size and per-capita income growth.
Would decreasing the size of government help with corruption, at least? Aren’t big governments more prone to corruption? It doesn’t seem so. Here’s a recent meta-analysis investigating this question and finding that “after controlling for publication selection bias, a negative or zero mean effect remains, which overturns the conventional wisdom.” Bigger governments are not more corrupt and might even be less so! And, no, endogeneity is not driving this result.
So, if nothing else, you don’t need to worry about social democracy destroying things.
Social democratic capitalism and economic freedom
Here’s how the system looks like in terms of the Fraser Institute’s five key variables. Take Denmark in 2019, for instance.
To be a social democratic capitalist country, you should have a low score on the size of government dimension. Denmark gets a 5.34 (out of 10), which puts it in the 150th spot in the world. So it has low economic freedom (“Big Government”) on this count.
You should have a high score on the legal system/property rights dimension. Denmark gets an 8.6 (out of 10), and sits in the global top 10. Lots of economic freedom here.
You should have a high score on the sound money dimension. Denmark gets a 9.6 (26th in the world).
The same goes for freedom of international trade. Denmark gets an 8.8 (8th in the world). On trade, social democratic capitalists are, in a sense, neoliberals.
When it comes to regulation, social democracy is slightly more complicated. Denmark, for instance, gets a very high overall score on regulation: an 8.5 out of 10, securing it 9th place in the world rankings by economic freedom. But when we unpack regulation, we observe that although Denmark is highly economically free as far as credit market regulations and business regulations are concerned, it’s not as free with respect to labor market regulations. There, it gets a 7.3 (out of 10), which places it in the 48th spot globally.
A similar exercise can be done with Finland or Sweden or the Netherlands, etc.
So, in terms of economic freedom, here’s the difference between social democracy and neoliberalism. Social democracy gets tops scores on property, sound money, international trade, and many aspects of regulation. But it gets a very low score on government size and only a middling score on labor market regulations.
Neoliberalism, on the other hand, is economic freedom all the way. High scores on government size, property, sound money, freedom of trade, and the whole of regulation.
It might be countered that the Nordic countries and those others that I take to be social democratic societies would do well despite having social democracy. That is, they might do even better if they abandoned the existing system and switched to neoliberalism. Yeah, perhaps. But I doubt it!
Your post comes at a perfect time; I just returned from my first visit to Copenhagen. I was surprised to learn that Denmark has high rates of unionization, government-mandated employment benefits, generous unemployment insurance, *and* a lower unemployment rate than the United States.
I’d be curious to hear your thoughts on why I think this is the case.
Unions: Unlike in the U.S., Danish unions don’t restrict entry. Instead, they compress wages, which helps explain the country’s low inequality.
Government-mandated employment benefits: Non-wage benefits come at the expense of wages, but they don’t appear to reduce employment that much. My guess is that this works because Denmark’s workforce is highly educated and skilled. The same labor-market regulations would probably produce much higher disemployment effects almost anywhere else in the world.
Unemployment insurance: Denmark’s small, homogenous, high-trust society fosters a strong sense of social obligation to leave welfare and return to work.
So, in short, Denmark works better than a classical liberal like myself would expect at first glance, but it’s probably not scalable.
As one of your economically liberal friends from the U.S., I'm going to have to disagree and will present soon a full critique of Kenworthy, some of whose comparison graphs I don't think make sense. That's especially the case for innovation and productivity growth. In the meantime, I suggest a reading of one of the most important comparative systems papers ever written, "Can’t We All Be More Like Scandinavians? Asymmetric Growth and Institutions in an Interdependent World," by Acemoglu, Robinson, and Verdier, which explains the basis for arguing that the social-democratic countries of Europe have effectively been able to sustain their more generous welfare states only by free-riding on U.S.-originated innovation. The more unequal and lower-tax U.S. system, in this view, is the tradeoff for being at the global technology frontier. It's no accident that not a single one of the world's leading high-tech companies is located in Europe and that the continent has seen its per-capita income fall further behind the U.S. in the last two decades. That is not at all to say that the Nordic countries, in particular, are bad places to live. They are wonderful in many ways and I have great friends there, but we should understand that, in opposition to what Kenworthy claims, there are, in fact, tradeoffs.
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2132939