Focus Paper: Can the Welfare State Keep Up With Globalization?

In the past, more open economies used to have larger welfare states which served as a protection against external shocks. Our new focus paper suggests that the link between openness and the scope of the welfare state has weakened over time. For the last decade, it is hardly possible to verify a correlation between openness and the welfare state at all. This might have some explanatory potential for the increasing discontent with globalization.

Why should globalization and the welfare state go hand in hand?

Essentially, two arguments can be made in favour of the position that they should:

• More open economies are more vulnerable to external shocks: A strong welfare state provides insurance against these shocks and mitigates their effects when they arise.
• Trade induces specialization: Ideally, everyone produces what one is most competitive in producing. This means that if a country moves from a situation of little trade to a situation with a lot of trade, more competitive sectors grow and less competitive sectors decline. That of course means that while one sector is hiring, the other is shrinking. A well-functioning welfare state can facilitate transition from one sector to the other.

While there is little doubt about a positive net effect of trade, trade can induce substantial social problems at the micro-level. These problems are ideally addressed by the welfare state. Therefore, the social consensus of an economy opening up to trade and integrating into the world economy depends on the presence of an insurance mechanism.

So, are globalisation and welfare state evolving together?

The short answer is: They used to, but they are not anymore. The story can best be told in a few charts. The first one dates from 1978 – when Cameron found a clear and strongly positive correlation between the openness of an economy (exports + imports divided by GDP) and a proxy for the size of the welfare state – in this case the increase in percent of GDP represented by all governments’ revenues.

A similar exercise was repeated by Rodrik about 20 years later, in 1998. As you can see, the correlation is now a bit weaker – but it is still positive.

What does the correlation look like now, again roughly 20 years later? That is the contribution of the latest GED focus paper. The result is – the correlation almost disappeared, there is just a tiny positive relationship to be found in the data.

A word of caution is necessary: the three graphs are not entirely comparable. The different authors used different proxies for the welfare state and different measures for the variables involved. The focus paper discusses these issues in more detail. The intention of this paper is to provide prima facie evidence and to invite further and more thorough research on the topic.

Nevertheless, the trend is clear: While trade continues to intensify – and with it the sectoral specialisation effects – the welfare state is stagnating. This might explain some of the rising discontent with globalization and free trade. The answer would however not be less trade but a more effective welfare state, helping to spread the benefits of trade more evenly and fairly.

Interested in a more in-depth analysis of this phenomenon? Simply download our full focus paper at the top of this article!