With groups bemoaning social welfare as a cause of the economic crisis, Graeme O Meara examines the relationship between social welfare and the wider economy

Some have hailed Obama’s victory as a victory for macroeconomics: we are likely to see subdued austerity and job targeting through fiscal stimuli over the coming four years. It is interesting to look at the effect of government benefits on unemployment and the recession; conventional economic theory, as I have previously mentioned, suggests that taking money out of a weak economy only serves to make things worse, people have less to spend, and this puts firms out of business, thus deepening the recession. At the other end of the spectrum is the idea that overly grandiose social transfers to support the unemployed through hardship may in fact distort people’s incentives to return to work. An optimal government policy would strike a balance between benefits (fiscal expenditure) and costs (taxation).

In good times, such as the Celtic Tiger years, there was plenty of money to throw to social welfare because it was funded by high revenues accruing from property related taxes. But now that there is a squeeze on finances, should we ditch these lavish social welfare payouts? If an unemployed individual receives a weekly stipend from the government, as well as associated ‘off the job’ perks such as fuel/rent allowances, medical cards, education allowances for siblings and exemption from taxes and social charges, where is the incentive to return to work? If the next best alternative is a minimum wage job, without all these benefits, what’s the point in returning to the labour force?

Of course, this is a very simplistic picture I’ve painted; add in labour market immobility and structural difficulties of finding a job and the scene becomes much murkier. A recently unemployed architect’s next best alternative is unlikely to be McDonalds. In some cases however, minimum wage has been the next best alternative. Does anyone remember the massive line outside Londis on Stephen’s Green? Some pundits have thus argued that it is this supply side issue which is causing the recession.

For non-economists who are fortunate enough to be able think sanely, economic thought is sharply divided on a multitude of issues. For example, in the US, economic theorists scattered among some of the Ivy League universities along the east coast are known as ‘saltwater’ economists, while their inland counterparts such as Chicago, Minnesota and Michigan are known as ‘freshwater’ economists. Saltwater (left wing) economists derive from Keynes and like to blame recessions on a deficiency of aggregate demand, while freshwater (right wing) economists are supply-siders, deriving from the likes of Milton Friedman and celebrated their heyday when Ronald Reagan took office in 1980. The University of Chicago is considered the epicentre of this freshwater school of thought and they argue that cushy welfare payouts create a disincentive for the unemployed to take up employment. Casey Mulligan of the University of Chicago recently blamed Keynesian policies (expansionary fiscal policies, e.g. stimulus packages) as the root cause of this recession: “in a matter of a few quarters of 2008 and 2009, new federal and state laws greatly enhanced the help given to the poor and unemployed, from expansion of food-stamp eligibility to enlargement of food-stamp benefits to payment of unemployment bonuses, sharply eroding (and, in some cases, fully eliminating) the incentives for workers to seek and retain jobs, and for employers to create jobs or avoid layoffs.”

Proponents of this theory postulate that if countries continue to engage in fiscal expansions, it will serve to aggravate the situation even more by disincentivising work. In a snippet of his new book, Mulligan details the finances of an archetypal American family hit by unemployment. He also points to entire industries that slashed payrolls while experiencing little or no decline in production or revenue, documenting a disconnect between employment and production that occurred during the recession. Could it be that the safety net of government benefits encouraged firms to lay off workers? And falling national income is the result of lazy unemployed people? It is interesting to recall that earlier this year, our very own ESRI published a working paper which showed using data that 44% of Irish unemployed workers with families are in fact better off on the dole. This was particularly controversial and the think tank swooped quickly to remove the paper from public access and issue a statement that the methodology employed in the analysis was flawed. However, author Richard Tol has confirmed that the method employed was as robust as ever.

Nobody is advocating that in Budget 2013 we cut all support lines to unemployed workers, who wants to see 14.5% of the population impoverished and living in misery? However, many of these arguments, when examined in detail are in fact very compelling. At any point in time, there will always be a small proportion of the labour force ‘sponging off the system’; this is characteristic of any society. However, it becomes problematic when a potentially larger proportion is ‘sponging.’ When the Celtic Tiger returns and the money is rolling again, we will consider these incentives and what can be done to alleviate ‘spongers.’