A Welfare State or a Start-up Nation?

Who you vote for in the next election will largely be determined by how you answer the following question: Should we encourage more productive use of resources or more social welfare? Higher taxes to support a larger welfare state means a larger share of national resources pay for a Medicare system that everyone recognizes as expensive and inefficient. More spending reduction, especially for Medicare and Medicaid, allows a more productive use of resources for growth.

Rep. Paul Ryan's proposed budget--which would cut $6.2 trillion in spending from President Obama's budget over the next 10 years--is a great step in that direction. Mr. Obama has chosen to campaign for re-election as the defender of the welfare state and a woefully inefficient health-care system.

Neglecting the benefits of using resources more productively misses one of the main economic lessons of the past half century. Transfers, grants and redistribution did little to raise living standards in Asia, Latin America and Africa. Capitalist development and open economies lifted vastly more people out of poverty in a decade than welfare state policies had achieved in 50 years. Japan in the 1950s began to force its producers to compete in world markets. That forced its firms to use resources more productively. Korea, Taiwan, Hong Kong, Singapore and eventually China and India followed the Japanese growth model. Chile was an early successful convert; now we have Brazil and parts of Africa.

The lesson applies here in the U.S as well. The welfare of the citizens--poor, middle-class and wealthy--is best improved by using resources more productively. Of course, increased productivity isn't an instant cure for what ails us; there is no instant cure. Administration and Federal Reserve policies have tried mightily, and wastefully, to get quick gains--with few results to show. Despite near-zero interest rates and almost a trillion dollars in "stimulus" spending, unemployment remains stuck at 9% and a true recovery is elusive.

The Obama administration argues that the economy would have been much worse without its actions. But progress would have been far greater by now if the administration had simply copied the successful Kennedy and Reagan policies and permanently cut marginal income tax rates while eliminating burdensome regulations. Instead, the administration is promising higher taxes while regulation has increased and become even more arbitrary. Investment and productivity wilt under heightened uncertainty about future returns.

Mr. Obama and his followers claim they want a solution that is "fair." Why is it fair to distribute more welfare to today's voters at the expense of their children and grandchildren who will pay for this less productive use of resources? This is the same "fair" approach that Europeans chose decades ago, and which led to chronic low growth and high unemployment.

After 1990, France, Germany and Italy gave up the goal of bringing their per capita incomes to equality with the U.S. Germany spread its welfare state to the east. Italy and France pushed redistribution and fairness. From 1990 to the start of the crisis in 2006, the U.S. economy grew on average 1% a year faster than France, Germany or Italy, according to the Organization for Economic Cooperation and Development. After one generation, a one percentage point difference in growth rate becomes a 25% difference in per-capita income. Low growth significantly lowers real wages and living standards for everyone, which in turn lessens tax receipts and resources for redistribution.

As in the U.S., wealth accumulation in post-Thatcher Britain and pre-crisis Ireland also showed that gains in living standards from productivity growth more than compensate for limiting redistribution. The reaction in France is that Ireland should not have the lower tax rates that fostered investment and productivity growth. Is that fairness or envy?

It isn't fair to tax future generations just because they can't vote. We have a choice between a brighter future for our descendants and more social spending now. The missing words "more productive use of resources" are critical for a rational choice. To realize the promise that the U.S economy has always offered, we must choose less social spending, less intrusive regulation, and more efficient use of resources in both the public and private sectors.

Allan H. Meltzer is a visiting scholar at AEI.

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