Dimensions of the welfare state and economic performance: a comparative analysis

In recent years the desirability of an extensive Welfare State, especially in European countries, has been increasingly questioned on the grounds that economies with less social intervention by the Government are more competitive and productive. But even if countries are hit by fiscal austerity measures, and cannot increase public expenditures, changing the composition of the Welfare State might foster growth by rescaling their intervention in domains that are productivity enhancing. Education and health are the most striking examples given their role as sources of human capital, a fundamental ingredient in many growth models. It is thus important to empirically assess the impact of public expenditures on education and health on educational attainment and health status indicators, and real income. We do this for three groups of countries: a group of high income OECD economies, the EU before the enlargement and the EU enlargement group. This assessment can have important implications for Welfare State policy design in the EU and its OECD partners. Our empirical study is innovative in the sense that we identitfy long-run relationships across the main variables using the DOLS estimator corrected for cross-sectional dependence, and we also do this when testing for the presence of unit roots in our series. Additionally, we estimate short-run relationships that include an ECM term from the associated long-run equation by applying Fixed-Effects and Pooled Mean Group estimators. The data used comes from the World Development Indicators and covers the period 1960-2012. The results of the estimation of the long-run equilibrium relationships point to a positive, direct or indirect, influence of (public) education expenditures and of (public, private or total) health expenditures on output for the three groups of countries. Causality relationships exhibit mixed results concerning policy variables, within and between country groups, with the results for the high-income OECD (non EU) group supporting the use of social policy variables to foster economic growth.