Why Social Safety Nets Are Harmful To Economic Growth

During the current debate in Congress regarding whether to cut some of the planned future government spending, one of the accusations that opponents hurl at each other is that a proposed change will erode the “social safety net”. The assumption behind these accusations is that a softer social safety net is an unarguably good thing. However, I wonder if it is worth considering the possibility that the economic future for Americans overall would be brighter with a weaker welfare system.

A per-capita GDP growth rate of approximately 2 per cent per year during the 20th century made the U.S. the richest country in the world in 2000. Had the growth rate been 1 per cent during this period, we would have become the poorest Western country. One of the factors that leads to a higher growth rate is domestic savings, which can be reinvested in productivity-enhancing capital equipment.

Consider the public employee who knows that he or she will retire at age 50 with an inflation-adjusted pension guaranteed by a state constitution. Particularly if the pension is 90 or 100 per cent of the former salary, it doesn’t make sense for that person to defer consumption today and save. Roughly the same amount of money will be coming in 20 years from now. Private-sector workers have a greater incentive to save, of course, but they don’t need to save anything for medical expenses (due to Medicare) and they can be assured of a basic income through Social Security. Workers in the high-growth Asian economies haven’t had these assurances from their governments and therefore have been saving a much higher percentage of their income (see this post, which notes that the Chinese saved 40 per cent of their income during the 1990s and the number has actually risen to 45 per cent more recently; this paper says the number is closer to 50 per cent; the U.S. number is roughly 0 per cent (source)).

To date, the U.S. has not apparently suffered too much from our lack of domestic savings (our economic growth rate right now is feeble, of course, but it doesn’t seem to be due to a lack of money to invest). A lack of stability or perceived investment opportunity in other parts of the world has led to an influx of savings from other nations. However, looking forward a few decades it seems possible that investors will have a greater range of opportunities and won’t be so keen to lend us their money at low rates. If that happens we may find that it wasn’t such a great idea to have told so many Americans that the government would take care of them.

When we hear a politician promising to enhance Medicare or Social Security, is he or she really saying “I promise to retard the future economic growth of the U.S.”?

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