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The Limits of Social Spending as a Driver of Economic Equality

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10/30/2019

In the history of the development of the concept of equality, it has traditionally been understood as equality of individual rights before the law. Great minds from antiquity to modernity gradually created what are probably the most significant of man’s doctrines — equality and freedom — which became the basis of public order and justice in developed societies. 

However, followers of egalitarianism argue that people are not entirely free unless economic equality exists in society. Using some perverse logic, they made a quantum leap from the concept of equality of individual rights before the law to universal economic justice. Economic justice is habitually understood to be the equality of income among members of society. Libertarian scholars who have identified “human actions” as the main engine of economic development most adequately indicated the futility and danger of such an intent.

Murray Rothbard, in his book Power and the Market (1970), asserts “that equality cannot be achieved because it is a conceptually impossible goal for man, by virtue of his necessary dispersion in location and diversity among individuals.” Scientists in the field of evolutionary genetics have long ago emancipated themselves from the anathema of eugenics and biological determinism, explaining the diversity of traits and human actions as the interplay of innate nature and nurture.

Each born person is not only genetically unique but also exposed to heterogeneous environments in its development, not excluding random factors, of course. This, in turn, leads to a unique set of skills and a specific place in the division of labor. Therefore, it is impossible to achieve either equal opportunities or equal rewards for various economic actions. One might think that this state of affairs is regrettable, but this is the price that humanity pays for being an intelligent and complex creature and not a single-celled bacterium. Only among primitive life forms can equality akin to communism be achieved, not in human society.

Proponents of egalitarianism believe that the idea of income equality is noble, and its implementation results in an organization with higher moral qualities. The irony is that compulsory equality leads to the economic and moral degradation of society. History shows that social experiments undertaken by collectivists of all kinds have failed to achieve the desired result. Centralized distribution of income, universal leveling (excluding elites), and decoupling of remuneration from efforts led to the suppression of incentive, reduced economic efficiency, increased corruption, and illegal dealings. The attempt to gain equality for a mass population was made by arriving at the least common denominator of living standards. Borrowing the terminology from physics, one could say that economically and morally, collectivist societies are at a lower energy level than individualistic ones and are characterized by a state of equal misery.

It would seem that theoretical conclusions, reinforced by the lessons of history, should put an end to a futile attempt to achieve compulsory economic equality; alas, the world bureaucracy and the left academy are still trying to do the impossible. The redistribution of welfare through a generous social policy is the chief conductor of the modern left in the goal of achieving socialism. Over the course of the 20th century, wealth redistribution has converted from a purely abstract and political slogan into a crucial economic category. Economists of the International Monetary Fund (IMF), United Nations (UN), the Organization for Economic Cooperation and Development (OECD), and other international institutions calculate different indexes that are supposed to describe economic inequality within societies. The most popular is the Gini index, which is selected as an official measurement of inequality for OECD countries.

The Gini coefficient measures the difference between the levels of an income frequency distribution. It has two theoretical values of 1 and 0; a Gini coefficient of 1 expresses a situation of total inequality, where one person consumes all income while the rest of the population has nothing. A Gini coefficient of 0 describes perfect equality, where everyone has the same income.

The OECD has developed a Social Expenditure Database (SOCX) that provides internationally comparable statistics on social spending that covers 36 countries for the period of 1980–2015/16 and estimates for 2016–2018. It is reasoned that the actual level of government social spending can be more adequately evaluated if one is accounting for the full effects of the tax system. SOCX delivers "total net social spending" value in % of GDP that "takes into account public and private social expenditure, and also include the effect of direct taxes (income tax and social security contributions), indirect taxation of consumption on cash benefits as well as tax breaks for social purposes."

[RELATED: "'Social Expenditures' In the US Are Higher Than All Other OECD Countries, Except France" by Ryan McMaken]

It would be logical to analyze how social spending affects economic inequality. The figure below shows the latest data on social expenditure in %GDP and Gini coefficient (post-tax) for OECD countries. The first thing that catches your eye is that there are three distinct outliers: countries that have minimal social spending. There are two schools of thought on how to deal with outliers. The first suggests excluding them from the model and analyzing them individually. If one follows this logic, then it is found that there is no correlation between the magnitude of public spending and economic inequality whatsoever. Thus, the Gini coefficient is inert with respect to changes in social expenditure, and it depends on some other factors.

The second school of thought suggests including outliers in the model if they are not measurement errors. In this case, there is a slight negative correlation between spending and the Gini coefficient. If we assume that, in this particular case, correlation indeed implies causation, it means that an increase in social expenditure might lead to a decrease in economic disparity. As presented in the figure, quadratic regression achieves the best fit to empirical observations; however, only 44.6% of the variation in the response is explained by the model.

gindler1.PNG

The quadratic regression is a remarkable function that is characterized by the inflection point. At this data point, the value of economic inequality is minimal. The regression line reaches its minimum at 22.74% of GDP spending, which corresponds to the Gini coefficient of 0.29. The function descends before reaching an inflection point, meaning that, on average, an increase of social spending leads to a decrease in economic inequality. However, the function begins to ascend after an inflection point, which suggests that an increase in social spending results in a rise in economic inequality.

The lines passing through the inflection point divide the graph into four quadrants. Countries in the upper left corner are characterized by low social spending and high inequality. As they are located on a descending part of the curve, it is plausible to suggest that an increase in spending could result in a better Gini coefficient. Countries in the bottom left quadrant exhibit higher social expenditure and almost optimal inequality indexes. The bottom right quadrant unites countries that achieve low inequality by utilizing excessive social spending. Countries in the upper right quadrant are characterized by wasteful expenditure that does not benefit the cause of diminishing inequality. The latter result is entirely unexpected for the adherents of a constant increase in social benefits. This case is especially compelling, as it includes such world economic powerhouses as the United States, Japan, and the United Kingdom.

If we look at the dynamics of changes in social expenditure and inequality in the United States from 2004 till 2017, we can see the following picture. Social spending increased by 17.7%, but at the same time, economic inequality did not decrease but on the contrary, rose by 8.3%. How to make sense of the phenomenon?

First of all, economics is not a zero-sum game in which one person’s gain is another person’s loss. It is instead a positive-sum game. In a positive-sum game, all participants are engaged in mutually-beneficial relations, which leads to the production of additional wealth. The extra wealth is created by people actively taking part in the economy. Recipients of social programs are more free to not participate in the creation of new value for various reasons. The longer a person is alienated from productive work and other wealth-creating activities, the more his share in cumulative wealth diminishes compared to that of an active member of the market. Moreover, excessive social spending stimulates some people to stay away from real jobs and become dependent on societal generosity. Excessive and long-term social programs become ineffective because they exclude people from active production and exchange, that is, cut them off from the proportionally more significant portion of cumulative wealth. Rothbard points out that such a situation “is likely to freeze the economy into a mold of (non-productive) inequality.”

Therefore, economic equality is a senseless idea. It is a dream that cannot be reached, but efforts to achieve it can lead to rather adverse consequences. At the same time, economic inequality either does not depend on the magnitude of social spending or responds to it mysteriously. An increase in social expenditure might slightly reduce economic disparity; however, the effect of spending declines and becomes marginal at higher levels of spending. Or, as in the case of countries in the upper-right corner, it might lead to an increased level of disparity.

Author:

Allen Gindler

Allen Gindler is a scholar from the former U.S.S.R., specializing in Political Economy, Econometrics, and Industrial Engineering. He taught Economic Cybernetics, Standard Data Systems, and Computer-Aided Work Design in the Khmelnytskyi National University, Ukraine. He is currently a private consultant to IT industry on Database Administration and Cryptography. As a hobby, he is interested in political philosophy, history, population genetics, and Biblical archaeology. He has published articles and opinion pieces in Mises Wire, American Thinker, Foundation for Economic Education, and Biblical Archaeology Review.

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