Although all advanced industrial democracies have welfare states, there are significant differences in the typesof welfare states around the world. This differences reflect the historical experience of different countries andthe relative strength and weaknesses of different economic sectors. This brief summary will present the three-sector model of the political economy, discuss the historical circumstances of welfare states origins in the late19th and early 20th centuries, and conclude by analyzing why different welfare states are respondingdifferently to the pressures of globalization.

1.1 THREE SECTOR MODEL1.1 THREE SECTOR MODEL

It is common in economics to describe economies as consisting ofthree basic factors of production: land, labor, and capital. As afactors of production, “Land” are natural resources, real estate,and quasi-rents, “Labor” is the time and efforts of workers, and“Capital” are tools, including money, needed for production. Anyeconomic product can be thought of as different proportions ofthese factors. For example, a tupperware container is acombination of the materials the make up the plastic, the labor ofthe factory workers to make and package the container, and themachines and money to accomplish its production. They alsorepresent political interests. Labor represents the interest of wage-earners. Land is the interests of farmers and rentiers includinglandlords, bondholders, and primary economic sectors such asagriculture and mining. Capital stands in for the interests of the investing class, including banks but also theowners of firms. At any time, one group may be politically powerful and able to pursue policies that benefitthem, sometimes to the disadvantage of other groups.

1.2 SOCIAL WELFARE & SOCIAL INSURANCE1.2 SOCIAL WELFARE & SOCIAL INSURANCE

Social welfare is mainly social insurance against the risk individuals face in a modern economy. Farmers andminers face the natural risks of bad harvests and fluctuating commodity prices. Workers face the risk ofdisability and unemployment, the need to attend to the care and raising of their children, and changes in thecost of living. Capitalists face the risks of competition from domestic and foreign firms, technological change,and runs on leveraged assets (bank runs). Welfare states provide insurance against these risks to facilitate thesmooth operation of the economy. In the United States, price supports for agricultural products, subsidies formineral discovery and extraction, and guarantees for bond and pensions insure the major risks of landed andrentier interests. For workers, unemployment insurance, Social Security, education and training programs, taxsubsidies for employer-based health insurance, and maternity leave policies protect against many of the risksfacing workers and their families. For investors and entrepreneurs, organizations like the FDIC insuredeposits against bank runs, trade policies grant protection against unfair trade practices, and variousregulatory agencies protect businesses against unfair trade or business practices by their competitors. Inaddition, interventions in financial markets to preserve asset prices also provide insurance against inflationaryand deflationary risks.

2.0 TYPES OF WELFARE STATES2.0 TYPES OF WELFARE STATES

Although classifications vary, scholars generally divide welfare states into three broad categories: liberal,corporatist, and social democratic. Liberal states attempt to provide social welfare mostly through market-

WELFARE STATES WELFARE STATES

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based policies, such as tax incentives, and the promotion of workforce skills, such as broad-based educationand job retraining programs. In addition, welfare policies tend to be means-tested, meaning that services, suchas Medicaid and unemployment insurance, are made available on a need-based criteria. Corporatist welfarestates operate by giving organized groups, such as labor unions, agricultural cooperatives and tradeassociations, guaranteed representation and control over policies that affect their welfare that allow them tonegotiate collectively for their groups interests. For example, German works councils provide laborrepresentation on the corporate boards of companies that employ their workers. Social Democratic welfarestates aim at providing a minimum level of social welfare for all citizens through government programs withuniversal access. For example, they may provide longer maternity-leave, subsidized public and collegeeducation, and a guaranteed minimum and health insurance. They tend to be high tax states to support thesepublic programs.

2.1 LIBERAL WELFARE STATES2.1 LIBERAL WELFARE STATES

“Liberal” does not mean political left as it has come tomean in United States, but refers to its older meaningwhen it was associated with limited and smallgovernment and an appreciation for market-basedpolicies. Liberal welfare states include most of theEnglish-speaking advanced industrial economiesincluding the United States, Canada, Australia, NewZealand and the UK. As stated above, their welfarepolicies tend to be means-tested and market-based.Unemployment insurance and income maintenanceprograms provide a smaller share of income lost thanother welfare states and there is little intervention inlabor markets or labor protections compared to otherwelfare states. Social security is financed by a flat-taxon wage income. Many welfare programs workthrough tax incentives such as the American EarnedIncome Tax Credit (EITC) or tax subsidies/exemptions to employers to provide health insurance.There is little guaranteed maternity leave or publicprograms to assist families with child-care. The aim ofsocial policy in Liberal Welfare States is to maintainfluid and flexible labor markets and to maximizedsocial mobility and economic opportunity. As aresult, they are often characterized by lowerunemployment rates, lower tax rates, and lessgovernment regulation than other welfare statesystems.

2.2 CORPORATIST WELFARE STATES2.2 CORPORATIST WELFARE STATES

The countries of central and Southern Europe -- Germany, France, Italy, Belgium and Spain -- make up thebulk of the Corporatist welfare states, although Japan may also be included in this group. The central featureof Corporatist systems is the explicit recognition of social groups (as opposed to individuals) in decisionmaking and in the provision of welfare programs. As noted above, agricultural and fishing cooperatives, tradeassociations, and labor unions are granted a “seat at the table” to negotiate policies (public and private) thatimpact their welfare or expose them to greater economic risk. In addition, theyoften share responsibility with

LIBERAL FEATURES:

Labour market: - little active labor market policy (<0,8% GDP)* - moderate labor participation rate women (65-74%)* - large share of employment in wholesale and retail (>22%) - large share of employment in financial services (>11%)

Disability: - Social Risk: high threshold (>80%)*

Funding: - no tax exemptions on labor (at the wage level of an average production worker) - low yield of taxes and social security contributions (<38%) - no or low employer contribution to social security (max. 8%) - lower marginal tax rate single persons (<43%) - lower marginal tax rate double earners (<42%)

Unemployment and social assistance: - short duration of earnings-related unemployment insurance (non means-tested)

(max. 1 year) - low net replacement rate at the start of unemployment for wage of 2/3 average

production worker (60-69%) - low net replacement rate at the start of unemployment for wage of average

production worker (60-69%) - low net replacement rate after 5 years unemployment, single persons (<39%) - low net replacement rate after 5 years unemployment, couples without children

(<50%) - high share of means-tested social assistance in total social security spending (>15%)

Old age pensions: - public benefits are partially or completely means-tested

Surviving dependants’ pensions: - public insurance widows: low flat rate benefit- public benefits are partially or completely means-tested

Costs of children: - low level of public provisions - low average family allowances (< €140) - family allowance income-related or means-tested - relatively low family allowance for non-poor single parent families

Leave facilities: - low level of pregnancy benefit (<70% of earnings) - no pregnancy leave for all employed women

Adapted from: deBeer, Vrooman, & Wildeboer Schut 2001

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the government for providing welfare services. For example,the Catholic Church often plays a large and official role ineducation and welfare in many European countries. Laborunions are active in providing job training, apprenticeships,and labor quality. Business trade associations takeresponsibility for regulating their members and supportingailing firms. The role of the government is mainly to mediatebetween groups with competing interests and serve as aguarantor to agreements negotiated between them. Inaddition, since many programs and functions are performedby private or semi-public entities, much of the cost of theseprograms does not manifest in public budgets. The bestexample of this are Germany’s Bismarck “social insurance”model for healthcare insurance. The government requireseveryone to purchase insurance, but the insurance andhealthcare services are provided privately, while thegovernment regulates the cost and quality of the servicesprovided and supports those who are unable to pay for theirown coverage. In addition, the government lowers costs toproducers by subsidizing education costs for sociallybeneficial occupations, such as medicine.

2.3 SOCIAL DEMOCRATIC WELFARE STATES2.3 SOCIAL DEMOCRATIC WELFARE STATES

The core of the Social Democratic welfare states isScandinavia, including Denmark, Sweden, Finland andNorway. The central features of a Social Democraticsystem are the commitment to universality -- everyone iseligible to benefit -- comprehensiveness, and the aim toprovide a high basic level of well-being and income to all.They have high levels of taxation supported by a broadsocial consensus, including business groups, to generousand universal social provisions. Programs tend to beadministered through public agencies. Like the Liberalsystems, but unlike the Corporatist ones, the SocialDemocratic Welfare states provide services to individualcitizens, not as members of defined social groups. Thisfrees them from dependence on membership in socialgroups, while the universality and comprehensiveness ofthe government programs remove the stigma of usingpublic resources. In addition, the government provisionof basic social welfare functions makes them less sensitiveto the economic fortunes of individual economic sectors.

3.0 POLITICO-ECONOMIC ORIGINS OF WELFARE STATES3.0 POLITICO-ECONOMIC ORIGINS OF WELFARE STATES

Welfare states emerged from social contracts forged during the late 19th and early 20th centuries. While alldeveloped countries reacted to the twin developments of democratization and industrialization, the balance ofinterests differed from country to country. This section identifies these differences and shows how theyinfluenced the development of different welfare states. The discussion will be based on the three-factor model

CORPORATIST FEATURES:

Labor market: - moderate active labor market policy (0.5 - 0.8% GDP)* - low labor participation rate of women aged 25-54 (<65%)* - low labor participation rate of men aged 55-64 <60%) - low labor participation rate of men aged 65+ (<5%) - high coverage of collective labor agreements (>90%) - low share of employment in services sector (<65%)

Disability: - Social Risk: coverage restricted to (certain) employees - Social Risk: moderate threshold (65-79%)* - Social Risk: wage related benefits - Professional risk: full wage compensation

Funding: - largely financed by contributions of employers/employees (>50%) - no tax allowances for non-working spouses

Surviving dependants pensions: - no collective widow insurance for all inhabitants*

Occupationalism: - frequent arrangements for particular occupational groups - high level of social protection for civil servants (>$500 per capita)

Costs of children: - relatively high family allowances for non-poor couples - relatively low family allowances for poor single parent families - high tax allowance for children

Leave facilities: - long duration of parental, pregnancy, and childbirth leave (incl. non-

paid period > 1.5 year)

Adapted from: deBeer, Vrooman, & Wildeboer Schut 2001

SOCIAL-DEMOCRATIC FEATURES

Labor market: - intensive active labor market policy (>1.1 % BNP)* - high labor participation rate of women aged 25-54 (>75%)* - large share of employment in health/social work (26-30%) - no statutory minimum wage

Disability: - Social Risk: low threshold (<65%)*

Unemployment and social assistance: - high net replacement rate after 5 years unempl., families with children (>71%) - high net replacement rate after 5 years unempl., single parent families (>69%)

Funding: - high marginal tax rate breadwinners (62-64%) - high average rate of income tax and social security contributions (>26%)

Old age pensions: - high minimum level of public benefits non-ex-employees - high coverage of earnings-related occupational pension schemes (100%)

Surviving dependents pensions: - public insurance widows: high flat rate benefit* - no separate public insurance for widows of former employees

Costs of children: - relatively low family allowance poor couples with children

Leave facilities: - long duration of earnings-related parental, pregnancy, and childbirth leave

(>26 weeks)

Adapted from: deBeer, Vrooman, & Wildeboer Schut 2001

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presented earlier. At any time, one of the three factors is relatively scarce compared to the other two, allowingit to extract a higher return for its contribution at the expense of the other factors. In response, the other twofactors mobilize politically to balance the political influence and economic power of the scarce factor. Thiscleavage defines the axis of political conflict with implications for the form of welfare state.

3.1 LIBERAL ORIGINS3.1 LIBERAL ORIGINS

In the United States, the scarce factor was capital. Even inthe late 19th century, land was plentiful relative to thehuman and financial resources of the country. UnlikeEurope, there was not landed aristocracy that controlled theland. Labor was unorganized and low-skilled relative to itsEuropean counterparts. Open immigration further added tothe labor supply. Capital, however, was in scarce supply,with the House of Morgan funneling European capital intoAmerican businesses. In short, capital was scarce comparedto land and labor and the political battles were foughtmostly between the Populist coalition of farmers in theSouth and West with industrial workers in the large urbancenters and the financial and corporate interests of theNortheast and Midwest. This political division organizedpolitics in the US along economic lines posing the “haves”versus the “have-nots.” It also enshrined laissez-faire and small government as governing principles, so thateven when the New Deal passed a raft of social legislation, it was never as generous or comprehensive as itsEuropean counterparts. This coalition also yoked labor to farmers and Progressive reformers who shared asomewhat different social policy vision and precluded the emergence of labor as an independent and organizedpolitical force. Social policies developed piecemeal, starting with pensions for Union War veterans, andallowed the rise of private insurance provision through fraternal organizations and mutual aid societies.

3.2 CORPORATIST ORIGINS3.2 CORPORATIST ORIGINS

In central Europe, the scarce factor was labor, or morespecifically, skilled labor. Labor was highly organized andradicalized in the industrial cores of many Europeancountries. The unification of Germany was forged underBismarck’s coalition of “iron and rye” -- Ruhr industrialists(Capital) and Prussian Junkers (Land). In Japan, the MeijiRestoration was accomplished by an alliance of Osakamerchants (Capital) and Samurai / Imperial landlords(Land). In Italy, Piedmont-Lombard industrialists teamedup with Southern agricultural landlords held power duringthis period. To a lesser extent, these political coalitionsappeared in Latin America’s Southern Cone (Argentina &Brazil) with similar consequences. These politicalconstellations gave social policy a decidedly conservativecharacter. Many social welfare functions were left in the

hands of religious and family institutions. It is also not accidental that many of these regimes lapsed intoFascism during the interwar period. However, they all faced powerful and rising trade-union movements andworker’s parties that challenged the status quo. Many of the social reforms, such as Bismarck’s social insurance(mimicked by Giolitti in Italy and Hara Kei in Japan) policies, were passed as measures by conservative

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political elites to co-opt or appease political pressures created by these movements. Division between thepolitical and revolutionary wings of Socialist movements meant that they expanded their influence in both theworkplace and the public sphere. As labor evolved into “status quo” political force, they were oftenincorporated into shared power arrangements that gave labor organizations a voice and role in politicaldecisions, but also preserved prerogatives and interests of conservative social and economic groups.

3.3 SOCIAL DEMOCRATIC ORIGINS3.3 SOCIAL DEMOCRATIC ORIGINS

In the countries that developed into Social Democraticwelfare states, the scarce capital was often land. As smallisland nations (England) or near-Arctic climates(Scandinavia), arable land was in short supply, especiallyafter the population explosion attending the onset of theIndustrial Revolution. This land was often in the control ofaristocratic landlords who lived off the agricultural rents oftheir estates. These nobles often had disproportionatepolitical power and influence and used it to maintain theirposition and wealth by pursuing protectionist policiesagainst agricultural products. The debates over the EnglishCorn Laws is an example of these conflicts. High food pricesraise the living costs of industrial workers, created wagepressures that reduced the profit for new industrialcapitalists and entrepreneurs. Therefore, employers andworkers found common cause in opposing the interests of the landed elites. The alliance between the LabourParty and the more bourgeois Liberal Party prior to WWI showed the continued relationship. The unity of“good government” reformers from middle-class and professional backgrounds combined with working classvotes resulted in social policies that were more comprehensive, universal and publically administered than theirLiberal or Corporatist counterparts. Although Labour was a pillar of the governing coalition, it was a juniorpartner, and not the independent and institutionalized agent of workers as it was on the European continent.

While tensions remained between the interests of employers and workers, the political environment oftenmeant that employer concerns were incorporated into the design of policies and the adversarial relationshipfound in other countries is muted. A key aspect of Social Democratic welfare states is that the policies are astatement of social solidarity, a political commitment that all citizens, regardless of merit or means, is entitledto material resources required for a decent life. The passage of the British NHS after WWII reflected the senseof solidarity created by the shared sacrifice in the war effort. Similarly, the passage of welfare policies inScandinavia was intended to ameliorate underlying social conflicts. The “labor peace” and business-laborcollaboration in the WWII war effort in the US also laid the ground for social legislation. As a result, the valueof welfare state policies goes beyond its impact on economic outcomes alone.

4.0 EVALUATING WELFARE STATES: EQUITY vs. EFFICIENCY4.0 EVALUATING WELFARE STATES: EQUITY vs. EFFICIENCY

How well do different types of welfare states perform? It is common to answer this question by looking at theequity (equality) vs. efficiency tradeoff. We can either have economic efficient policies that promote growth andlower unemployment or we can opt for policies that address social ills and inequalities at the cost of economicgrowth. Efficiency can be gauged by looking at measures of income per capita, economic growth,unemployment and exports (as a measure of international competitiveness). Equity can be measured byexamining economic inequality and measures of social ills such as poverty. Sociologist Lane Kenworthy notesthat there are three competing hypotheses about the relationship between equality and efficiency, that can be

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shown in the following diagrams

In the first, there is a direct tradeoff between efficiency and equality: you can have efficiency or you can haveequality, but you cannot have both. The conventional wisdom is that Social Democratic welfare states scorehigh on equality, Liberal welfare states score high on efficiency and Corporatist ones fall somewhere in betweenon both criteria. The second diagram argues that, except at high levels of equality, it has no impact on economicefficiency. Different welfare states may be efficient through different means: Liberal ones through their relianceon market incentives, Corporatist systems by their ability to make “grand bargains” between competinginterests and Social Democratic ones by virtue of greater social solidarity and uniformity. However, the mainpoint is that the choice of welfare state policies is indifferent to economics and is primarily a political and socialstatement of normative values. The third diagram shows the “middle class” thesis that argues both high andlow levels of economic inequality are inconsistent with economic efficiency and growth. The best situation is alarge middle class with small groups of rich and poor reflecting their merits. A large, relatively affluent middleclass is also likely to be politically and economically moderate, balancing competing social and economicpriorities. There is evidence for all these positions. The chart below shows the performance of individualcountries on a range of economic variables. Simple averages for the welfare state type are in bold italics.

Adapted fromPontusson (2006)

Gini CoefficientDisposable

Income

GDP/CapitaUS$ at PPP

(2002)

Real GDP/CapitaGrowth

1960-1980

Real GDP/CapitaGrowth

1980-2000

ExportsPercent of GDP

AverageUnemployment

Rate (2000-2003)

AnnualEmployment

Growth1990-2002

LIBERAL .330 29,483 2.5 2.3 40.0 5.6 1.7

Australia .311 28,068 2.5 1.9 22.9 6.4 1.5

Canada .302 30,303 3.2 1.5 45.9 7.3 1.4

Ireland .325 32,646 3.5 4.7 94.9 4.3 3.5

New Zealand 21,783 1.4 1.3 36.7 5.3 2.0

UK .345 27,976 2.0 2.0 28.1 5.1 0.5

USA .368 36,121 2.1 2.1 11.2 5.1 1.2

CORPORATIST .279 27,752 3.3 1.7 48.7 6.3 0.7

Austria .266 28,872 3.7 2.0 50.1 4.0 0.9

Belgium .250 27,716 3.6 2.0 86.3 7.3 0.5

Germany .264 25,947 3.1 1.6 33.7 8.4 -0.2

Netherlands .248 29,009 2.9 1.9 67.2 3.0 2.0

Switzerland .307 29,940 2.1 1.0 46.4 3.2 0.7

France .288 27,217 3.5 1.6 28.7 9.0 0.6

Italy .333 25,568 4.0 1.8 28.4 9.4 0.6

SOC. DEMO. .247 29,624 3.2 2.1 45.1 5.8 0.2

Denmark .236 29,328 2.7 1.7 43.8 4.8 0.2

Finland .247 26,478 3.7 2.4 42.9 9.3 -0.4

Norway .251 35,482 3.7 2.5 46.6 3.9 1.1

Sweden .252 27,209 2.7 1.6 47.2 5.3 -0.5

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The next two charts show the impact on welfare state policies on reducing income equality. The chart to the leftshows the contribution made to reducing inequality from taxes (pre- and post-tax incomes) and transferpayments. The chart to the right shows the level of inequality based on market outcomes and after taxation.The length of the line is the implied impact of welfare state policies on income inequality and the progressivityof the tax code.

4.1 CHANGING VIEWS OF WELFARE STATES4.1 CHANGING VIEWS OF WELFARE STATES

Over time, the expert consensus on the relative merits of different welfare state systems has changeddramatically. In the late 1970s, with the US and UK mired in stagflation, many of the Corporatist welfare states(including Japan) seemed to be more successful due to their ability to moderate wage pressures and respond tointernational competition better due to their ability to negotiate “grand bargains” between labor and business.

In the mid-1990s, with Sweden in the recent aftermath of bank bailouts, Germany sluggish due to their effortsto integrate the economically backward East Germany into the West and high unemployment throughout theEurozone had many Europeans questioning the desirability of their social and labor market policies. Inaddition, the prolonged slump in the 1990s in the relatively generous welfare state of Canada supported thisassessment, along with the post-bubble Japanese economy’s malaise. At the same time, the US seemed tobooming with low unemployment and rapid job growth combined with policies to reform welfare, reducebudget deficits, and liberalize trade and capital markets seemed to be the model economy. The US’ successconvinced several of Europe’s countries, notably Ireland, Iceland and the Baltic States, to adopt their ownversions of America’s “neo-liberal” policies, while some Social Democratic countries to “right-size” theirgenerous social welfare policies and reduce tax burdens.

If we scan the landscape today in the wake of the 2008 global financial crisis, we may take a differentperspective. The Social Democratic welfare states have weathered the crisis quite well, despite the problems ofthe Eurozone’s periphery. While the US has not been the worst performer, renewed concerns about growinginequality, slowing economic mobility, high unemployment, growing public debt, and rising poverty call intoquestion many of the reputed advantages of the American model. Meanwhile, most of continental Europe isfacing critical choices about whether to revise or reaffirm their social contract. This review of history is notintended to show that any past judgment was right or wrong, but should remind us to be circumspect in ourjudgments about the future of these policies in all countries.

One should also be careful about one-to-one comparisons across welfare states because different countriesaccomplish the same social welfare goals using different methods, policies and institutions. This is especially

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important when looking at their impact of public finances. A country that relies heavily on tax expendituresand the tax code, like the United States, may understate the total cost of social welfare policies. They areinvisible because they are only foregone revenue with respect to budget balances. The prime examples of thisare the EITC and the exemption of employer-based health insurance from taxation. In addition, while notordinarily counted as a “welfare” policy, education expenditures promote economic mobility. If publicspending on education is included, the size of the American welfare state rivals Europe’s largest. Anotherexample with the Corporatist regimes is that many social welfare functions are delegated to private or semi-public entities and do not show up on the public fisc. A prominent example is Germany’s “job-sharing”program that encourages workers to work less to maintain higher employment. Part of the cost is carried byprivate actors and so its real cost is not reflected in public budgets. When making comparisons, one shouldstrive to make “apples-to-apples” comparisons as much as possible.

5.0 THE FUTURE OF THE WELFARE STATE5.0 THE FUTURE OF THE WELFARE STATE

Contemporary welfare states face four major challenges in the near future to their sustainability andeffectiveness. Since they differ in how they provide and finance social welfare functions, these challenges affectdifferent systems differently. However, all welfare states face choices about their economic viability and thenature of their social contract. This final section will describe the four major challenges to the welfare state anddiscuss how they may interact with different welfare states.

The Globalization Challenge. One of the great economic risks is foreign competition and exposure to foreigntrade has historically been one of the risks that social insurance and welfare policies protect their citizensagainst. Countries with more exposure to international markets tend to have higher social spending than theirless exposed counterparts. However, the rise of the international marketplace through developments intransportation and communication infrastructure combined with the expansion of free trade has put workersin developed nations in direct competition with cheaper labor in developing countries. As a result, critics arguethat developed nations must work to reduce labor costs either by lowering wage or eliminating benefits. Thechart below shows the average hourly compensation forcountries around the world. Many workers in Europe’sSocial Democratic and Corporatist welfare states enjoysome of the highest hourly compensation levels in theworld. In addition, some hold that labor markets should bederegulated and workers’ protection to make companiesmore flexible to deal with international competition. Thismay present a particular problem for welfare states that relyheavily on employers to provide or finance the cost of socialwelfare, such as private pensions, healthcare, and health,safety, and labor market regulations. This may pose aparticular problem to large Corporatist welfare statesbecause it may undermine the power and membership oflabor unions. If labor unions weaken, they may become lesseffective advocates for policies protecting workers, a criticalfunction in Corporatist systems. In small economies,employers and workers may be “in the same boat” withrespect to foreign competition and corporatist institutionsmay help them realize their mutual self interest. However,in larger economies, global competition with low cost labormay undermine unions where employers and workers mayhave less of a common interest. The “luxury” of the welfarestate might not survive global competition.

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The Tax Arbitrage Challenge. Oneconsequence of globalization is greater capitalmobility for firms and high wealthindividuals. In the past, they may have had noalternative to accepting high progressive taxrates on corporate and individual income.However, greater capital mobility allowscorporations and individuals to pursuepolicies of tax avoidance by moving capital tolow tax jurisdictions. This create twoproblems for welfare state policies. First, hightax welfare states, such as the SocialDemocratic welfare states of Scandinavia,may be less able to finance welfare policiesthat operate through public budgets becausethey may face difficulties collecting taxes atthe highest marginal rates. Corporations maychoose to relocate production and jobs tolower tax locales and individuals may shieldtheir wealth in offshore tax havens, deprivinggovernments of revenue. Second, the mobilityof capital may shift the burden of taxation from capital to labor, taking advantage of the lower mobility oflabor relative to capital. This means that workers may be net losers because even if they maintain their socialwelfare benefits, they will be doing so at a higher individual cost to themselves. Welfare states that are lessreliant on tax revenues because they operate through regulation or provision through private or semi-publicinstitutions may be less affected by this challenge.

The Demographic Challenge. Most every advanced industrial society faces the challenge of aging societies. Assome people live longer and birth rates fall further belowreplacement, the population will age. The key statistic here is thedependency ratio, which is the number of individuals (mostly theelderly and the young) who depend on the working age populationto support them, often through social welfare policies. As the graphto the right shows, the dependency ratio for most developed nationsis expected to double over the next half century. Since socialprograms for the aged depend on taxing incomes of individuals inthe workforce, a higher dependency ratio may make financing theseprograms in the future difficult. Countries may decide to reducethe generosity of these programs, raise retirement ages to reducepayouts, or raise taxes on current workers, creating disincentives forwork. One possible solution to the demographic challenge is toliberalize immigration policies to allow more young immigrantsfrom developing nations to work legally in advanced economies andthereby increasing the size of the workforce. However, immigrantworkers might undercut labor unions and worker’s wages. Some

European welfare states have responded to this problem by implementing pro-natalist policies, such as longermaternity leaves, income maintenance, and childcare initiatives that provide incentives to bear and raise morechildren and slow the aging of population.

The Immigration Challenge. The final challenge to European welfare states is the impact that immigration may

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portend for social solidarity necessary to supportwelfare states. Although some countries areencouraging migration to address thedemographic challenge, increased immigrationand larger foreign-born populations may have twonegative impacts on social welfare programs. First,many welfare states have enjoyed homogeneouspopulations, which facilitate redistributive welfareprograms because of the perception that therecipients are “people just like me” makes themmore acceptable and legitimate in the public’s eye.Second, there is the -- often incorrect -- perceptionthat immigrants “free ride” and benefit fromsocial welfare systems without making a faircontribution to its maintenance. These views maymake welfare programs less palatable andsustainable politically. This development mayprove to be a particularly thorny problem for theScandinavian welfare states both due to theirgenerosity, their pride in their social tolerance,and their relatively homogeneous societies until present. As the recent Breivik massacre in Norway suggests,these tensions may undermine the social and political consensus necessary to sustain welfare state programsand institutions.