Welfare State vs. Market Forces in a Globalization Era
Globalization radically changes income distribution and triggers intense international tax competition. Therefore, globalization entails an extensive restructuring of the welfare state. We analyze a parsimonious model of an open economy, in its trade and finance transactions with the rest of the world, governed by voter-majority-controlled welfare state. We analyze the interactions between taxation, provision of social benefits, and globalization. We demonstrate how these interactions are grounded on trade-related and macro-related fundamentals, familiar from a standard open-economy model:
(i) Degree of trade border frictions, (ii) Degree of international finance frictions, (iii) Relative factor abundance that determines the capital intensity of the country’s exports; and, (iv) Domestic savings and productivity of domestic investment, which determines whether the country is a financial capital exporter or importer.
We address the issues of whether the welfare state enhances (or inhibits) the trade and financial openness driven by diminished border effects; whether globalization chips away at the generosity of the welfare state; and, whether the welfare state efficiently spreads out the gains from globalization from winners to losers.
The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.