Economic Integration and the Welfare State

1. Economic Integration and the Welfare State

2. Economic integration • Increasing mobility of people, goods and factors of production institutions and policies through different channels. • Factor price equalization (e.g. Freeman) • Policy experimentation (e.g. Mukand and Rodrik) • System competition (e.g. Sinn)

3. System competition • While competition among firms tends to be beneficial for the general public, this is not necessarily so for the case of competition among governments. • Sinn (1997): ”Since governments have stepped in where markets have failed, it can hardly be expected that a reintroduction of a market through the backdoor of systems competition will work. It is likely to bring about the same kind of market failure that justified government intervention in the first place.” • Ex1 Public goods financed by a mobile tax base • Ex2 Redistributive taxation

4. System competition cont. • Tax competition model formalized by Zodrow and Mieszkowski (1986), but topic in public finance for a long time: • Break, 1967: “Active tax competition, in short, tends to produce either a generally low level of state-local tax effort or a state-local tax structure with strong regressive features”. • Oates, 1972: “The result of tax competition may well be a tendency toward less than efficient levels of output of local services”. • But welfare consequences of tax competition is not trivial… • Brennan and Buchanan, 1980: ”The primary purpose of federalism … is to create competition between jurisdictions” • Second best solution: Tax competition restrains a public sector that otherwise would have been too large.

5. Can the welfare state survive? • The tendency to factorpriceequalization makes theincomedistribution in richcountries more unequal and increasestheneed for an activewelfarestate. • Butclosereconomicintegration makes it more difficult to maintainthewelfarestate. • Eachcountry has incentives to limit redistribution to avoidattractingnetrecipients and repellingnetcontributors. • In its most extreme form ’a race to thebottom’.

6. Openness and government size • Rodrik (1998) empirically investigates the relationship between openness and government spending.

7. Openness and governmentsizecont. • This cross countryrelationship is robust to: • Including a setofcontrol variables • Differentmeasuresof gov. Spending • Differentsubsamples (high and lowincomecountries). • Excludingoutliers • Rodrikconcludesthattheassociation is not driven by omitted variables. • The effect is strongeston transfer and socialsecurity spending.

8. Openness and governmentsizecont. Table from Fiva (2006)

9. Openness and governmentsizecont. Table from Fiva (2006)