The effect of openness on welfare state generosity - an empirical analysis of 18 OECD-countries 1970-2000
Author: Nina Lillelien, ESOP Student Scholarship Recipient 2008.
This thesis investigates the impact of economic integration, or openness, on welfare state generosity. I provide an overview of the development of Western welfare states and describe two competing hypotheses on how national governments react to openness in terms of welfare provision. The compensation hypothesis states that increased openness means higher risk for citizens and thus a demand for higher welfare state generosity, the focus of the efficiency hypothesis is that both welfare migration and the assumption that countries will have to alter of tax rates in order to attract mobile tax bases both will put downward pressure on welfare generosity. The contribution of this thesis is empirical. To motivate the empirical exercise, I present a simple theory for how increased economic integration affects welfare states through tax competition. I also discuss different ways of defining welfare state generosity and how to choose the measure that captures the essential characteristics of the welfare system, while at the same time being easy to compare among countries in empirical research. Earlier studies have found conflicting evidence on the subject. There might be several reasons for this: particularly, the results may depend on the choice of welfare measure, the explanatory variable or choice of econometric method. Here, using Stata 9.0, the effect of economic integration is estimated utilizing international trade as proxy for openness on several welfare variables for an unbalanced panel of 18 OECD-countries over the years 1970-2000. I conduct the analysis by using fixed effects regression and find evidence in favor of the efficiency hypothesis. This result is robust to several sensitivity analyses.