"Why America Will Need Some Elements of a Welfare State"

An excellent column by Martin Wolf in the Financial Times, where he is the lead economics editor. Starting with principles put forward by Ben Bernanke in his recent speech on income inequality, Wolf concludes that America cannot do without some form of a welfare state, specifically improved training, education, and universal health care.

The section of the speech that Wolf uses as his point of departure has been neglected by the US press. Perhaps it’s because most Americans would agree with Bernanke’s principles, but they sit poorly with the Administration and free market fundamentalists:

That economic opportunity should be as widely distributed and as equal as possible; that economic outcomes need not be equal but should be linked to the contributions each person makes to the economy; and that people should receive some insurance against the most adverse economic outcomes, especially those arising from events largely outside the person’s control.

Put this way, it’s hard to argue with Bernanke. Yet, for example, the point of private schools and tutors is to assure that your children get into good schools and have good jobs to give them a big leg up in the game of life. This behavior demonstrates that people in the upper echelons are making considerable investments of time and money to make sure that economic opportunity is not equally distributed, but is skewed in favor of their progeny. They wouldn’t be spending this kind of money if they didn’t think it worked.

And Bernanke finds that income inequality is indeed increasing:

In real terms, the earnings at the 50th percentile of the distribution . . .  rose about 11½ per cent between 1979 and 2006. Over the same period, the wage at the tenth percentile . . .  rose just 4 per cent, while the wage at the 90th percentile . . .  rose 34 per cent.

In the course of the article, Wolf poses some questions about income inequality, two of which are crucial, and one of which has been considered, at best, in passing in the US: what are the causes and what should be done? Bernanke and Wolf feel that technological change, rather than globalization is the main culprit:

Mr Bernanke himself comes to the standard and, in my view, largely correct, conclusion that “the influence of globalisation on inequality has been moderate and almost surely less important than the effects of skill-biased technological change”. This has long been the persuasively argued view of Jagdish Bhagwati of Columbia University (see Technology, not globalisation, is driving wages down, FT, January 4, 2007). Support for it is given in a very recent paper by Robert Feenstra of the University of California, at Davis.***

Prof Feenstra notes that the relative wages of non-production workers have been rising in US manufacturing (see chart). In the 1980s, there was also increased employment of such people, though this was less true in the 1990s. Interestingly, exactly the same phenomenon could be identified in Mexico: higher wages and employment of non-production workers.

Standard trade theory cannot explain this combination. The normal proposition would be that relative wages of the less skilled production workers should have risen in Mexico, where such people are relatively abundant, and fallen in the US. This suggests that technical change is the more plausible explanation. Yet Prof Feenstra notes that new possibilities for specialisation in tasks along the value chain may increase demand for skilled labour in both richer and poorer trading partners. But his empirical evidence still suggests that technology is more significant. More important still, productivity is the principal determinant of real wages in the long run. It is here that openness almost certainly makes its biggest contribution to the economy.

Wolf discusses the implications: preserving fairness and equality of opportunity requires government intervention.

Surprisingly perhaps, evidence suggests that inter-generational mobility is smaller in the US and in the UK than in the Nordic countries and even Germany.*** The plausible explanation is that the relative poverty of the parents is visited upon the educational achievements of their children. Thus, rising inequality directly undermines the achievement of Mr Bernanke’s first principle. Equally, the more competitive the business environment and the smaller the identification between companies and domestic workers, the less able or willing will companies be to provide either health insurance or pensions.

In a country in which much social insurance has historically been supplied by employers, the loss of jobs and the closure of businesses is particularly traumatic. Protectionism then emerges as the politically correct form of resistance to the market.

For these two reasons, developments now under way threaten the survival of Mr Bernanke’s principles. There are two possible responses. One is to insist that people are simply on their own. The present administration will, I predict, be the high water mark of this conservative tide. The other is to create a system of support that does not destroy incentives. That would have to contain at least two elements: greater funding of education for the disadvantaged (ideally, with private supply) and universal health insurance. The left will also want higher minimum wages and generous subsidisation of low earnings.

I am not suggesting that the US should embrace Europe’s interventionist follies. But without more generous government-financed services, the US may be unable to maintain a dynamic, internationally open and socially mobile society. That may seem a paradox. It is not.

Marx believed that the contradictions of capitalism would lead to its destruction. The history of the 20th century proved otherwise. But as Wolf’s analysis shows, the contradictions of capitalism inhibit it from existing in its pure, unchecked form. It’s too ugly for most people to tolerate.

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