A New Paradigm for Social Welfare in the New Millennium

A New Paradigm for Social Welfare in the New Millennium

edited by Lee-Jay Cho, Hyungpyo Moon, Yoon Hyung Kim, and Sang-Hyop Lee

Korea Development Institute

The Korea Development Institute (KDI) is an autonomous policy-oriented research organization founded in 1971. KDI was established by the Korean government as an economic think tank to provide a rigorous academic perspective on the various economic policy issues that had arisen during Korea’s rapid growth and development in the 1960s. Since then, the scope of KDI’s activities has grown, and it is now called upon to provide expert analysis and advice on all aspects of long- and short-term government policies in areas ranging from domestic economic policy to international trade and investment. In addition, KDI has played an increasingly important role in promoting international economic cooperation. By sponsoring international forums on development and maintaining close links with research organizations and individual scholars all over the globe, KDI helps to strengthen ties between Korea and the rest of the world.

© November 2005 Korea Development Institute 207-41, Cheongnyangni-dong, Dongdaemun-gu P.O. Box 113, Cheongnyang Seoul, Korea ISBN 89-8063-228-2 93320

Contents List of Figures List of Tables List of Boxes Contributors Preface Introduction and Overview Lee-Jay Cho and Sang-Hyop Lee

viii ix xi xii xiii xv

Part I. A New Paradigm for Social Welfare 1. The Political Economy of Welfare Reform in the United Kingdom Meghnad Desai Introduction The British Welfare State Financial Crisis and the State Criticisms of the Welfare State The Quest for a New Welfare State The Conservative Solution: Containing the Welfare State, 1979–97 Conclusion 2. Welfare Reform in the United States Robert Haveman and John Karl Scholz The Structure of the Social Safety Net in the United States Prior to Reform Social Insurance Programs in the United States Means-Tested Transfer Programs in the United States Public Expenditures on Safety Net Programs The Reform of Safety Net Policy in the 1990s The 1996 Welfare Reform Act (PRWORA/TANF) PRWORA/TANF: The 1996 Legislation Emerging Models for Assistance to Needy Families The Future of TANF Making Work Pay: The Effects of the Earned Income Tax Credit The EITC and Other Countries Is the U.S. System of EITC and TANF a Model for Other Nations? 3. Productive Welfare: Welfare of Korea Woo Hyun Cho Introduction Productive Welfare: Concept, Context, and Vision Concept Background of Productive Welfare Vision of Korea’s Productive Welfare

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3 3 4 7 8 11 13 21 25 25 26 27 29 30 35 36 37 41 42 44 45 55 55 55 55 56 59

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Contents Social Assistance System Implementation of Basic Livelihood Security Program Recommendations Labor Market Policies Overview of Unemployment Measures Recommendations Social Insurance System Strengthening the Social Insurance System Recommendations Direct Market Intervention versus Indirect Subsidy Direct Government Intervention in the Labor Market Indirect Government Support Concluding Remarks COMMENTS Dae Il Kim Hyungpyo Moon Alejandra Cox Edwards

62 62 64 66 66 68 72 72 78 80 80 81 83 89 93 96

Part II. Labor Market Policy 4. Overcoming Labor Market Challenges in the U.S.A. Alejandra Cox Edwards Introduction Implications of Labor Market Challenges on Economic Growth and Social Welfare Increased Demand for Skills Main Explanations: Technological Change, International Trade, and Institutions Technology and the Rising Importance of the Services Sector Balance of Labor Market Flexibility and Social Protection Unemployment Insurance: Key Aspects of Its Design Federal, State, and Local Minimum Wage Policy Policy Measures Taken to Overcome Labor Market Challenges Economic Dislocation and Worker Adjustment Assistance Program Trade Adjustment Assistance Program NAFTA Transitional Adjustment Assistance Program Health Benefits under the Consolidated Omnibus Budget Reconciliation Act Education and Training Effectiveness of Government Training Programs: Importance of Evaluation Efforts Comparing Earnings of Trainees before and after the Program Randomized Experiments: Differences in Differences Matching Samples The Case of GAIN in California Suggestions for Experience Sharing

103 103 104 104 105 106 111 112 114 118 119 119 120 121 121 122 122 122 123 123 124

Contents 5. Labor Market Changes in Korea since the 1997 Crisis Dae Il Kim and Gyeongjoon Yoo Introduction Policy Responses to the Crisis and the Environment Redundancy Layoff and Tripartite Agreement Temporary Work Agency and Replacement Workers Reducing Unemployment Social Safety Net Changes in the Labor Market Changes in Employment Unemployment and Underemployment Wages and Inequality Nature of Job Growth and Unemployment Revisited Job Losses and Gains Changes in Behavior and Implications on Unemployment Labor Demand and Unions Shift in Labor Demand Labor Unions Concluding Remarks: Lessons and Remaining Issues Data Appendix COMMENTS John Karl Scholz

v 131 131 133 133 136 136 138 138 139 142 147 153 153 161 164 164 166 170 172 181

Part III. Pension Reform 6. Aging and Old-Age Support Systems: Issues and Reforms Sang-Hyop Lee and Andrew Mason Old-Age Support Systems Family Support Systems The Current Situation The Future of Family Support Systems The Advantages and Disadvantages of Family Support Systems Labor and Retirement Policies Saving and Old-Age Support Are Saving Rates Adequate? Saving and Public Policy Public Programs Reform Issues The U.S. Support System Social Security and Reform Proposal Conclusion 7. The Korean Pension System: Current State and Tasks Ahead Hyungpyo Moon and Youngsun Koh Introduction Current State and Problems of the Old-Age Income Security System

187 187 190 191 194 195 197 202 203 206 208 212 218 219 222 229 229 230

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Contents Public Pension Schemes Retirement Allowance Scheme and Corporate Pension Schemes Personal Pension Schemes Tasks for Reform of the Old-Age Income Security System Restructuring Public Pension Schemes Promoting Corporate Pensions and Linking Them to the National Pension Private Management of the Pension Reserve Fund Conclusion COMMENTS Hyehoon Lee Sean Nicholson

230 242 244 245 245 248 253 254 258 260

Part IV. Health Care Reform 8. Public Policy and Health Care Expenditures Sean Nicholson and Barbara Wolfe Introduction Expenditures and Growth in Expenditures Market Failures Growth in U.S. Expenditures: The Tie to Insurance Coverage Coverage: Private Coverage: Public The Lack of Coverage International Differences in Health Policies Health Care System in Singapore China’s Experiment with Medical Savings Accounts Pros and Cons of Medical Savings Accounts Reimbursement Reform in the U.S. Medicare Program U.S. Managed Care: Supply-Side Controls on Utilization of Medical Services Defined Contribution Insurance: The Future of Health Insurance? 9. Containing Health Care Expenditures in Korea: Issues and Strategies Hyehoon Lee Introduction Health Care Expenditures in Korea Level of Health Expenditures Trends in Health Expenditures Analyzing Components of Health Care Expenditures in Korea Quantity Changes Price Changes Decomposition Analysis of Health Care Expenditures Main Reasons behind Rising Health Expenditures in Korea Pervasion of National Health Insurance

265 265 265 270 272 273 273 274 274 277 280 282 284 285 287 291 291 292 293 297 300 300 301 302 304 304

Contents Fee-for Service Payment System Structural Changes in Population: Aging Policy Measures to Contain Health Expenditures in Korea Reforming the Payment System Restructuring the Cost-Sharing Scheme Concluding Remarks COMMENTS Youngsun Koh Gerard Russo Part V. Major Findings and Policy Implications COMMENTS Alejandra Cox Edwards Jin Soon Lee Andrew Mason John Karl Scholz

vii 309 311 312 313 317 318 323 325

335 337 339 341

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List of Figures

List of Figures 2.1. 2.2. 2.3. 2.4. 2.5. 3.1. 3.2. 4.1. 4.2. 4.3. 4.4. 5.1. 5.2. 5.3. 5.4. 5.5a. 5.5b. 5.5c. 5.6. 5.7. 5.8. 6.1. 6.2. 7.1. 8.1. 8.2. 8.3. 8.4. 8.5. 8.6. 9.1. 9.2. 9.3. 9.4. 9.5. 9.6. 9.7. 9.8. 9.9.

Total social insurance, cash, and in-kind means-tested transfers Public attitudes on welfare and assistance to the poor: GSS data Child, elderly, and aggregate poverty rates, 1959–98 Percent of children in single-parent families, 1960–98 Annual income-earnings relationship facing a typical family on AFDC as they shift into the labor force Path of productive welfare in Korea Local community technology center as a local network of NGOs, local government, and businesses U.S. labor market: 1948–2000 Nonfarm payroll, private industry Work schedules in the United States: 1997 Federal minimum wage (hourly), 1982 dollars Changes in employment and unemployment Nominal wages Job gains, losses, and net job gains during the economic crisis Effect of net job growth on unemployment Entry into unemployment: From nonparticipation (new entry) Entry into unemployment: From employment (job loss) Entry into unemployment: From unemployment (continued search) Actual and predicted unemployment Share of four-year college graduates by age in 1999 Share of college enrollment among those 20–24 years old Savings rate, pseudo-Taiwan, 1900–2050 Replacement rates of workers with forty-year careers who invest in U.S. stock market and retire over period 1912–97 Corporate pensions’ opt-out case (forty years of contribution) Total expenditures on health: Japan, Korea, UK, and USA Relationship between 1990 level and 1990–98 growth rate in per capita health spending China’s 1995 experiment with MSAs in two cities Supply-side control in U.S. health maintenance organizations Impact of U.S. managed care on U.S. medical expenditures Defined contribution model of health insurance (example: Vivius) Health spending and GDP in OECD countries Nominal health expenditure and GDP growth Real health expenditure and GDP growth GDP shares devoted to health expenditure Growth rates of population and health care utilization Overall consumer price and medical care price index Changes in financing sources for health care expenditures Out-of-pocket expenditure Per capita health care expenditures at different ages

29 30 31 32 33 61 69 103 104 108 114 139 147 154 157 162 162 162 164 166 167 205 217 252 268 276 280 281 286 287 295 297 299 299 300 302 307 307 311

List of Tables

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List of Tables 2.1. 3.1. 3.2. 3.3. 3.4. 3.5. 3.6. 3.7. 3.8. 3.9. 3.10. 3.11. 3.12. 3.13. 3.14. 3.15. 3.16. C.1. 4.1. 4.2. 4.3. 4.4. 4.5. 4.6. 4.7. 5.1. 5.2. 5.3. 5.4. 5.5. 5.6. 5.7. 5.8. 5.9. 5.10. 5.11. 5.12. 5.13.

Earned Income Tax Credit parameters, 1979–99 Unemployment trend Income inequality trend Public social expenditure in OECD countries, 1980–97 Ratio of social expenditure to GDP at per capita income level of U.S. $10,000 Minimum cost of living for year 2000 Composition of clients on cash assistance Trend of social expenditure Government budget for unemployment measures as a percentage of GDP Budget for protection of the unemployed and the social safety net Social insurance coverage Legal social insurance premium Relative salary and the income replacement rate of a 40-year subscriber Medical insurance balance Increasing trend of social expenditure by businesses High school graduates entering universities/technical colleges (1964–99) Tuition support for students from low-income families Poverty lines and minimum wages in the U.S. and Korea Change in real weekly wages for full-time workers, 1963–95 Health and pension coverage by type of work arrangement, 1999 Wage and salary workers paid hourly with earnings at or below the prevailing federal minimum wage by selected characteristics Coverage of the Unemployment Insurance system Trade Adjustment Assistance program, 1995 NAFTA–TAA Program, 1995 Per-month rotation rates by sector Selected macroindicators since the 1997 crisis List of unemployment and poverty policies Changes in sectoral employment Demographic changes in employment Demographic changes in unemployment Length of completed unemployment spells Job composition and work hours Nominal wages and growth rates Various wage premiums Percent changes in income and expenditure by income decile Percent changes in per capita consumption by consumption decile Demographic distribution in job gain, losses, and net gains Net job gains by sectors and employment types

28 57 57 60 61 62 63 64 66 67 72 73 75 77 79 82 83 94 104 111 115 118 120 120 125 132 134 140 142 143 144 146 148 149 151 152 155 156

x 5.14. 5.15. 5.16. 6.1. 6.2. 6.3. 6.4. 6.5. 6.6. 6.7. 6.8 6.9. 7.1. 7.2. 7.3. 7.4. 7.5. 7.6. 7.7. 7.8. 7.9. 7.10. 7.11. 7.12. 7.13. 8.1. 8.2. 8.3. 8.4. 8.5. 8.6. 8.7. 9.1. 9.2. 9.3. 9.4. 9.5. 9.6.

List of Tables Comparison of emerging and disappearing job quality Changes in sectoral unemployment through net job gains Estimated demand index by gender/education groups Summary measures of aging for Asia and major regions of the world Support systems Average retirement age among men, OECD countries 1950–95 Statutory retirement age Characteristics of a pre-transition and post-transition population Coverage of schemes providing cash benefits to the aged, disabled, and/or survivals Percentages of social security expenditure and tax revenue, selected years Percentage of old-age benefit and other social security expenditure in GDP, circa 1993 Income replacement rates during retirement Financial trends of the National Pension Scheme Financial prospects of the National Pension Scheme Financial trends of the Government Employees Pension Scheme Financial prospects of the Government Employees Pension Scheme Financial trends of the Private Schoolteachers Pension Scheme Financial prospects of the Private Schoolteachers Pension Scheme Financial trends of the Military Personnel Pension Scheme Korea’s public pension schemes Average income of participants in the NPS by type, 1999 Current state of participation in the NPS (as of February 2000) Current state of retirement allowance beneficiaries Retirement insurance vs. corporate pension Opt-out systems in other countries Total expenditures on health Total per capita health expenditure, 1990–98 Total health expenditures as a percent of gross domestic product, 1990–98 Health expenditures in the United States, 1960–98 International differences in incentives affecting medical technological change Singapore’s method of financing medical care Impact of the Balanced Budget Act of 1997 on Medicare expenditures by type of service Total expenditures on health care in GDP Health care expenditure in GDP Real Health care expenditures in Korea Nominal health care expenditures in Korea Per capita utilization by health insurance types Per claim cost of health care services

158 160 165 188 189 199 201 204 209 210 211 220 231 232 233 234 235 236 237 238 239 240 242 243 250 266 267 269 272 275 277 284 294 296 298 298 301 302

List of Tables 9.7. 9.8. 9.9. 9.10. 9.11. 9.12. 9.13. 9.14. 9.15. 9.16. 9.17. 9.18.

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Per claim expenditures of the population over age 65 to those under 65 Decomposition analysis results Health care expenditures by financing sources Caesarean section ratio Distribution of Caesarean section ratios Aging trends and prospects in Korea Aging trends around the world Pilot program of DRG–based payment system Performance of DRG–based payment system: Evidence from a pilot program Cost sharing in national health insurance Out-of-pocket expenditure for large-sum health care services Major indicators of health expenditure before and after implementation of small-sum out-of-pocket payment scheme

303 304 306 309 310 311 312 314 315 317 318 318

List of Boxes 7.1. 7.2.

Retirement allowance schemes in other countries Structural reform proposals by the National Pension Reform Board (1997)

241 245

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Contributors

Contributors Lee-Jay Cho. Senior Adviser, East-West Center, Honolulu, and Chairman, Northeast Asia Economic Forum. Woo Hyun Cho. Professor, Department of Economics, Soong Sil University, Seoul, Korea, and former Member of the Presidential Commission on Policy Planning. Meghnad Desai. The London School of Economics and Political Science, United Kingdom. Alejandra Cox Edwards. Professor, Department of Economics, California State University-Long Beach. Robert Haveman. John Bascom Professor, Department of Economics, La Follette Institute of Public Affairs, and Institute for Research on Poverty, University of Wisconsin-Madison. Dae Il Kim. Associate Professor, Department of Economics, Seoul National University, Korea. Youngsun Koh. Senior Research Fellow, Korea Development Institute, Seoul. Hyehoon Lee. Former Research Fellow, Korea Development Institute, Seoul. Jin Soon Lee. Former President, Korea Development Institute, Seoul. Sang-Hyop Lee. Assistant Professor, Department of Economics, University of Hawaii at Manoa, and Adjunct Fellow, East-West Center, Honolulu. Andrew Mason. Professor, Department of Economics, University of Hawaii at Manoa, and Senior Fellow, East-West Center, Honolulu. Hyungpyo Moon. Senior Research Fellow, Korea Development Institute, Seoul. Sean Nicholson. Assistant Professor, Department of Policy Analysis and Management, Cornell University. Gerard Russo. Associate Professor, Department of Economics, University of Hawaii at Manoa, and Adjunct Fellow, East-West Center, Honolulu. John Karl Scholz. Professor, Department of Economics and Director, Institute for Research on Poverty, University of Wisconsin-Madison. Barbara Wolfe. Professor, University of Wisconsin-Madison. Gyeongjoon Yoo. Research Fellow, Korea Development Institute, Seoul.

Preface

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Preface

Since the outbreak of the economic crisis in mid-1997, many East Asian countries have suffered deleterious social consequences: rapidly expanding unemployment, declining wages and income, growing absolute poverty, worsening income distribution, and increasing educational and health risks. Even after the affected economies began to recover, social impacts have continued to be felt. Social problems such as unemployment and inequality will require a longer time frame to be resolved. Having a relatively poor social safety net, East Asian countries lack a well-functioning buffer to absorb economic shocks and thereby mitigate detrimental social consequences. The East Asian economic crisis and its effects have highlighted the importance of a social safety net. On the other hand, the new millennium will be characterized by knowledge-based economies, globalization, and aging populations. As knowledge embedded in human capital becomes a more crucial determinant of employability, the position of the less educated and the elderly in the labor market will deteriorate in terms of employment, pay, and working conditions. As East Asian economies are more rapidly incorporated into the global economy, international mobility of labor as well as capital across borders also increases and thereby exacerbates the labor market conditions of the disadvantaged. With the accelerating trend toward globalization and an aging population, a crucial challenge in the new millennium will be to construct a more efficient and sustainable social welfare system that can maximize potential human resource development and promote sound socioeconomic development. As a new paradigm for maximizing the potential of human resources development and sustaining sound socioeconomic development emerges as the basis for successful welfare reform programs in many developed countries, it has become crucial for East Asian economies to cooperate and share their experiences. The best way to maintain economic growth and thereby social welfare itself in an aging economy is to encourage labor forces to stay within the labor market as long as possible. Ironically, experiences in many developed countries show that overly generous social welfare benefits encourage workers to leave the labor market earlier than the normal retirement age. Constructing a social safety net by removing incentive distortions while encouraging maximum productivity will be a crucial challenge in the new millennium. It is therefore important to discuss the experiences of various countries in developing a new welfare paradigm that seeks to improve the quality of life for all people, including the socially marginalized, by encouraging the active economic participation of all people and by assuring a fair distribution of benefits.

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Preface

A conference, organized by the East-West Center and the Korea Development Institute, was held in Honolulu, Hawaii, in 2001 to deal with these imperative issues under the theme “A New Paradigm for Social Welfare in the New Millennium.” Participants discussed the weakness of the current social safety net and the framework to develop a new model of social welfare incorporating recent trends in social and economic conditions. They reaffirmed that the welfare state is facing unprecedented challenges in almost all countries and that a paradigm shift in social welfare is inevitable. They also confirmed that one of the best ways to achieve sustainable and equitable growth is to counter the detrimental impacts of aging on the national economy by keeping as large a working population as possible, and that the new paradigm should be more compatible with labor markets in which labor participation is encouraged for all age groups—particularly the elderly. This volume contains the papers presented at the Honolulu conference, covering the issues of a new welfare paradigm and strategies for such fields as social assistance, labor market policy, pensions, and health care. On publishing this volume, I would like to thank Dr. Lee-Jay Cho, Senior Adviser of the East-West Center, Dr. Sang-Hyop Lee, Assistant Professor, Department of Economics at the University of Hawaii and Adjunct Fellow of the East-West Center, Dr. Hyungpyo Moon, Senior Research Fellow of the Korea Development Institute, and Dr. Yoon Hyung Kim, Professor, Department of Economics at Hankuk University of Foreign Studies and Senior Fellow of the East-West Center for their commitment and hard work in coordinating the conference and preparing this volume for publication. My gratitude goes to Dr. Kennon Breazeale for production coordination and the East-West Center’s graphic and production services, which prepared the cover and book design and brought the book to a cameraready state. I also wish to thank the writers, discussion participants, and others involved in contributing to the success of this conference. Jung Taik Hyun President Korea Development Institute

Introduction and Overview Lee-Jay Cho and Sang-Hyop Lee With the turn of the new millennium, globalization, knowledge-based economies, and population aging have emerged as main economic concepts. These convey several intertwined ideas for social welfare programs. Integration with world markets holds the promise of growth, but it could be a source of worker reallocation and increased inequality. As knowledgeembedded human capital becomes a more crucial determinant of employability around the world, labor market positions for the less educated and the elderly will increasingly deteriorate. Further, the global spread of public health technology has played a key role in worldwide gains in life expectancy and declines in fertility. This same force is leading to population aging, and the needs of the aged now receive priority attention in many countries. The Asian economic crisis has highlighted the importance of reform for social welfare programs in the region. Since the outbreak of the economic crisis in mid-1997, many Asian countries have suffered from its social consequences. Long after the affected economies have recovered, social impacts continue to be felt. Korea may be a good case study of this situation. The nation survived the brunt of the economic crisis but is still faced with numerous socioeconomic problems that emerged during and following the crisis. The most serious problems include the widening gap between the rich and poor, employment instability, and the rising numbers of disadvantaged households and elderly people. These problems call for substantial reform in welfare programs. The demand for government activities to resolve these problems has reached its peak. In this volume, we review reform in welfare programs that provide for the most important of human needs: employment, old-age support, and health care. The underlying premise is that it is how governments reform existing efforts and design new programs that maintains efficiency and equity, further promotes economic growth, and minimizes social conflicts. A new paradigm for maximizing the potential of human resources development and sustaining sound socioeconomic development is emerging as the basis for successful welfare reform programs in many developed countries. Thus it has become crucial for Asian economies to cooperate and share their experiences as well. The book consists of five sections: Part I, A New Paradigm for Social Welfare; Part II, Labor Market Policy; Part III, Pension Reform; Part IV, Health Care Reform; and Part V, Major Findings and Policy Implications. Each section is comprised of two or three papers, one of which is authored by experts from Korea, while others are by those from different countries. This structure allows for dialogue and interaction between primarily Westxv

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Lee-Jay Cho and Sang-Hyop Lee

ern views and those of a newly industrialized economy in Asia. Leading experts in each field provide commentaries following presentation of the main papers in each section. These experts present their views on the significance of the issue under discussion, the major points of contention, and the likely results of social welfare reform, with further suggestions on how the issue may be settled.

New Paradigm for Social Welfare In chapter 1, Meghnad Desai reviews the United Kingdom’s struggle to contain its own welfare system. Containment is being made possible largely because of the synthesis of the views of the Left and the Right on welfare reform. Desai presents the background of welfare in the UK and the principles of reform as offered by the Conservative and Labour governments and provides some lessons. Desai assesses the rise and fall of the Beveridge Welfare State, which began during World War II. The British welfare system had certain guidelines, such as universality of claim, uniformity of provision, and minimum standards. Thus, with the middle classes included as beneficiaries, the system was not as distributional as some would have liked. The system worked well while times were good, but in the early 1970s a host of international economic challenges brought a decline in profitability to the UK and the guidelines became problems. The worst effect was that the private profit-based economy shed employees that were rehired in the public nonprofit-making sector. The loss of surplus generation in the profit-based sector reduced the funds available to finance the welfare state. The author mentions four grounds why the welfare state was criticized: (1) the persistence of poverty, (2) the disincentive to work, (3) discouraging community help, and (4) market distortion. Throughout the period from 1979 to 1997, containment was the goal of the Conservative Party. They achieved reduced expenditures without challenging the logic and structure of the welfare state. The debates between the Conservative, Labour, and New Labour Parties led to a much greater measure of agreement. Desai enumerates the steps taken to achieve containment, such as shifts in the composition of welfare expenditure and reducing the size and scope of entitlements, but he also mentions the new look of welfare: as favors provided by the state, rather than as rights due to the individual. He also recounts the politics of the welfare system and how the party in power must court public favor. Public opinion was gradually changed, and by the end of the Conservative Party years almost no one wished to go back to the “good old days.” The Labour government did not reverse the Conservative government’s modifications to the welfare state. Instead, they rethought the role of the benefit system as a way to encourage people to become employed

Introduction and Overview

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again under changing labor market conditions. Globalization and deindustrialization have completely changed the unemployment situation in the past fifteen years. Unlike the short durations of unemployment in the past, now a person’s periods of unemployment were longer but also more frequent. New job skills were necessary to break into the job market. Thus policies are focused on tax incentives and they enhance the income of the poor going back to work. Desai also refers to working mothers, redistribution, tax concessions, and reinstating the earnings link for state pensions. Finally, Desai suggests that the Labour Party believes in universalism but would also like to alter the distribution pattern. This is only possible with a severely progressive tax system. He reminds us that the welfare-towork program has been largely successful because of the nine-year economic boom through the year 2000. Even so, the budgeting constraints that the welfare system has been working under for the last twenty-five years have started to show some strain. Desai’s statements all seem to say that the system is working. But, he adds, with the restored economy, “oldfashioned ideals” may be back on the table. In chapter 2, Robert Haveman and John Karl Scholz describe and appraise how two entities, the Temporary Assistance for Needy Families (TANF) and the Earned Income Tax Credit (EITC), have been able to change the U.S. social safety net since 1996. From 1936 to 1996, Aid to Families with Dependent Children (AFDC; also known as “welfare”) was the central safety net program for poor families with children in the United States. The authors cite five reasons why Americans have had a longstanding antipathy toward welfare: (1) the persistence of poverty; (2) the disintegration of the family; (3) the disincentive to work; (4) a general cynicism that government programs do not work; and (5) a perception that the young and less educated exhibit counterproductive behavior as recipients of benefits. The 1996 Personal Responsibility Welfare Opportunity Reconciliation Act (PRWORA) abolished AFDC and in its place established TANF, which requires a time limit for benefits, financial incentives to work, and enforcing parental responsibility for their children. The responsibility for TANF is left to the individual states, and the federal government gives block grants to finance state programs as long as these requirements are met. The authors then present the programs in Wisconsin, Minnesota, and Oregon to cite examples the success of which is still being weighed nationwide. Though welfare in general is still under study and no state is ready to do without it, some programs appear promising. The EITC was introduced in 1975 and is the largest federal cash antipoverty program. Targeting provides that over 50 percent of this credit goes to families with below-poverty income. It is based on income, not wages, but nevertheless it seems that 40 percent of payments go to those

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with wages in the bottom 25 percent of all workers with children, with 80 percent of all payments going to workers below the median wage. Most eligible beneficiaries file for benefits, and there is a perceived benefit from working and receiving the credit, even if the particulars are not always understood. The EITC appears to be effective for the low-wage labor market, and it is directed at the family unit. It is linked to U.S. individual income tax, which results in low administrative costs to the government, because most families file taxes anyway. Haveman and Scholz offer some reflections on the question of whether the welfare-to-work approach in the United States holds potential for other nations. First, to the extent that dependence on public transfers is a major problem for many nations, such a change may be attractive. In countries where health care and child care services are already in place, the employment search is just a final phase. Second, for adults with low skills, research has shown that job training in a classroom situation is no more cost effective than just putting these people to work. Third, the advantage of income support through employment is clear: a rise in self-esteem for the individual and a decrease in taxes and employment-related charges for both business and government. Finally, the increased emphasis in the United States on parental responsibility for one’s children as embodied in its child support system is one that other nations are likely to find attractive. This can reduce the need for state provision for the well-being of children and encourage greater involvement of the parent not residing with the child. The authors conclude by noting two additional concerns raised by the U.S. reform. First, because the amount of federal block grant support is fixed under TANF and thus states should bear full costs, there is no incentive for states to expand support. Second, states appear to have no incentive to require and pay for serious evaluation efforts. The authors therefore recommend that any state-authorized programs be rigorously evaluated. In chapter 3, Woo Hyun Cho assesses the “productive welfare policy” in Korea. He evaluates the social assistance, labor market policy, and social insurance systems in turn and offers recommendations. Cho explains the concept of productive welfare and its background. Productive welfare as a policy aims at securing a minimum standard of living for those unable to work, while simultaneously promoting self-support in a market-friendly atmosphere inducing creativity and individuality for those who can work. With Korea’s high unemployment and low economic growth after the outbreak of the financial crisis, there is a need for a more efficient and systematic social safety net. Also, the Korean people are painfully aware of the ever-widening income gap between the wealthy and the poor. Because of the requirements of the information age and globalization, and given the rising age of the labor population, there is an


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increasing demand for more quality and quantity of welfare as well. The author suggests several things for the current major social assistance system, known as the National Basic Livelihood Security Law (NBLS) of 2000. NBLS states that citizens with incomes below the official poverty line shall have the right to ask the state for cash support. He suggests using a classification system for those able to work and denying cash benefits to those not working full time. He also suggests that instead of the benefit rate reduction incurred because of earned income, an earned income credit be introduced. Another recommendation is regional support of job counseling, placement, and a training network to appropriate government bodies. He proposes that a social welfare center evaluation system be implemented that could be accessed and assessed online. Finally, part-time work in the social service sectors could be promoted for the “difficult-to-place” people through cooperative association with local and civic organizations. Cho has three major recommendations for labor market policies targeting the worsening unemployment problem in Korea. He recommends increasing the role of the private sector and local governments by way of private outsourcing of public works projects, deregulating and subsidizing private employment agencies, and building a new infrastructure for job training. Second, he wants a proper incentive structure for people to get back to work or to keep working by utilizing an education account system as people upgrade their learning and skills, by expanding the educational and job-training voucher system for reimbursement, and by publishing a handbook on occupational outlook and employment. Third, he suggests promoting a more flexible labor market through the use of private initiatives. Cho then discusses the social insurance system at length, particularly the Korean National Pension Scheme (NPS) and medical insurance. The author’s first recommendation is to devise ways to make an accurate income assessment of the self-employed. He also suggests that an individual unemployment account be set up to cover nonregular workers and that the government establish an unemployment relief fund for those outside the safety net. Cho’s highest recommendation is for a dual insurance program for both pensions and medical care. The NPS would have two parts: a basic social insurance to cover everyone regardless of income and a supplementary earnings-related pension system to be run by private insurance companies. Concerning medical insurance, minor illnesses would be covered by the individual medical savings accounts (MSAs) and serious illnesses by social medical insurance. By instituting MSAs and converting the employer’s mandated retirement allowance to private pension plans, there would be a much lighter burden on business.

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Labor Market Policy In chapter 4, Alejandra Cox Edwards explains the challenges of the current U.S. labor market and key policy areas affecting labor market dynamics, reviews efforts to change the composition of jobs, and summarizes other labor market interventions. The worsening wage inequality in the U.S. labor market mainly comes from an increasing demand for skilled workers. The unequal wage dispersion between skilled and unskilled workers is more obvious in the upper half of the wage distribution and amongst those working full time. She adds that globalization of the U.S. economy, the decline of labor unions, and the minimum wage may also have affected increasing income dispersion. Another challenge originates from shrinking manufacturing industries’ employment and expanding employment in business services and engineering. The employment shift raises concerns about the quality of jobs, nontraditional forms of employment, and job security in the expanding service sector. In addition to evaluating the current unemployment insurance system and minimum wage, Edwards discusses policies undertaken to combat labor market challenges. The Economic Dislocation and Worker Adjustment Assistance Program (EDWAA), for example, assists workers who have lost their jobs due to plant closures. Job search assistance is offered, as well as retraining and income maintenance. The Trade Adjustment Assistance Program (TAA), and specifically the North American Free Trade Agreement TAA (NAFTA-TAA), is designed to assist workers compromised by loss of employment, fewer hours, or lower wages because of increasing imports to the United States. Currently there is more income support than training and job search, and these two programs service only 1 percent of the total number of unemployed. Edwards also briefly discusses other policies regarding health benefits and education and training—for example, the Consolidated Omnibus Budget Reconciliation Act (COBRA) of 1986, which allows for continuation of health insurance when workers lose a job, and the Workforce Investment Act of 1998 (WIA), which reforms federal job training programs and creates a new, comprehensive workforce investment system building on experience with earlier programs. Edwards also describes various government training programs and presents her evaluation of them. It seems that women benefit more than men and men benefit more than disadvantaged youth from these programs. The “work first” program used in California—which is less expensive per recipient to implement than training programs facilitating human capital acquisition—appears to be very effective initially but loses this advantage over time.


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In conclusion, the author promotes more analysis regarding sector changes in employment and the effect of government training programs. In particular, she warns that highlighting job reductions in one sector or for a particular reason is inherently arbitrary since the vast majority of job separations are offset by job accessions elsewhere in the economy. In chapter 5, Dae Il Kim and Gyeongjoon Yoo examine the Korean labor market during and after the 1997 economic crisis, documenting and comparing the changing patterns of employment, wages, and unemployment, and they comment on lessons and some remaining issues. The paper begins with a look at government policy responses to the crisis that were related to changes in the labor market. The first was the introduction of redundancy layoff, which was an agreement between the International Monetary Fund and the Korean government. Union representatives finally accepted the bill for redundancy layoff, in part because the government promised a generous unemployment package. Unfortunately, large layoffs resulted in serious confrontations as unions complained about unfairness and firms not trying all means to avoid them. Large corporations lost money in the costly procedure and suffered from the no-new-hiring mandate, and joblessness grew. Other policy responses described by the authors include the creation of a temporary work agency, replacement of workers for those on strike within firms, reducing unemployment, and improvement of the social safety net. The authors document the changing patterns of employment and wages. They report in some detail the rapid change in sectoral and demographic patterns of employment, rapid increases in unemployment and underemployment, and worsening income inequality. Kim and Yoo then revisit the crisis period to analyze job growth and unemployment, focusing on the transition of labor market status. The authors note that in addition to the well-documented reduction in regular employment, the economic crisis caused a massive reallocation of workers. Under changes in behavior and implications of unemployment, they discuss evidence that individual behavior has the potential to induce high unemployment based on the interaction of various effects that follow from labor decisions. In an attempt to forecast the future course of the labor market in Korea, Kim and Yoo provide a discussion of the labor market environment and an estimate of the shifts in labor demand. Labor demand has shifted toward women and educated men, and the college premium appears to be a long-term trend. The background history and importance of labor unions in Korea is also provided. The two major impacts of the economic crisis, they say, are growing inequality and what they call the permanent increase in unemployment. Inequality will grow as the economy becomes ever more knowledge based and unskilled workers lose out. Dependence on part-time, temporary, and

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daily workers will continue to grow as firms attempt to lower labor costs. Redundancy layoffs, temporary help agencies, and flexible work hours all make it easier for firms to reduce labor costs, and the result is to place workers at a disadvantage. The authors blame the unemployment increase on market forces and changing institutions. There are more job searchers as opposed to nonparticipants, as well as more new entrants from lowincome households, such as married women. Koreans seem to be responding to the unfavorable situation by collective movement, which results in a loss of efficiency and is not the ultimate solution. Instead, Kim and Yoo propose job creation, education and training, distribution policies such as a progressive income tax, an effective placement service, and a proper social safety net—nothing significantly new, but how to accomplish them is the key. All of this must be accompanied by economic restructuring, a healthy financial sector, and profitable firms. The authors assert that careful coordination of the measures is more vital than the measures themselves.

Pension Reform In chapter 6, Sang-Hyop Lee and Andrew Mason describe key features of old-age support systems, how they are evolving in the face of important demographic changes, and the policy issues and reforms that arise with respect to these systems, utilizing examples mostly from Asia and the United States. Lee and Mason explain the current situation of the family support system and its advantages and disadvantages. Traditionally, Asian countries have kept strong family support systems and have relied less on public transfer schemes. Like the West, however, these countries are seeing changes in lifestyle and family structure that will put pressure on the existing system. Family support systems are also becoming a much less effective institution for smoothing life-cycle variation in household income. Furthermore, family support systems are not better than public old-age support systems in pooling against risks of longevity and income shock. The authors then cover various scenarios in the labor force under different retirement policies. From a social welfare perspective, encouraging early retirement can reduce employment, income, and economic welfare in general, and the authors explain why. They suggest eliminating the mandatory retirement age altogether. The authors especially promote the elimination of labor market rigidities to enable seniors to work part time or, with decreasing responsibility, to be paid by productivity, not seniority. Training programs to keep older workers well equipped are also recommended. Savings will play a critical role because it can finance the accustomed standard of living during retirement. Savings also promotes economic


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growth, as does spending one’s savings later in life. But many do not have enough forethought or concern to plan or sacrifice while young to insure comfort in old age. The authors discuss in detail how much saving is enough, the effect of changing demographics on the need for a solid savings rate, and the interconnection between savings and various public policies. Lee and Mason then examine the reform issues in the old-age, survivor, and disability benefit (OASDI) programs. They include (1) whether governments can or should mandate universal participation in these oldage security programs; (2) whether to use funded or pay-as-you-go (PAYGO) systems; (3) the benefits of systems allowing for risk pooling to keep the financial future of the elderly secure; and (4) the benefits of private fund management over public fund management. The U.S. support system, which is significantly less dependent on family support, is described in detail by the authors. They list several key features of the current program being debated: It is an intergenerational transfer program; it makes substantial intragenerational transfers; the system is a defined-benefit plan as opposed to a defined-contribution program; the program has a negative influence on savings and work incentives; the Social Security system is publicly administered—though reliably and efficiently; and the program is not sustainable. These points are followed by a list of reform proposals. In conclusion, Lee and Mason provide some lessons. Savings are promoted as a better alternative to PAYGO systems, but funded schemes may leave those in poverty without resources, so this needs to be addressed. Sometimes it is necessary to start with a PAYGO program, but policy makers should also consider that transition to other programs is difficult. The family support system cannot continue to provide total support for the elderly in Asia. The authors assert that the time to introduce complementary programs is now. In chapter 7, Hyungpyo Moon and Youngsun Koh describe Korea’s current pension schemes along with their problems. They conclude that Korea’s old-age income support system should avoid excessive reliance on public pension schemes but instead utilize a multipillar system representing the state, private corporations, and individuals. Moon and Koh explain Korea’s four major pension schemes: the National Pension Scheme (NPS), the Government Employees Pension Scheme (GEPS), the Private School Teachers Pension Scheme (PSTPS), and the Military Personnel Pension Scheme (MPPS). The structural imbalance between benefits and contributions is the most serious problem confronting these pension schemes. This is particularly true in the latter three occupational pensions where benefit levels are much higher than the NPS. Another difficulty is with assessing the income of the self-employed. Also,

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the needs of the poor and the temporary workers present special problems, as they make little or no contribution but are in the greatest need of old-age income security. Other private pension programs such as corporate and personal pension plans have problems, too. Currently, corporate pensions do not have universal appeal for employers and employees because workers as yet have varying needs, and employers foresee additional burdens and few benefits. The personal pension plan market has grown, but it does not serve the purpose of old-age income because people regard it as a profitable investment that need not sit until retirement. The authors endorse the National Pension Reform Board’s proposal. A two-tiered system had been advised, one layer for basic pension and one layer for earnings-related pension. The basic pension would be universal and just enough to cover the minimum cost of living. Funds would be obtained from general taxation. The earnings-related pension would be an optional choice for those with corporate pension plans. This proposal has been opposed thus far, and the authors warn that the more pensioners are added, the more difficult it will be to achieve reform. For occupational pension schemes, Moon and Koh advise not only raising the contribution rate but gradually raising the pensionable age to sixty. They also advise reducing the pension benefit for those reemployed and adjusting the benefit formula using the lifetime average wage as its basis. In addition, they recommend the consumer price index to figure benefits instead of using wage growth. Finally, they propose portability of pension rights between the NPS and occupational pensions. Utilizing a two-layered system, with the basic pension under a universal basic pension plan and allowing for an opt-out for the earnings-related part of the plan, would put the occupational pensions more in line with the NPS. Moon and Koh then present three ways to actively promote corporate pensions. They recommend that the lump-sum retirement allowance be converted into corporate pensions and linked to the NPS in one of the following ways: (1) tax advantages to encourage participation (independent corporate pensions with no direct linkage to public pensions); (2) waivers from the NPS for the earnings-related segment if corporate pensions are utilized (opt-out or partial replacement model); or (3) totally privatizing public pensions. They list the particulars and scenarios of each choice. The authors endorse the opt-out plan as being the most viable at this time to keep both contributions and benefits in line. Finally, the authors stress that with the growing size of the public pension fund reserve, the government should no longer manage the fund as a monopoly and using the reserves for government programs. The Korean government has acknowledged this and has embarked on pilot projects to begin contracting out the pension fund management.


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Health Care Reform In chapter 8, Sean Nicholson and Barbara Wolfe document the levels and trends of medical care expense in developed countries and describe the market failures in health care and the issues of distribution, particularly in the United States. They propose some alternatives to improve the current system. Tables and figures are presented to show the increase in health care expenditures in industrialized countries, particularly in the United States. The authors argue that although the per capita cost of medical care has increased substantially, the poor make up about 32 percent of the uninsured in the United States. Nicholson and Wolfe then describe the various types of medical coverage in the United States: employer-based plans, private medical insurance, and public plans such as Medicare (for the elderly) and Medicaid (for the poor or children near poverty). Public sources finance almost half the medical care. For managed care and employer-provided plans, the premiums are rising to finance increased expenditures, and this increase will be passed on to employees. The authors then look closely at Singapore and China, because these countries have instituted medical savings accounts (MSAs) to finance their health care systems. In Singapore, MSAs are the principal means of financing its system. Individuals pay full price for medical care and are able to draw on their personal accounts for this purpose. China introduced mandatory medical savings in the cities of Zhenjiang and Jiujiang. Here, patients can use their funds for any medical service, not just inpatient and expensive outpatient services, as is the case in Singapore. In both Singapore and China, the government has taken steps to regulate and thus curtail what is offered to the patient, and this also helps decrease health care spending. These health care systems seem to be working well, and it appears that containing the demand side of medical care keeps medical expenses from increasing. The authors acknowledge that there are pros and cons to MSAs. With catastrophic insurance policies in place, having people “pay their way” with MSAs eliminates the moral hazard from health care insurance. On the other hand, the poor may not be able to afford catastrophic insurance. Furthermore, given the difficulty of evaluating the benefits of medical care, consumers might consume too little medical care. People might not save a sufficient amount to finance their medical expenditures because they believe the government will pay for their care if they incur catastrophic expenses. The final problem is that the healthiest consumers might also drop their traditional health plans and opt for MSAs. Nicholson and Wolfe conclude with the reform efforts for Medicare, managed care, and defined contribution insurance. Before the Balanced

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Budget Act of 1997, Medicare paid on a cost-plus basis, which led to a significant increase in medical expenditures. Changing to fixed reimbursement, as it is with physicians and hospitals, brought these costs more in line. Managed care is a supply-side control offering enrollees lower premiums and copayments, coinsurance rates, or deductibles by monitoring or restricting the amount of care received. The latest idea is defined contribution insurance. Under this plan, the employer provides catastrophic insurance only. The employee creates his own package in terms of premiums, deductibles, and copays, and a computer program calculates the cost to the enrollee. The downside is that the segmentation risk destroys the implicit subsidy of the healthy for the sick. In chapter 9, Hyehoon Lee documents the rapidly growing health care expenditures in Korea and presents measures to contain them. Lee maintains that, although Korea’s share of health care in GDP is still low, with an ever-growing aging population, Korea needs to work toward containing health care expenditures. Tables and figures detail the comparisons of OECD countries in health care expenditures. Korea does not appear to be spending as much as some on health care, but when per capita health spending is measured against per capita GDP, the evidence indicates otherwise. Korea also has a higher growth ratio of GDP share spent on health care, but this could be typical of lower-GDP countries. She concludes that rapidly increasing health expenditures in Korea are demonstrated by, in order of importance, per capita utilization, overall consumer price, population aging, and the relative price of medical care. She explores these four areas further in an effort to explain increasing health expenditures. Lee presents measures to contain health expenditures in Korea as a result of (1) national health insurance encouraging consumer moral hazard; (2) the fee-for-service scheme facilitating physician-induced demand; and (3) the unparalleled aging trend. Full-scale restructuring is now imperative. The author then explains the Diagnosis Related Group (DRG)-based payment system model, which makes payments of medical care by category regardless of the number of treatments. This, in addition to freeing doctors of the incentive to overtreat, would greatly reduce the administrative costs of filing, examining, and reimbursing claims. Pilot programs in Korea for inpatient care have demonstrated good results, showing decreasing costs in per capita expenses, decreasing length of hospital stay, and a drop in antibiotics used in the hospital—with a resulting increase in outpatient use of drugs that were still covered by fee-for-service. Undertreatment did not seem to be a problem. An alternative to DRG outpatient care would be the global budgeting system, in which insurers and providers work together to set fees that the physicians then must adhere to.


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Lee acknowledges the need for consumer accountability and suggests raising the deductible to make the patient more responsible. She also advises restructuring to ensure reduction of out-of-pocket expenses for the patient in catastrophic illness, a measure to protect households against unaffordable health risks. Politically, the change away from the fee-for-service payment system and also toward higher deductibles for the consumer will be difficult because of opposition from both doctors and patients. However, the author asserts that dramatic reforms in the payment system and full-scale restructuring of the cost-sharing scheme are clearly necessary because the provider can take advantage of encouraging more utilization of services resulting from the government regulating the fee, as well as because of population aging.

Major Findings and Policy Implications Alejandra Cox Edwards mentions that the overwhelming majority of job separations are offset by accessions in the United States and that this appears to be true in Korea as well. But she is concerned with the duality of the labor market—one characterized by high wages and stable employment and the other by job insecurity and low earnings. Edwards recommends market liberalization and job security regulation reform to remove this rigidity. Edwards also asserts that too high a level in Korea’s welfare benefit program might serve as an employment disincentive. Korea’s model for its pension and health care systems is based on single-worker families, but today’s families more often have two or more workers. The reform model needs to be updated to reflect this, says Edwards. Jin Soon Lee states that Korea’s new productive welfare program has not yet been “productive,” in the sense that it has to strike a balance between income security and work incentives. Social welfare programs in the UK, the United States, and Korea all share the common goals of lengthening workers’ stay in the labor force and funding welfare systems as their populations age. Yet Lee cautions that Korea cannot simply imitate other countries; it must determine the most appropriate reform for its unique needs. On labor market issues, Lee is concerned about how to achieve a balance between labor market flexibility and income distribution. Pension reform requires establishing an adequate level of old-age income security, long-term financial stability, and intergenerational equity. The same is true for health care reform, the aim of which is to provide high-quality service at affordable cost. Lee believes Korea must choose the most appropriate reform model. Andrew Mason notes that Korea’s early emphasis on economic growth over social welfare has been criticized, but the phenomenal transformation

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in the country now makes it possible to afford a generous safety net for its citizens. In addition, an eroding family support system and rapid population aging in Korea emphasize the need for pension and health care reform in Korea. Korea appears to be well positioned for these changes. Even though declining, the family support system is still far more important in Korea than in the United States and other Western countries. Policies that reinforce its continuing role are vital. Korea also has a high savings rate, although it may not represent a large portion of the population. Still, increasing numbers of Koreans are likely to be dependent on their accumulated wealth in their retirement years. Mason acknowledges general agreement among contributors in this volume on the need for development of a strong and secure financial sector and a close examination of the current pension policies and programs. John Karl Scholz discusses a number of the issues that concern social welfare and related policy reform. He emphasizes the importance of making personal responsibility a part of effective social welfare policy. He believes the overly generous—and unfunded—Korean pension system may be a misallocation of resources given Korea’s high personal saving rates. Scholz notes the need of all nations to balance three social welfare goals: generosity of benefits, targeting the most needy, and maintaining desirable incentives. Evaluation is the cornerstone of an effective social policy. Political constraints also need to be taken into account for practical economic policy making. Finally, Scholz observes that too much change too quickly can also be a policy problem. He recommends arriving at a consensus on reform priorities to avoid the attempt to fix everything at once.

Concluding Remarks Among the participants in this volume, there appears to be general consensus regarding some of the more broad and important issues. First, the new paradigm of social welfare should not only provide an adequate minimum level social safety net, but the structure of programs should also encourage socially desirable behavior. Considerable success with workoriented social policies offers insights to other nations. For example, the advantage of providing strong incentives toward employment, such as the TANF program in the United States, appears clear. It assures a rise in selfesteem for the individual and the financial sustainability of welfare. The same rule applies to pension and health care reform. However, there are inevitable tensions between the provision of a social safety net and maintenance of desirable incentives for socially desirable behaviors. How to ease these tensions may be the biggest reform issue. Second, public support and political consensus are necessary to minimize social conflict in implementing programs. Social welfare reform can


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be a struggle between different interest groups. The public will support a shift in welfare programs only if they realize the importance of budget discipline and lessons learned from the failure of past programs. Some governments may seek expediency in the short run, which often does not produce the best results for the long run. The subsequent government, as well as younger generations, will not support reform that is a burden on them. Lessons from the UK appear significant: Social welfare is being carried out largely because of the coordination between political parties and interest groups on welfare reform. Third, sound institutions and macroeconomic policy play important roles. These include building a secure financial sector, new infrastructure for job training and education, and effective placement services. Promoting a more flexible labor market is another requirement, but it should be balanced with equity. Macroeconomic polices need to be designed in a manner that is consistent with the underlying labor market and old-age support policies. Needless to say, social welfare obligations need to be administered more efficiently. Although there is a general consensus regarding the broader issues, both authors and discussants caution that the experiences of other countries cannot simply be imitated in practice. First, there are inherent differences in social welfare systems across nations. For example, although the traditional family support system has declined in Korea, it remains an integral part of the social welfare system, to a greater extent than in the United States and other Western countries. In fact, the current welfare reform process in Korea is analogous to searching for a new safety net rather than a shift amongst current public welfare programs. The type of policies that should be pursued or avoided in order to keep the family as a viable part of the social welfare system is an important issue that needs to be addressed. Second, differences in economic and tax systems across countries should be considered. For example, the Korean government may wish to adopt a program similar to the EITC. However, household income in Korea has not been identified within a reasonable degree of accuracy, as tax assessment is done at the individual level. Thus, the administrative costs of implementing EITC-like programs in Korea may be high. Pension reform in Korea faces similar problems. With a large self-employed sector and difficulties in assessing incomes, the first recommendation should be to devise ways by which an accurate income assessment can be made. Likewise, specific pension and health care reforms that should be pursued largely depend on the sources of inefficiencies within a nation. Finally, the differences between macroeconomic conditions of individual countries may cause difficulties in evaluating the effectiveness of programs. They also make policy emphasis different across nations and

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through time. Job creation strategies for welfare reform utilized in the UK and the United States appear to have worked well during periods of economic prosperity. The success of the welfare-to-work transition was, in part, because of the availability of employment. This may not be an easy task for those countries experiencing slow economic growth. In the case of Korea, the two major concerns appear to be growing inequality and the permanent increases in unemployment and underemployment. With a lagging economy, Koreans may face a more difficult battle for welfare reform.

Part I

A New Paradigm for Social Welfare

1. The Political Economy of Welfare Reform in the United Kingdom Meghnad Desai

Introduction The welfare state is a portmanteau name for a clutch of policies that provide insurance against adversities such as unemployment and ill health, smooth income over the lifetime by providing pensions, and guarantee a safety net for those few who are poor or indigent. Although it has its origins in the nineteenth century, much of its growth has been in the last half century since the end of the Second World War. Again, while there are a small number of exceptions, the welfare state is by and large a developedcountry achievement; these countries are defined here as the members of the Organization for Economic Cooperation and Development (OECD). Kuwait is an interesting exception. Over those fifty-odd years, the welfare state has grown in its scope in every country of the OECD. Yet its coverage remains different in the different parts. There is a comprehensive Scandinavian model with very generous benefits, especially for those in the labor market—-whether unemployed or temporarily off work as a result of pregnancy or parental responsibilities—financed by a high tax take reaching 60 percent of GDP. The European continental model with the core EU countries—France, Germany and the Benelux countries, and Austria—is comprehensive especially for those out of work, but the benefits are not as high nor the coverage as large as in Scandinavia. (Here again the case of the Netherlands is interesting). The tax take is in the 55 percent neighborhood. Then there is the UK, which taxes at under 40 percent of GDP and the benefits are much more stringently defined, not generous and means-tested. At the bottom end would be the United States, with a much lower tax take and much more selective benefits. The southern European countries—Spain, Portugal, Greece, and Italy—would be in this category. (For a survey of the European data in the UK context, see Skidelsky 1997, Table 1; also for a recent comparative study, see Kuhnle 2000 and Goodin et al 1999). This paper is devoted to an analysis of the UK experience. The UK has restructured its welfare state over the last ten years. There has been an intense public debate, with lay as well as expert opinion playing a big part and political parties trying their best to innovate. There have been think tanks both of the Left and the Right that have gone on “thinking the unthinkable” over this period. Under the new Labour Government that came into power in May 1997, there has been an interesting synthesis of the Left and the Right views on welfare reform. This is labeled the “Third 3

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Way,” a concept popularized by Anthony Giddens of the LSE, who is a close adviser of Prime Minister Tony Blair (DSS 1998; Giddens 1998). The paper is organized as follows. In the next section, a general background of the UK welfare state is given. The problem as seen in the 1960s to the 1990s is described, with various solutions that were being proposed. In the following section, I discuss the solutions as proposed and implemented by the Conservative and Labour Governments. An important point here is to show the underlying principles more than the details of the reform. I show the connections between the visions of the two parties about welfare reform and I show that the reforms of the Conservative Government about the productive economy, as well as its efforts to contain the welfare state, were crucial to New Labour reforms. The “New Deal,” or “Welfare to Work,” as it is called, is a basic redrawing of the boundaries of the welfare state in terms of who claims and what they can claim. This has enabled the UK to restructure its welfare state while keeping the share of the welfare state in total GDP more or less constant. The final section will draw some lessons on reforming a welfare state.

The British Welfare State Despite some earlier developments in the first decade of the twentieth century, for all practical purposes the foundation of the present welfare state can be said to begin with William Beveridge’s efforts during the Second World War. “The Beveridge Report Social Insurance and Allied Services” (Beveridge 1942) was published as part of the war effort to enthuse the public with a promise of a better life to come. There was an intense battle with the treasury about the cost of the various proposals, and Churchill as prime minister was not pleased with some of Beveridge’s attempts to hype up his report. But Beveridge is central to the later developments. He also wrote another noncommissioned popular report, Full Employment in a Free Society (Beveridge 1944), which more than anything tied the Keynesian policies of full employment to Beveridge’s welfare proposals. Ever since then the expression “Keynes-Beveridge welfare state” (sometimes “welfare capitalism”) has been popular. (For a history of the British welfare state, see Timmins 1996. I will refer to his book at various points.) The connection between Keynesian full employment policies and the Beveridge welfare state is more than a mere slogan. One depends on the other. The problems of the Beveridge welfare state started when the Keynesian full employment regime broke down in the 1970s. It took another fifteen years, however, before welfare reform could be seriously undertaken. To see why this was so, it is necessary to look at the original Beveridge welfare state and its growth. The core of the Beveridge proposal was a contributory insurance policy that a male worker (there were few women employed) entered into over his working life. This guaranteed him bene-

Welfare Reform in the United Kingdom

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fits when he was unemployed as well as a pension when he retired. In those sexist days, only men were supposed to work and women were supposed to be wives. Thus the benefit had to be calculated so as to support a couple. The scheme was a social—that is, collective—insurance scheme. It redistributed a worker’s income over his lifetime to smooth the consumption flow. But being a universal scheme, it was mildly redistributive across individuals, especially from those who would never be unemployed (e.g., civil servants, teachers) to those who could be (e.g., industrial workers). Allied to this social insurance scheme was a safety net that helped those not in a job or not even likely to be economically active. This was the National Assistance or Supplementary Benefit, now called Income Support. This was ex gratia payment to keep citizens from total indigence. It was not generous. In a pioneering study of UK poverty, Townsend (1979) showed that in the 1960s the Supplementary Benefit was about 25 percent short of the poverty level. Besides these, there were state pensions for those who had been employed (paid their social security stamps) and their widows. Widows also got special payments if they had no pensionable rights inherited from husbands. During the 1970s, the Labour Government introduced a system of Child Benefits, which were paid directly to the mother rather than through the male wage earner’s pay packet. This has remained very popular. Besides establishing the Beveridge welfare state, the 1945 Labour Government also created the National Health Service. This provided for free health care on demand via state owned and administered hospitals and GPs who were paid for their patient load. This became a central part of the welfare provision, though ideally it is not everywhere a part of the welfare state. The UK also had public housing built by local authorities who were subsidized by the central fisc and free primary and secondary education provided by schools that were owned and run by local authorities. (Scotland has some differences with England and Wales, but I shall ignore them). I do not deal with the reforms of the health service and of education in this paper in the interest of brevity. The British welfare state had certain guiding principles that became its problems over the fifty years it grew. First was universality of claim. There was a deep-seated opposition to any selectivity labeled “means testing” (a test of the claimant’s resource position to see whether he was poor enough to deserve the benefit that was applied during the Depression years). This meant that everyone was to be allowed to claim benefits that were available. This meant that the benefits could not be targeted. The one exception to this rule was, of course, the National Assistance/Supplementary Benefits, which was directed at the poorest. Secondly, there was the uniformity of provision. Whatever had to be provided had to be the same for everyone. As Howard Glennerster has put it, it is “the principle of a citizen’s universal right of access to services of an equal standard regardless of

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geography or income” (Glennerster 1990: 14). There were minimum standards set for the benefits received. Thus when a worker who contributed to the National Insurance scheme was unemployed or fell sick or retired, the state tried to ensure that “the citizen’s standard of living did not fall below a minimum.” Minimum standards were set for uniform housing across the land, as well as for health care and for maximum class sizes in schools. The problem with universality and minimum standards was that the beneficiaries were often those who were better off; in making sure that the deserving poor were not left out, many undeserving rich benefited, too. “Indeed, the inclusion of the middle classes for the first time as major beneficiaries inevitably made the post-war welfare state even less redistributive in overall terms than its 1930s predecessor which had embodied ‘targeting.’ . . . It was only in the 1950s and 1960s that the Labour Party and academic social reformers came to see equality or redistribution as a goal for the welfare state, distinct, that is, from security and free access which had been at the centre of the campaigns of the 1930s and 1940s” (Glennerster 1990). There was also a strong centralizing tendency in the British welfare state. There were criticisms as early as 1950 that the older habits of selfreliance and community support were eroding because of the existence of a universalist welfare state. The original idea that the welfare provision would be financed from the insurance contributions (the contributory principle) was soon abandoned as the expenditure grew and general taxation became the source of finance. Expenditure on welfare provision, broadly defined, doubled in all OECD countries from 13.1 percent (UK 13.9 percent) in 1960 to 25.6 percent (UK 23.7 percent) in 1981. (This includes direct public expenditure on education, health services, pensions, unemployment compensation, and other income maintenance programs and welfare services. Housing is not included in this total.) This growth was driven by three factors: increase in demand, expansion of scope, and improvement in provision. The increase in demand was because over the years the population that stood to gain from public services—those of school age and those in retirement—grew faster than the population as a whole. In 1951, the elderly were 11 percent and the school age children 14 percent of the population. By 1971 the percentages had grown to 13 and 16. The age of compulsory schooling was raised and many more stayed on at school beyond the compulsory age for free education. (For global trends in aging and its implications for pension systems, see Lee and Mason 2001.) There was also an expansion in scope of the welfare state and a steady improvement in the provision of welfare services. Thus, across the OECD, higher education expanded and was provided generously to mainly middle-class youth, either completely free or at heavily subsidized rates. Groups besides the elderly, the children, the unemployed, and the sick were brought into the net. Thus the provision for the mentally and physi-


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cally handicapped, for children with special educational needs (e.g., dyslexia, autism), and for those with mental disorders improved in coverage and quality. The improvement in provision across the board was driven by strong idealism. There was a concerted effort—with large public support—to make welfare capitalism into humane capitalism. It was felt that all members of society should share in the general prosperity. The limits were not dictated by resources but by political will. The housing had to be improved, benefit levels expanded in line with income growth, and the quality of welfare services had to be enhanced. So it was thought, until disaster struck and the prosperity taken for granted came under threat. This is when, perhaps, the welfare state was needed more than ever before. But precisely at such a time, it came under a concerted attack. Financial Crisis and the State The first twenty-five years after the Second World War (1945–70) are now called the Golden Age of Keynesianism or the Keynesian Quarter Century. They were also happy years for welfare capitalism. There was full employment, income growth at unprecedented rates, moderate though rising inflation, and benign fiscal conditions. The postwar settlement had imposed the Bretton Woods system with fixed exchange rates, based on a dollar-gold link, controls on capital movements, and gradual liberalization of trade. This virtuous era came to an end in the early 1970s. The abandonment of the dollar-gold link in August 1971 led to the collapse of the Bretton Woods system and the end of fixed exchange rates. There were fears about the exhaustibility of nonrenewable resources and hence the sustainability of rapid income growth. There followed a quadrupling of crude oil prices in October 1973, which unleashed inflationary pressures. There were also social and political movements across OECD countries for civil rights, environmental protection, and women’s rights— and against the war in Vietnam and all bureaucratic authoritarian institutions. There was, in general, a demand for liberation in the air. The inflation was symptomatic of a crisis in profitability in the OECD countries. The arguments for abandonment of controls on capital movements and for the imposition of controls on domestic money supply came from a common philosophical source. This was market liberalism, which began to counter the confidence in the state and the efficacy of fiscal policy, which were the hallmark of the Keynesian revolution. The decline in profitability was perhaps the most serious in the UK. But a worse effect was that as the private profit-based economy shed employees, they were rehired in the public nonprofit-making sector. This led to a problem labeled “Too Few Producers” (Bacon and Eltis 1976). The shrinkage of the surplus-generating sector meant that there was less available to finance the welfare state. While superficially there was full employment (though unemployment went above 1 million—nearly 5 percent—

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during the late 1970s), the effective limit on the affordability of the welfare state was not a result of overall employment but private employment and the productivity of labor in private employment. This was, however, not a Keynesian but a “classical” way of looking at the problem. Neither Keynes nor Beveridge foresaw a shrinkage of the surplus-producing sector and the parallel expansion of the state sector. Their followers had long forgotten such distinctions. In their macroeconomic models, all employment was the same. The swelling of the state sector, stagflation, and the decline in profitability were all parts of the same failure to appreciate that the welfare state can only be financed from the surplus produced in the profit-making sector of an economy. This is the true limit that Keynes puts on Beveridge. Yet this perspective has never been articulated. The criticism of welfare took other forms in the 1960s and 1970s. Criticisms of the Welfare State Criticisms of the welfare state began in the days of the Wilson government, 1964–70 (for a detailed account of earlier criticism, see Timmins 1996, chapter 13). They took a more virulent form after its defeat. At first, the critics were from within the Labour Party, and their criticisms were directed toward the failure of the welfare state to tackle poverty and to mitigate the long-persisting inequalities in housing, health, education, or in general in life chances. Later on, critics from the Right began to focus on the structure of households to locate the reasons for “cycles of deprivation” that persisted over generations. By and large, the Left concentrated on rules and structures, while the Right concentrated on culture and behavior. The Left said the welfare state was mean and selective in its provisions that kept people from claiming their entitlements. The Right said that rules of payment encouraged dependency that gave people no incentives to help themselves out of poverty. Although the political divide persisted through the 1970s and 1980s, a number of important insights were gained about the nature of the welfare state. Persistence of Poverty The “rediscovery” of poverty in the early 1960s in the UK and the United States surprised many people. Even after a decade of full employment and rapid economic growth, poverty was seen to be widespread, affecting up to a fifth to a quarter of the population (Townsend 1979). The poor were seen to be “relatively deprived” in many dimensions—housing and the quality of their neighborhood, the quality of schooling their children got and the time they stayed on at school, their skill base and work opportunities. The elderly, single mothers with children, and couples with children where there was unemployment—these emerged as the categories in which poverty was concentrated. The answer did not seem to be a simple raising of the safety net entitle-


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ment, although that would prevent the small number of cases of absolute poverty. The root causes were in many dimensions—health, housing, employment, education. The Right picked up on the breakdown of marriage, which led to unstable households, which in turn led to problems about seeking work. The intergenerational persistence of poverty drew much attention from Keith Joseph, who was the intellectual politician in the Conservative Party of the 1970s and 1980s. Perverse Incentives The structure of benefits for the unemployed and the economically inactive had grown in size and complexity over the years. To the basic cash entitlement—Unemployment Benefit or Supplementary Benefit—certain “in-kind” benefits were added: concessions on rents or rates (local taxation), fuel allowance, free school meals for children of such households, and so on. But if the claimant found paid work, then these in-kind benefits were progressively withdrawn—a phenomenon known as the “taper.” The implicit rate of taxation in going from unemployment to paid work was computed to be as high as 80 percent (this is well illustrated in the Commission of Social Justice report of 1994). Thus, those not working but on benefits had little economic incentive to seek work at the margin. This led either to continued dependence on the dole or moonlighting—that is, taking paid work without declaring it to the unemployment office. The expression “poverty trap” was coined in 1971 for this perverse set of incentives by two Labour intellectuals, Frank Field, later an MP, and David Piachaud, now a professor at the LSE (see Timmins 2000: 284). There were other disincentives built into the system. In entitlement to free care for the elderly, there was a disqualification if the claimant had accumulated savings above a certain modest limit (roughly equal to the average annual earnings). This encouraged the elderly to dispose of their assets or tell lies. In paying benefits, a man and spouse got less than twice the single person’s entitlement. This was a “cohabitation tax” of about 30 percent. This again encouraged couples to live apart, especially because until the mid-1970s, public housing was available on a points system that favored the single woman/mother (see Desai 1997). These anomalies had grown up as ad hoc attempts to save money, to means test, or find some way of rationing benefits in a formally universalistic system. There was a tension between a desire to avoid destitution and discourage false claims. Erosion of the Community Before the welfare state was made universal, arrangements for social insurance, safety nets, and access to health care were patchy. The poor, especially if labeled as nondeserving or feckless, received very little help. Private charities and mutual help associations took care of the respectable

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working poor, the lower middle classes, and the distressed gentle folk. The framework was local and varied, as the local community did or did not galvanize to help. With the entrenchment of the welfare state, many of these institutions withered away. Communities that were bound together in bonds of varying strength lost their cohesion. The neighborhood, the parish, the local church, and the Pru (private insurance schemes) became a memory of the past. Many critics claim that the tax and benefit regime discourages such schemes of mutual help. Rather than supplementing private collective efforts (friendly societies, mutual bodies), the public provision replaces it. Its centralization, uniformity, and strict rules of eligibility cannot, however, properly cater to varying needs that can only be met by local bodies with local knowledge. Many citizens brought up under the old system refuse to claim their state benefits, as they believe there is a stigma attached to being seen receiving a “handout.” As recently as 1998–99—that is, after fifty years of the welfare state—between 13 and 21 percent of eligible people were not claiming what they were entitled to. These nonclaimant proportions were the highest for safety net type benefits, or those designed to tackle poverty among the working families. Thus Income Support (formerly Supplementary Benefits) was claimed by 3.5 million but not by another .7 million eligible people. Family Credit meant to top up low wages in work was claimed by .7 million but not by another .3 million. Even the Job Seekers’ Allowance (Unemployment Benefit) had a nonclaimant rate of 25 percent. This criticism was initially dismissed as nostalgia for an old failed system. It was also for a while the preserve of the Right. But during the 1980s and 1990s, it was taken up more widely as proof that the welfare state has failed to meet its promise of universality or adequacy of provision. Frank Field, MP, who was briefly a minister in charge of welfare reform, has been a prominent champion of this strand (Field 1997). Efficiency Loss and Market Distortion A new strand of criticism opened up during the 1980s. The restructuring of the British economy that Mrs. Thatcher inaugurated in that decade was designed to make the economy more competitive. This meant downsizing the firms, whether private or publicly owned, to reduce (labor) costs and increase efficiency and profitability. The neoliberal doctrine that inspired this restructuring insisted that those who would be made unemployed in the process would find alternative work. The market for labor will clear. In fact, there was a dramatic rise in unemployment, which trebled between 1975 and 1985. Unemployment at historically high levels not seen since 1945 persisted through the 1980s and much of the 1990s. It was in trying to explain the failure of the market to restore full employment that various theoretical and empirical stratagems were employed. The one that concerns us here is the idea that it is the “high”


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level of unemployment benefits relative to the wage that keeps people in unemployment. The ratio of benefits to wages, called the “replacement ratio,” was given a prominent role in many debates. But besides the level, there was also the duration of the benefit—which was unrestricted in the first thirty years of the welfare state—that attracted criticism. The U.S. example was one of a low replacement ratio but long duration. The Swedish example was one of a high ratio but a short duration. (These are political rather than technical statements. I cite them to illustrate the debates that went on.) The structure of unemployment benefits—level plus duration—was thus seen to be a major obstacle to the efficient working of the labor market. By preventing unemployed workers from seeking work (a perfectly rational response given the cost benefit calculus), an economic loss is imposed on the community since these unemployed could not only earn more if employed but also could generate value added over and above their wage, especially if they worked in the private sector. This argument is similar but not identical to the one about “too few producers.” These two arguments come together if we add that the tax burden required to finance such benefits is a disincentive to work and accumulation. This connection has been made most strongly by Professor Robert (Lord) Skidelsky in his essay, “Beyond the Welfare State” (1997). He displays a scatter diagram that plots unemployment rate against government revenue as a percentage of GDP. The latter is a broad indicator of the size of the state and indirectly of the size of welfare spending. Twenty-one OECD countries are included in the sample. There seems to be an upwardsloping relationship—the larger the share of government expenditure, the higher the unemployment. The author warns against taking this “too seriously because there are too few observations.” Yet the point is made. Other reasons for efficiency loss have been cited. Thus, the social security system as a whole, by insuring against income loss while in work and pensions when retired, is thought to discourage savings. Of course, what happens is that the savings are done by the state via taxation on behalf of the individuals who are then free to make adjustments at the margin if the state-dictated savings ratio does not suit them. The argument is then shifted to say that the state may not obtain as high a return as the private individual can if all the savings were to be left in private hands. This is almost impossible to test since there are externalities in the state spending behavior-improving workers’ morale and hence productivity, for example.

The Quest for a New Welfare State While the British economy was restructured in drastic ways during the 1980s, the welfare state was left pretty much as it was. The safety net aspects of the welfare state, especially unemployment benefits, were cru-

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cial to the maintenance of social peace. Mrs. Thatcher as a political leader was acutely aware of the need for political support in pushing a reform agenda. Her restructuring of the productive sectors required the cushion of the safety net, but she also sensed that while the public complained about benefit fraud and “scroungers,” there was no desire for a drastic change in the welfare state. What was needed was to assure the public that waste would be cut out, that fraud would be punished, and as far as possible the tax burden would be reduced. Thus there was a constant rhetoric against public spending at the central but especially at the local level. This was met with opposition and complaining about “Thatcher’s cuts” (Timmins 2000, chapters 17 and 18). The facts, however, reveal a different story. Broadly speaking, expenditure on the welfare state in real terms barely moved during the 1980s. During the severe crisis years of the mid-1970s—in the wake of oil price rises and stagflation—it rose sharply from 21.6 percent of GDP in 1973–74 to a peak of 25.5 percent in 1977–78. By 1979-80 (election year), it was 22.9 percent. It rose to 24.5 percent by 1984–85—largely a reflection of the unemployment situation-but was back to 23 percent by the late 1980s. From 1980 to 1990 it moved between 22.5 percent at the bottom and 24.5 percent at the top. Thus, as Julian Le Grand (1990) remarks in his survey of the period, “There is no evidence here to support a story of serious decline.” The 1990s continued this practice, but with less rigor. Another recession in 1990 led to expenditure going up again. The welfare state has been stabilized at around 25 percent of GDP, but it rose to about 26 percent in 1992–93 to 1994–95. Thus the rate of growth of the welfare state was reduced so that it would be roughly equal over the cycle to the rate of growth of GDP. But the slippage in the years 1992–97 while John Major was prime minister led to further soul-searching. The sharp rise in the share of the welfare state in GDP from about 10 percent in 1960 to 20 percent by 1970 and 25 percent by 1975 was fought to a standstill during the 1980s, and though the 1990s led to a slight rise, this was still an achievement. How has this been done? In the first phase, which covers the years 1979–97, while the Conservative Party was in government, it was done by a number of devices that reduced expenditures without challenging the logic and the structure of the welfare state. There were strong voices on the radical Right that urged a dismantling of the welfare state—introduction of private health insurance with public subsidy, private insurance for unemployment, loss of entitlement to unmarried couples and their children, and so forth. But the response was moderate—indeed, conservative. It was not easy to contain the growth of the welfare state in the face of high unemployment and other social changes. It was done throughout with public support. The public wanted a welfare state, but not a costly one. The debates in those years led to a much greater measure of agreement between the Conservative Party and the Labour


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Party, especially New Labour. The Major years were not suitable for drastic reform, as his government did not have a sufficiently large majority and his own party was divided (not about the welfare state so much as about Europe). Thus when drastic reforms were undertaken, it was the New Labour government that took the task on. But in doing that, it did not reverse any of the number of small “cuts” that the Conservatives had made. It just rethought the logic of the welfare state. I shall survey the changes in 1979–97 broadly before tackling the reforms made by New Labour. The Conservative Solution: Containing the Welfare State, 1979–97 Through the eighteen years of Conservative rule, the major achievement was getting the growth of the welfare state in line with the growth of GDP. This was clearly a shock to the utopian hopes that were being placed on an expanded and fully universalized welfare state by the egalitarians. But it was also an acceptance that containment was the limit to which reform could go. There would be no reduction in the size of the welfare state; certainly not in absolute spending terms, but not even in terms of the share of GDP. Politically this was not an easy decision for the ideologues of the radical Right, who were active in the many think tanks that were mushrooming in those years. In this respect, while the UK gave up any ambition of catching up with the Scandinavian welfare state, it did not adopt the U.S. model either. It stayed roughly in line with the continental model, departing most drastically in its labor market reforms, but little else. Containment was achieved by (a) shifts in the composition of expenditure between different headings and (b) reducing the rate of growth in the size and scope of entitlements. A smaller part was played by the practice of charging for nonstatutory services or privatizing them. This affected local authorities since they were in the direct firing line of providing social services. School meals, municipal swimming pools, and “hotel” services in the NHS began to be charged directly. This is not dealt with further here, as it is too detailed in relation to the contribution it made to the control of welfare expenditure. There was also a redefinition of the welfare state’s claimants in negative terms. Thus “benefits” came to be spoken of as if they were anything but. Welfare claims were not citizen’s rights but favors done by the state—favors that any sensible person would refuse. This recasting of the welfare state as a problem area rather than a splendid achievement, as a refuge of the undeserving, was very effective. It put many people off claiming, and this by itself may have contributed to the containment. Shifts in Composition The most significant shift in the composition of welfare expenditure was in housing. There is an extensive system of local authority-owned public housing in the UK that was rented at subsidized prices to eligible tenants. Eligibility was by indicators of economic or social need. But until the end of the 1970s, council housing (as it was called) was a working-class pre-

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serve. From one generation to the next, families lived locally within the council housing system. The housing stock, built soon after 1945, was extensively renewed in the 1970s. For those not eligible for council housing but still in economic need, there was a housing benefit that contributed toward the rent. Middle classes enjoyed a tax relief on mortgages that financed house ownership. In the late 1970s the size of the subsidy for mortgage matched that on council housing—about £3 billion. But the middle-class subsidy was tax not collected while council housing subsidy was expenditure incurred. The latter was welfare state, the former not. The government stopped any further council house construction and steadily reduced the rent subsidy. Later it launched a (very popular) scheme of selling council houses to its tenants at below-market value (thus affecting a progressive wealth redistribution). The expenditure of housing (including housing benefits) fell from 20.4 percent of total welfare budget in 1974–75 to 12.1 percent by 1989–90 and rose to 16.1 percent by 1995–96, mainly due to rising housing benefits. After growing at 12 percent per annum between 1979 and 1989, capital expenditure fell from around £11 billion on average between 1973 and 1978 to £4 billion in the 1980s and 1990s (all expenditure data in real terms in 1995–96 prices). Mortgage relief grew from an average of £2.5 to £3 billion in the 1970s to £5 billion in the late 1980s but was steadily reduced to £3 billion in the 1990s. As a percentage of GDP, public spending on housing fell from about 4 percent in the 1970s to under 2 percent by the late 1980s and stayed there in the 1990s (Glennerster and Hills 1998). In other areas, the cuts came in capital expenditures rather than in current expenditure. In education, capital spending fell from £4 billion in 1973–74 steadily (i.e., under Labour and Conservative governments) to £1.2 billion by 1989, rising to £1.8 billion in 1995–96. In overall terms, education went down from 5.8 percent of GDP in 1973 to 4.9 percent in 1985–86 but then went up again to 5.2 percent by 1995–96. Reduction of Size and Scope of Entitlements This was perhaps the more effective policy. There were items in the welfare budget that were “demand determined”—that is, not subject to forecast and control. During the 1980s, unemployment benefit was the main such item. In the ten years from 1979 to 1989, real expenditure on unemployment benefit was the main such item, increasing from £2.6 billion to £7.0 billion. But even this was contained by frequent changes in eligibility and keeping the real value of benefits constant at around £50. It went down to £44 in 1980 and 1981, but this drastic reduction led to much social disorder. Any real reduction was abandoned after that. Apart from unemployment, the other major increase in demand for welfare benefits was from the elderly. The demographic change toward a longer life expectancy as well as longer life meant that more people claimed pensions and for longer. The state pension was indexed to the retail price index rather than being upgraded with average earnings annually. The State Earn-


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ings Related Pension Scheme introduced by the Labour Party was dismantled partly by encouraging people to switch to private pensions (Timmins 2000: 402–403). Many more people were in occupational pensions encouraged by the generous tax incentives. Thus private pensions grew from under 50 percent in the late 1970s to above 75 percent by the mid-1990s. The indexing of basic state pension to prices rather than earnings continues to be a controversial topic since it is believed to have contributed to poverty among the elderly. These elderly poor are also entitled to Supplementary Benefits (Income Support) but are reluctant to claim (See Moon and Koh 2001). There was an overall shift from universal and nonmeans-tested benefits to means-tested benefits. In other words, there was more targeting, but in a political culture built around the notion of citizens’ entitlement, this was not always politically popular. Over the years, the virtues of targeting as an antipoverty device and even for its redistributive effects (i.e., why pay benefits to those who are well off) have been appreciated in the political dialogue. In 1978–79, £28.0 billion fell in that category. Means-tested benefits rose from £2.5 billion in 1973–74 to £10.0 billion in 1988–89 and to £17.6 billion in 1995–96 (all in 1995–96 prices). These trends introduced in the 1980s continued in the 1990s up to 1997. Thus the unemployment benefit was renamed Jobseeker’s Allowance, and both the eligibility and duration were much more tightly defined. Those in long-term unemployment had to fall back on Supplementary Benefits/Income Support after they had exhausted the duration during which they could claim the unemployment benefit. The New Labour Response: Rethinking the Welfare State The containment of the welfare state was a successful strategy inasmuch as the public support for the welfare state was maintained. The Conservative Party won four elections in a row and kept power for eighteen years, during which unemployment never returned to the level before 1979. Income growth was healthy, though below the high levels of the 1945–73 period, and there were two severe recessions in 1980 and 1990. To have won elections in the face of this background indicates that while the other factors no doubt contributed to its success, the Conservative Party simultaneously led and responded to public opinion on economic issues. By the mid-1990s, there was no strong support for going back to the “good old days” of Welfare Keynesianism. In this respect, the reeducation of the public—and more particularly of the Labour Party—was a profoundly significant event. Welfare reform is always a political exercise. Technical solutions, even when more efficient, have to be abandoned if they cannot command public support. The public can change its views and expectations, but it will not be hurried. It will also dissemble when asked about its attitudes. Almost every opinion poll shows that the British public is willing to pay extra taxation for a better welfare state. Only one poll contradicts this and that is an actual election. Labour’s fourth defeat in 1992—when it had reformed

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itself and even projected a fiscally responsible image (via its then shadow chancellor and later leader, John Smith)—owed something to its promise to upgrade benefits paid for by higher taxes. This policy was carefully crafted to be fiscally prudent and hurt only a minority of voters. As it turned out, the public did not buy it. The Labour Party had to rethink completely the nature of its commitment to the welfare state. It did this painfully but successfully. During the early 1990s after the 1992 defeat, the Labour Party appointed a Commission on Social Justice. The commission produced its report in 1994, but John Smith, the leader who had commissioned the report, had by then died (Commission on Social Justice 1994). The new leader, Tony Blair, let it be known that the report, though much criticized at the time for its caution, was not the way he wished to reform the welfare state. The party was going to be prudent about finances and caring but not carefree in its spending. The refusal to reverse the many modifications to the welfare state made by the Conservative Party was accepted. What is more significant is that the reform of the labor market and the many privatizations were not to be reversed either. Thus the approach, though labeled radical, was quite cautious to begin with. In fact, much of the welfare reform implemented by the Labour government after 1997 drew extensively upon the approach adopted by the commission. It was understood that there was no going back to the welfare state pre-1979. This was not just because it would be costly, but more because the old welfare state was not designed to tackle the new problems caused by changing labor markets, altering demography, and the need for an educated workforce in the new knowledge economy. The old welfare state had also failed to tackle poverty or persistent unemployment. So a new approach was needed. This would not uproot the containment of the welfare state. It would not reject the market. But it would rethink the nature of work and of the role of the benefit system in encouraging the people to take up work. Upon coming to power, the government published a green paper entitled “New Ambitions for Our Country: A New Contract for Welfare” (DSS 1998). In the preface, Tony Blair laid down the general outlines of his welfare reform. I will quote selected sentences from it to give an idea of how the reforms were “sold” to the public. “Work for those who can: security for those who cannot.” In the area of welfare to work, we have the New Deal, the largest assault on structural unemployment ever undertaken in this country, benefiting the young and long-term unemployed and, potentially, many lone parents, disabled people, and those with long-term illnesses. “The transformation of how the tax and benefit system interacts with the world of work.” We should not forget why reform is right, and why whatever the con-


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cerns over individual benefits, most people know it is right. Above all, the system must change because the world has changed beyond the recognition of Beveridge’s generation. The world of work has altered—people no longer expect a job for life; traditional industries have declined; new technologies have taken their place. There is a premium on skills and on reskilling throughout life. The role of women has been transformed. Family structures are different. We live longer but work for fewer years. And the expectations of the disabled have changed out of all recognition from half a century ago. We need a system designed not for yesterday but for today. “Inequality has risen sharply and large numbers of people-principally pensioners and children-are living in poverty.” “A system in which you spend more, but fail to stem urgent need, is plainly not working.” “The system all too often acts against those who want to work-creating a number of disincentives to move from benefits into the world of work.” “It is open to abuse.” “We want to cut the cost of economic failure.” “In essence, [the green paper] describes a third way: not dismantling welfare, leaving it simply as a low-grade safety net for the destitute; nor keeping it unreformed and underperforming; but reforming it on the basis of a new contract between citizen and state, where we keep a welfare state from which we all benefit, but on terms that are fair and clear.” Arriving at this fulsome rhetoric of the green paper had not been an easy task for New Labour or for its architects, Blair and Brown. The first step was to accept an overall fiscal discipline. There was a school of British Keynesianism, very influential on the Left, that passionately believed in budget deficits and currency devaluation and regarded public debt as of no importance and inflation—albeit mild inflation—friendly to full employment and growth. This set of beliefs defined Labour Policy well into the 1980s. By 1992, budget discipline had been understood as saying that deficits should not be increased irresponsibly. Soon after the 1992 defeat, Gordon Brown, the new shadow chancellor, adopted a much tougher stance. The Maastricht Treaty, to which the UK had been a signatory, also helped. It had laid down convergence within for joining the Economic and Monetary Union (EMU). While the Conservative government had secured an opt out, Labour, as the opposition, wanted to do better. The criteria laid down a deficit of less than 3 percent of GDP, a debt-to-GDP ratio of 40 percent, and low inflation. As a result of the recession of 1990, the budget deficit went up to 7.5 percent in 1992–93. Labour could then promise to be more prudent. There was a total rejection of reversing the many changes the Conservative government had made to eligibility and a selective promise of upgrading child benefits, but little else. This was controversial within the party. There was to be no earnings link for the basic state pension. There were protests about the Jobseekers’ Allowance but no promise to restore

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the old benefits. Thus the containment of the welfare state was accepted and adopted by the Labour Party. There were, however, severe consequences of this containment. Poverty in the UK had increased over the previous twenty years, as had inequality of incomes. The poor were mainly in three groups: the elderly, the children, and single parents (mainly women). There was poverty among the unemployed, especially the long-term unemployed and in households where neither parent worked. But there were also the working poor, people earning such low wages that even with a full-time job, they did not earn enough to qualify as nonpoor. (Definitions of poverty have continued to change. Now it is in terms of 50 percent of median income or less.) Whatever else the Labour Party could abandon, it could not abandon its commitment to alleviate poverty and tackle inequality. The fiscal discipline did not in principle entail no change in taxation. But lower income taxes had been a potent Tory weapon. The highest income tax rate had been cut from 98 percent to 40 percent and the basic rate had been cut to 25 percent, with a promise of lower taxes yet. Progessivity in income tax beyond this was foresworn by Labour. Indirect taxes, especially VAT, were accepted as part of the fiscal tool kit. Thus, if there was going to be redistribution, it would have to be via expenditure. The big breakthrough in Labour’s thinking was to see the benefit system not as a passive shock absorber but as an active accelerator for return to work. Until then, the welfare state was seen as supplementing the market, providing shelter for those who had failed, temporarily or not, the employability test. Benefits were designed to smooth income loss but not help toward a higher income-earning capacity. Taking unemployment as the central cause of the high welfare spending, a strategy was devised to change the benefit system to encourage work. The trick was not merely to treat unemployment benefit as a whiplash to send people back on the job market but to make it easier for them to find work even as the duration of benefits shrank; as the cliché went, not a safety net but a trampoline. The idea was that all those who could work had to find a job or be in the process of equipping themselves to find one. Welfare could not be taken for granted by those out of work. Since unemployment was concentrated among the very young—16- to 25-year-olds—or the mature mid-40s-plus who were “unreemployable,” the principal means of helping the unemployment was training and reskilling. No one could expect to receive the benefit (JSA) if they were not actively in work, seeking work, or training to find work. During the first twenty-five years of the welfare state, unemployment was infrequent and unemployment spells short. After the mid1970s, there were changes in the nature of the world economy (globalization) and of the British economy (deindustrialization/restructuring) that made unemployment spells more frequent and longer in each spell. Men in the mid-40s-plus age group found that once unemployed they were


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unreemployable. They were unskilled or semiskilled, and the industries in which they were employed had moved abroad. New jobs were skill-intensive, required literacy, numeracy, and, increasingly, computer literacy. Thus unemployment could become a long-term if not permanent experience. The time of unemployment had to be used to acquire skills that were in demand; some of those skills could be acquired only on the job. If so, these jobs had to be subsidized. From welfare to work was the New Deal. Hence welfare and work are seen not as alternatives but complementary. The timing, however, was fortuitous. The labor market reforms of the Conservative government had weakened trade unions, reduced demarcation (who does what job) disputes, made part-time and temporary work easier to offer and get, and relaxed any constraints on hours worked. The restructured economy came into its own with the shift from manufacturing to services that could use semiskilled and skilled workers of all ages. Information technology and communications created jobs in entirely new fields. Telesales, for example, is a big growth area now employing over a million workers. Thus the job strategy fitted in with the expanding job market. There had also been other changes in the labor force. Many more women had gone back to work than before, and the economic activity rate in the UK is the highest in Europe—28 million workers constitute a 75 percent activity rate in the working-age population. There were new issues for a welfare state to face. One was to make work pay, altering the incentives and especially the disincentives (the taper, for example). Thus the system of deductions had to be modified. The Conservatives had supplemented the incomes of low-paid workers by paying a “family credit.” Labour criticized this when in opposition as a subsidy for bad employers who paid low wages. But now the family credit has been replaced by the Working Family Tax Credit, which will do much the same job; the tax foregone will not count as public expenditure, while family credit did. The incentive to stay out of work is now considerably reduced. The desire to see everyone who can work take up a job led to considerable efforts to make single mothers take up employment. As in the case of youth, there was to be job counseling, training, and mentoring. Single mothers would be discouraged from giving up work if they had once taken it up since they will not be able to get the benefits they previously received. This did lead to much criticism, and some of the harsher penalties were modified. Putting work at the center of welfare reform meant that there was also a poverty alleviation strategy inasmuch as many poor were working but unable to earn enough. There were also families in which neither of the two parents was working, and they and their children were among the poor. Here again, making work pay by working tax credit seems an answer. Poverty is thus alleviated when the poor get back to work and, when working, have their incomes enhanced by tax incentives. This is

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Meghnad Desai

much the way the World Bank or UNDP would tackle poverty in the Third World. Thus the approach is uniform. Rich countries can no more alleviate poverty by handouts at home as they can do the same for the Third World by foreign aid. Self-help is the central principle. Redistribution still remains an issue. Here again, there was an innovative recasting of the redistribution agenda. Normally redistribution is thought of as shifting income from the upper deciles to the lower deciles. But it is possible to look beyond and behind income. By looking at needs in relation to income (i.e., looking at income in terms of equivalence scales), we can recast the problem. Thus poverty is concentrated among households with children relative to households without children at each income level. Therefore, one way to think of redistribution is to transfer income from those without children to those with children. This, of course, can only be done above a certain income threshold. But by integrating this with the income tax system, which has allowances for married couples and for children, all one has to do is alter the concessions so that it is not being married that is important but having children. Thus the money given away in the married couples allowance can be used for couples with children. By being spread across many income deciles, this redistribution does not incite class envy while meeting real needs. These tax concessions have the advantage that they are in one sense universal, but they are also means-tested. Every household with children qualifies—but, of course, only if they are taxpayers. Child benefits, which are truly universal, go to all families—rich or poor. While they are helpful in poverty alleviation, they are also costly. But the political support for universal child benefits has been very strong. Even a proposal to tax child benefits as part of the mother’s income has not had much support. There are highly paid women who receive child benefits, but there are not enough out there to incite jealousy. After floating a few kites, the idea of taxing child benefits was abandoned. This issue of redistribution has, however, caused much trouble among the elderly. The basic state pension is indexed only to retail prices and not to earnings. There has been a demand to revive the earnings link that was there during the Labour government of 1974–79 but was abolished by the Conservative government. There has been a constant battle within the Labour Party with the Labour government about this issue. It has been led by two formidable veterans of the party: Barbara Castle, the cabinet minister responsible in the 1970s for upgrading the pensions, and Jack Jones, who was a powerful trade unionist in the 1970s and 1980s and who now heads the Pensioners movement. They have argued for a restoration of the earnings link for the basic state pension and the revival of the State Earnings Related Pension (SERPS). The government has held out against both proposals. The argument is that SERPS is not only costly but regressive since the high earners get more than the low earners. The earnings link is


21

also costly since basic state pension is universal. While in the 1960s and 1970s the majority of pensioners were poor, now many pensioners have occupational pensions and thus are quite well off. Only a minority of pensioners are poor, but they are a large part of the poor. Thus one needs a targeted strategy. Therefore the government has introduced a Minimum Income Guarantee (a relabeling of Income Support but exclusively for the elderly) that the poor pensioners can take advantage of. This, however, is means-tested since a pensioner has to prove that he or she is poor. There has been a great effort by the government to popularize the scheme, but it has not had many takers. The means-testing stigma is most felt by this generation of pensioners because their parents suffered from it. The political dimension of welfare reform is ever present in such matters. In 1999 the government announced that the upgrading of the basic weekly state pension for the coming year was £.75. This was in one sense a sign of success at having achieved low inflation. But the sum was derisory, especially at a time when the government was boasting that it was flush with money and paying back debt. The political backlash led in November 2000 to a higher upgrading of the pension. Without conceding the principle of price indexing, the increases granted were far above inflation for the next two years (£5.00 per week). The government also provides payments annually for fuel allowance (this was upgraded from £60 to £200), and free TV licenses were given to those over 75 (a £100 subsidy annually). There is no doubt that this is redistributive in the standard sense. Among the elderly (i.e., those over 60), the poorest two deciles will have gained much more (8–9 percent) in their family income than the top two deciles (1 percent) as a result of these latest announcements. Yet the dilemma is poignant, especially for the Labour Party. It believes in universalism, but it would also like to be redistributive. The two can be combined if one has a severely progressive tax system. But since progressive income tax is a political no-go area, a new approach has to be devised. The reform thus abandons universalism wherever better redistribution is achievable by targeting—that is, means testing. (For a recent estimate of the modest redistribution achieved by the Labour government since 1997, see Timmins 2001).

Conclusion Implementing the vision of the Third Way in reforming the welfare state has been a mixture of politics, economics, institutional detail, and a lot of rhetoric. A combination of accepting the reforms already accomplished by the previous government and thinking innovatively about how to change the system without breaking the fiscal constraints has been the hallmark of this strategy. But there is also an element of luck. The UK, like the United States, enjoyed a nine-year boom uninterrupted by a recession till the end of 2000. Such a benevolent economic regime is rare, and it is a result of a

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Meghnad Desai

consensus on macroeconomic management that has not existed since the 1960s. A job creation strategy for welfare reform has worked precisely because the jobs have been there in the private sector. This has to be sustained in the future if the transition from welfare to work is to be permanent. A severe recession may test the system yet. But even so, not all tensions have been resolved. The budgetary straitjacket that has prevailed for the last twenty-five years is proving hard to sustain. There is growing evidence that the containment of welfare spending—especially the cutback in capital spending—has harmed the quality and the capacity of the system to deliver services. In the fourth year of the Labour government, there have been signs of dissatisfaction with this situation. Large increases in spending on health, education, and transport over the next ten years have been announced. These are crucially contingent on the maintenance of a benevolent economic growth regime. Keynes is crucial not only to Beveridge, but also to Blair’s welfare state. But there is also a matter of ambition. One way to look at welfare reform in the UK is to see it as an in-tandem exercise over the last twenty years by the two political parties. The Thatcher years restructured the private or production part of the economy root and branch but held back on the reform of the state provision of welfare beyond containment. Blair has kept the private economy reforms in place and accepted the logic of globalization. He has taken up the task of catching up with the reform of the welfare state. Yet there are risks of success as well as failure. Only in the last five years or so have the citizens of the UK begun not to think of their country as an economic failure. But once that idea gains ground, the old but temporarily abandoned ambitions to create a superb welfare state—a “New Jerusalem” as the rhetoric in the Labour Party goes—will resurface. The safety net has been converted into a trampoline. The universalism of the old model has been contained and restricted to a few benefits only. Redistribution stays on the agenda but as an antipoverty policy, not as an egalitarian program. Work has become the passport to all welfare benefits, but those out of work for perfectly good reasons—students, mothers with young children, caregivers of old and disabled people (also largely women)—are left behind. In valuing paid work, much unpaid work that is crucial to social and family life is unvalued, if not devalued (Desai 2000). Many of these ambitions—for equality, for universality, for a citizenship-based claims system—have been at the heart of the debates in the Labour Party for the last thirty years. In the face of the economic reverses that started in the mid-1970s, the British public gave a carte blanche to its leaders to sort the mess out, while it held back its ambitious demands. Now the economy has been restored to unprecedented strength. This is when the demands will come back on the table. British welfare reform has just completed its first cautious phase. The real radicalism is yet to come.


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References Bacon, R., and W. Eltis. 1976. Britain’s Economic Problem: Too Few Producers. London: Macmillan. Beveridge, W. 1942. “The Beveridge Report Social Insurance and Allied Services.” London: HMSO (Cmnd 6404). ———. 1944. Full Employment in a Free Society. London: Allen and Unwin. Commission on Social Justice. 1994. Social Justice: Strategies for National Renewal—The Report of the Commission on Social Justice. London: Vintage. Desai, M. 1997 “A Proposal for Basic Income.” In R. Skidelsky, ed., The Future of the State. London: SMF. ———. 2000. “Well Being or Wel Fare?” In N. Fraser and J. Hills, eds., Public Policy for the 21st Century (London: Policy Press, 2000), 77–93. DSS. 1998. “New Ambitions for Our Country: A New Contract for Welfare.” London: UK Department of Social Security (Cmnd 3805). Field, F. 1997. Reforming Welfare. London: Social Market Foundation. Fraser, N., and J. Hills, eds. 2000. Public Policy for the 21st Century: Social and Economic Essays in Memory of Henry Neuberger. London: Policy Press. Giddens, A. 1998. The Third Way: The Renewal of Social Democracy. Cambridge: Polity Press. Glennerster, H. 1990. “Social Policy since the Second World War.” In J. Hills, The State of Welfare (Oxford: Clarendon Press, 1990), 11–27. Glennerster, H., and J. Hills, eds. 1998. The State of Welfare: The Economics of Social Spending. Second Edition. Oxford: Oxford University Press. Goodin, R., et al. 1999. The Real Worlds of Welfare Capitalism. Cambridge: Cambridge University Press. Hills, J., ed. 1990. The State of Welfare: The Welfare State in Britain since 1974. Oxford: Clarendon Press. ———. 2000. “Taxation for the Enabling State.” In N. Fraser and J. Hills, eds., Public Policy for the 21st Century (London: Policy Press, 2000), 115–142. Kuhnle, S., ed. 2000. Survival of the European Welfare State. London: Routledge. Lee, S-H, and A. Mason. 2001. “Aging and the Old-Age Support Systems: Issues and Reforms.” Paper presented at EWC-KDI conference, Hawaii, January 2001. Moon, H., and Y. Koh. 2001. “The Korean Pension System: Current State and the Tasks Ahead.” Paper presented at EWC-KDI conference, Hawaii, January 2001. Skidelsky, R. 1997. Beyond the Welfare State. London: Social Market Foundation. Timmins, N. 1996. The Five Giants: A Biography of the Welfare State. London: Harper Collins. ———. 2001. “Labour’s Quiet Redistribution Policy Exposed.” Financial Times, February 12. Townsend, P. 1979. Poverty in the UK. London: Penguin.

2. Welfare Reform in the United States Robert Haveman and John Karl Scholz

There are inevitable tensions among the three primary goals of any nation’s social safety net. These three goals are adequacy (providing a socially acceptable minimum level of living to those unable to attain it on their own), targeting (the provision of support to the neediest at the lowest public cost), and desirable incentives (providing financial and other encouragement for socially desirable behaviors in the structure of programs). Generous programs are costly. Costs can be limited by targeting benefits on the most needy, but doing so implies rules that reduce public support when private income increases, or rules that restrict benefits to those with income or assets below some threshold, or rules that limit benefits to adults with children. Such rules tend to inhibit work, skill development, and asset accumulation and to encourage nonmarital childbearing. Targeting becomes easier if benefits are low, but low benefits may come with the cost of consigning the poor to lives of deprivation. The safety net in the United States has resolved the inherent tensions in a way that is quite different from other industrialized countries. By international standards, the size of the U.S. safety net is small. Moreover, the safety net is composed of many programs, each with different target groups and eligibility requirements. In addition, it has numerous other characteristics that give taxpayers concern. By the late 1980s, American citizens of all political persuasions were calling for reform of this system. The first two sections of this paper briefly describe the key safety net programs in the United States prior to 1996 and the tensions associated with this system. These tensions led to the 1996 Personal Responsibility, Welfare and Opportunity Reconciliation Act (PRWORA). The next two sections of the paper describe and then provide brief appraisals of the two major—and complementary—changes to the U.S. safety net in the past decade: PRWORA and the sharp expansion of the earned income tax credit (EITC). The final section of the paper offers lessons for other countries drawn from the U.S. experience with antipoverty policy.

The Structure of the Social Safety Net in the United States Prior to Reform1 Programs in the U.S. safety net can be broadly broken into two groups: social insurance and means-tested transfers. The distinguishing characteristics of social insurance programs are that they are universal, in that all individuals or their employers make contributions to finance programs and all

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Robert Haveman and John Karl Scholz

people can receive benefits when specific eligibility requirements are met. Most of these programs have dedicated funding mechanisms in which social insurance taxes are remitted to trust funds from which benefits are paid. Means-tested transfers, on the other hand, are financed by general revenues and tend to be categorical, in the sense of being restricted to those who satisfy some set of personal (e.g, single parents) or resource characteristics (e.g., disabled who are poor). All such programs provide benefits only to those judged on income or asset levels to be needy, and they generally reduce public support as recipients’ incomes increase. In most industrialized countries, means-tested transfers have a smaller budgetary cost than social insurance programs. Social Insurance Programs in the United States The largest social insurance program is Social Security, formally known as the Old-Age, Survivors, and Disability Insurance program (OASDI). It is a massive program and pretax-and-transfer poor families receive half of its benefits. Consequently, it has a major effect on poverty rates among the elderly and disabled who are the primary beneficiary groups. The elderly receive the bulk of cash benefits from social insurance. Aggregate retirement income payments were $334.4 billion in 1999 and averaged $750 per month for a retired worker ($1,300 for couples). The elderly also receive substantial benefits from Medicare (hospital insurance and for some households, supplementary medical insurance), which covers almost all people over age 65 and most people under 65 who are receiving Social Security disability benefits (DI). Real Medicare outlays have increased more than tenfold from $16.9 billion in 1967 (the year the program started) to $233.4 billion in 1999 and averaged over $5,800 per enrollee in 1998. In recent years, the elderly have typically received between 85 and 90 percent of all payments for both Medicare and Social Security.2 Three smaller social insurance programs, Unemployment Insurance (UI), Workers’ Compensation, and Disability Insurance (DI), target primeage workers. Unemployment Insurance ($21.4 billion in 1999) provides temporary and partial wage replacement to recently employed workers who become involuntarily unemployed. Workers’ Compensation ($42.6 billion in 1998) provides cash and medical benefits to some persons with job-related disabilities or injuries, as well as to their survivors. Disability Insurance (DI) ($51.3 billion in 1999) is part of the OASDI program and provides income support to covered workers who are permanently and totally disabled.3 Over time, the enormous increase in the aggregate value of the five social insurance programs has been driven largely by increases in Social Security and Medicare.

Welfare Reform in the United States

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Means-Tested Transfer Programs in the United States Medicaid ($188.8 billion in 1998) is the largest means-tested transfer program, providing medical assistance to low-income persons who are aged, blind, disabled, members of families with dependent children, and certain other pregnant women and children. Asset and income tests that vary across states determine eligibility. Supplemental Security Income (SSI, $29.7 billion in 1999) is a federally funded but state-administered meanstested safety net program for the aged, blind, and disabled whose income and assets are below threshold levels. The disabled comprise nearly 80 percent of SSI recipients. Aid to Families with Dependent Children (AFDC) was the central safety net program for poor families with children from 1936 to 1996, and it was the primary target of the 1996 welfare reform. This program was directed at single-parent families, though some two-parent families with an unemployed parent also received benefits. The program was a meanstested entitlement, meaning that all applicants whose income and assets were below the stipulated levels could receive benefits. States determined benefit generosity that varied widely, and states and the federal government shared the costs of the program according to a federal matching formula. AFDC benefits were $24.1 billion in 1995. Expenditures for its postreform successors are difficult to determine, but they appear to be around $13.4 billion, reflecting the precipitous drop in welfare caseloads over this period. The largest federal cash or near-cash antipoverty program is the Earned Income Tax Credit (EITC). Since its introduction in 1975, the EITC has been expanded in Republican and Democratic administrations. The credit’s most rapid growth has occurred in the last fifteen years, with phased-in expansions legislated in 1986, 1990, and 1993. The EITC is administered through the federal personal income tax and is directed primarily to working poor and near-poor taxpayers with dependent children. In 1999, taxpayers with two or more children could get a credit of 40 percent of income up to $9,540, for a maximum credit of $3,816. Taxpayers (with two or more children) with earnings between $9,540 and $12,460 receive the maximum credit. Their credit is reduced by 21.06 percent of earnings between $12,460 and $30,580 (Table 2.1 lists the evolution of EITC parameters since the inception of the credit). The credit is refundable, meaning that if the EITC exceeds the taxpayer’s other liabilities, the U.S. Treasury writes a check to the taxpayer for the difference. In fiscal year 1999, the credit cost $31.9 billion, providing support to 19.5 million taxpayers. In comparison, the credit cost roughly $3.8 billion in 1975 (in 1999 dollars) and gave benefits to 6.2 million taxpayers. Two other major means-tested programs are the Food Stamps program ($15.8 billion in 1999) and housing assistance ($27.6 billion in 1999). Food

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Table 2.1. Earned Income Tax Credit parameters, 1979–99 (in nominal dollars) Year

Phase-in Rate (%)

Phase-in Range

Maximum Credit

Phaseout Rate (%)

Phaseout Range

1975–78 1979–84 1985–86 1987 1988 1989 1990 1991a

10.0 $0–$4,000 $400 10.0 $4,000–$8,000 10.0 0–5,000 500 12.5 6,000–10,000 11.0 0–5,000 550 12.22 6,500–11,000 14.0 0–6,080 851 10.0 6,920–15,432 14.0 0–6,240 874 10.0 9,840–18,576 14.0 0–6,500 910 10.0 10,240–19,340 14.0 0–6,810 953 10.0 10,730–20,264 16.71 0–7,140 1,192 11.93 11,250–21,250 17.32 1,235 12.36 11,250–21,250 17.61 0–7,520 1,324 12.57 11,840–22,370 1992a 18.42 1,384 13.14 11,840–22,370 a 1993 18.51 0–7,750 1,434 13.21 12,200–23,050 19.52 1,511 13.93 12,200–23,050 1994 23.61 0–7,750 2,038 15.98 11,000–23,755 30.02 0–8,245 2,528 17.68 11,000–25,296 7.543 0–4,000 306 7.65 5,000–9,000 1995 34.01 0–6,160 2,094 15.98 11,290–24,396 36.02 0–8,640 3,110 20.22 11,290–26,673 7.653 0–4,100 314 7.65 5,130–9,230 1996 34.01 0–6,330 2,152 15.98 11,610–25,078 40.02 0–8,890 3,556 21.06 11,610–28,495 7.653 0–4,220 323 7.65 5,280–9,500 1997 34.01 0–6,500 2,210 15.98 11,930–25,750 40.02 0–9,140 3,656 21.06 11,930–29,290 7.653 0–4,340 332 7.65 5,430–9,770 1998 34.01 0–6,680 2,271 15.98 12,260–26,473 40.02 0–9,390 3,756 21.06 12,260–30,095 7.653 0–4,460 341 7.65 5,570–10,030 1999 34.01 0–6,800 2,312 15.98 12,460–26,928 40.02 0–9,540 3,816 21.06 12,460–30,580 7.653 0–4,530 347 7.65 5,670–10,200 Source: 1998 Green Book, Committee on Ways and Means, U.S. House of Representatives, U.S. Government Printing Office, 867. 1998 and 1999 parameters come from Publication 596, Internal Revenue Service. Notes: a. Basic credit only. Does not include supplemental young child or health insurance credits. 1. Taxpayers with one qualifying child. 2. Taxpayers with more than one qualifying child. 3. Childless taxpayers.


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Stamps are designed to enable low-income households to purchase a nutritionally adequate low-cost diet. The program is the country’s single, almost-universal entitlement for those with low income and assets.4 Housing aid is primarily a federal government function, and comes through public projects rented to low-income families and via income-conditioned subsidies for securing private rental housing. Waiting lists for support are common in housing programs.5 Public Expenditures on Safety Net Programs Figure 2.1 summarizes the evolution of spending on social insurance and means-tested transfers. The cost of social insurance—the largest category—has risen steadily because of rapid increases in the cost of social security and Medicare. Total social insurance expenditures (in real dollars, excluding Workers’ Compensation because of data limitations) rose at an annual rate of 6.9 percent in the 1970s, 3.1 percent in the 1980s, and 4.0 percent in the 1990s (through 1998). The bottom two lines of Figure 2.1 show total spending on in-kind transfers (without Medicaid, which is roughly the same size as the combined value of the other in-kind transfers) and cash transfers. In-kind transfers (including Medicaid) grew at an annual rate of 12.3 percent in the 1970s, 3.7 percent in the 1980s, and 8.9 percent in the 1990s. Cash transfers—the sum of AFDC/TANF, the Earned Income Tax Credit (EITC) and SSI—grew at an annual rate of 4.7 percent in the 1970s, 1.8 percent in the 1980s, and 4.2 percent in the 1990s.

(dollars) 800,000 700,000 600,000

Social Insurance w/o WC Cash Transfers In Kind, no Medicaid In Kind, w/Medicaid Social Insurance w/WC

500,000 400,000 300,000 200,000 100,000 0 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 1985 1984 1983 1982 1981 1980 1979 1978 1977 1976 1975 1974 1973 1972 1971 1970

Year

Figure 2.1. Total social insurance, cash, and in-kind means-tested transfers (1999 dollars)

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The Reform of Safety Net Policy in the 1990s For many years there was widespread dissatisfaction with one key component of the safety net-the AFDC program, which was known as “welfare.” Figure 2.2 plots the responses to a question drawn from the General Social Survey (GSS), a large and regular household survey.6 The question is: We are faced with many problems in this country, none of which can be solved easily or inexpensively. I’m going to name some of these problems, and for each one, I’d like you to tell me whether we’re spending too much money on it, too little money, or about the right amount. Are we spending too much money, too little money, or about the right amount on . . . The two lines beginning in 1973 highlight Americans’ schizophrenic attitudes toward the safety net. They plot the percentage of respondents saying “too little on welfare” (the bottom series) and “too much on welfare” (the top series). In 1984, the GSS started asking an identical question on “assistance to the poor.” The lowest line (that starts in 1984) shows the percentage that says we are spending “too much on assisting the poor.” The highest line (that starts in 1984) shows the percentage that says we are spending “too little.” The GSS responses are striking. First, a near majority of respondents appear to simultaneously believe we are spending too much on welfare

(percent) 80 70 60 50 40 30 20 10 1996

1994

1993

1991

1990

1989

1988

1987

1986

1985

1984

1983

1982

1980

1978

1977

1976

1975

1974

1973

0

Year Too little on welfare Too much on welfare

Too little on assisting poor Too much on assisting poor

Figure 2.2. Public attitudes on welfare and assistance to the poor: GSS data (no survey in 1979, 1981, 1992, or 1995)


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and too little on assisting the poor. The conflicting responses to welfare and assistance to the poor highlight tensions that arise when crafting the safety net between an instinct to help disadvantaged families and an unwillingness to do so through welfare programs. Second, there was a sharp increase, starting in 1993, in the percentage of respondents who said spending on welfare was too high. The increase coincides with President Clinton’s 1992 campaign pledge to “end welfare as we know it.” There was a comparable decline in the percentage of respondents who said we were spending too little. These patterns both influence and are influenced by public debates, but they document Americans’ longstanding antipathy toward welfare. Many factors probably contribute to Americans’ dislike of welfare. The first is the stubborn persistence of poverty, despite years of antipoverty spending. Figure 2.3 shows trends in the official (cash income) measure of poverty for persons older than 64, children under 18, persons 18 to 64, and for the full population.7 Poverty rates for children are very high-nearly 20 percent of children are being raised in a poor family.8 The 1998 child poverty rate (18.9 percent) is only 8.4 percentage points lower than the 1959 child poverty rate and is almost 5 percentage points higher than its lowest point in the late 1960s and early 1970s.9 The second pressure point on the social safety net is the perceived disintegration of the American family. Figure 2.4 shows the sharp upward trend in the fraction of U.S. children being raised in single-parent families. While research has found, at most, a minor link between welfare benefits and the prevalence of single-parent families, the welfare system in the (percent) 36 32 28

Full Population Children