How are you doing? Are you happy? Do you believe you have had adequate opportunities in your life to maximize your potential? Are you able to afford your basic needs, such as housing and health insurance? These and other elements make up our well-being.
In economics, we refer to the well-being of a society as its welfare. Did you know that the quality of welfare can change a lot about the economic possibilities we all experience? Don't believe me? Read on to see how welfare in economics affects us all!
Welfare Economics Definition
What is the definition of welfare in economics? There are a few terms that contain the word "welfare", and it can be confusing.
Welfare refers to the well-being of an individual or group of people. We often look at different components of welfare such as consumer surplus and producer surplus in the buying and selling of goods and services.
When it comes to social welfare programs, the government gives a payment to people who are in need. People who are in need are generally living below the poverty line, and require some assistance to help them pay for basic necessities. Most developed countries have some sort of welfare system; however, what varies is how generous that welfare system will be to people. Some welfare systems will offer more to their citizens than others.
Welfare economics is a branch of economics that looks at how welfare can be enhanced.
Welfare is defined as the general well-being and happiness of people.
Welfare analysis in economics looks at components of welfare such as consumer surplus and producer surplus in economic transactions of goods and services.
Therefore, economists will generally look at common welfare programs and see who are the recipients and whether their well-being is being improved. When a government has many welfare programs for its citizens, it is typically referred to as a welfare state. There are three general goals of a welfare state:
Alleviating income inequality
Alleviating economic insecurity
Increasing access to healthcare
How are these goals achieved? Typically, the government will provide aid to low-income individuals and families to relieve the hardships that they face. People who receive aid in the form of transfer payments or benefits will generally be under the poverty line. Specifically, the United States has many programs designed to help low-income individuals and families who are in poverty.
Some examples of welfare programs in the United States are the following: Supplemental Nutritional Assistance Program (commonly known as food stamps), Medicare (healthcare coverage for the elderly), and Supplemental Security Income.
Many of these programs are quite different from one another. Some require individuals to meet a certain income requirement, some are given as money transfers, and some are social insurance programs. As you can see, there are a lot of moving parts that must be accounted for when analyzing social welfare programs!
Economics of Social Welfare
Welfare and its surrogates receive a lot of political scrutinies as it's very easy to find some aspects of its aid unfair to others. Some people might say "why are they getting free money? I want free money too!" What effects does it have on the free market and the large economy if we do or don't help? Why do they even need help, to begin with? To find answers for these questions, we need to understand the economics of social welfare.
The free market, fueled by intense competition has provided society with innumerable wealth and amenities. Intense competition forces businesses to provide the best at the lowest prices. Competition requires someone to lose for another to win. What happens to the businesses that lose and don't make it? Or the workers who were laid off so a company could become more efficient?
So if a competition-based system requires losses, what is to be done about those unlucky citizens who experience it?Moral arguments can be made about the reason for forming societies to collectively alleviate suffering. That explanation may be good enough for some, but there are actually valid economic reasons for doing so as well.
The Economic case for welfare
To understand the economic reasoning behind welfare programs, let's understand what happens without them. Without any assistance or safety nets, what happens to laid-off workers and failed businesses?
Individuals in these circumstances must do whatever it takes to survive, and without an income, that will include selling assets. Selling assets such as a car can generate a short burst of income to cover food costs, however, these assets provide utility to the owner. The number of available jobs is directly tied to your ability to access those jobs. In North America, this means that you have to drive to the job in most cases. Suppose that people have to sell their cars to make ends meet, the ability of workers to commute will then depend on public transit and friendly city design. This new limitation to the movement of labor will hurt the free market.
If individuals experience homelessness, they suffer immeasurable mental health problems that degrade their abilities to hold a job and work effectively. Additionally, without a house to rest safely, individuals will not be physically rested enough to work effectively.
Lastly, and most importantly, we must consider the costs the economy pays as a result of allowing poverty to run out of control. Lack of opportunity and deprivation of basic resources are some of the biggest causes of crime. Crime and its prevention are a massive cost to an economy, one that directly inhibits our efficiency. Not to mention that when convicted of crimes, we send people to jail where society now has to pay for all their living expenses.
Everything can be best understood by viewing its trade-offs.
Consider two scenarios: no welfare support and robust welfare support.Scenario A: No welfare support
No funds are allocated to social programs. This decreases the tax revenue the government is required to take in. A reduction in taxes will increase economic growth, increasing the growth of businesses and investments. More jobs will become available, and business opportunities will increase with a reduction in overhead costs.
However, citizens who fall on hard times will have no safety nets, and homelessness and crime will increase. Law enforcement, judiciaries, and prisons will expand to accommodate the increase in crime. This expansion of the penal system will increase the tax burden, reducing the positive effects created by the tax decrease. Every additional job required in the penal system is one fewer worker in the productive sectors.Scenario B: Robust welfare support
First and foremost, a robust welfare system will increase the tax burden. This tax burden increase will discourage business activities, reduce the number of jobs, and slow economic growth.
A robust safety net that is effectively implemented can protect individuals from losing their productive capacity. Real affordable housing initiatives can eliminate homelessness and lower overall costs. Reducing citizens' suffering experience will remove an incentive that leads people to commit crimes. Reductions in crime and prison populations will lower the overall cost of the penal system. Inmate rehabilitation programs will change the inmates from being fed and housed by tax dollars. To have them work jobs that allow them to pay taxes into the system.
Impact of Welfare
Let's go over the impact of welfare programs in the United States. There are many ways one can measure the impact that welfare has had on the United States.
Looking at Table 1 below, the funds allocated to social expenditures are listed as a percentage of GDP. That is a way to quantify how much a country spends against how big the country's economy is and what it can afford to spend.
The Table indicates that compared to other developed nations, the United States spends the least on social expenditures. Consequently, the poverty reduction effect of the welfare programs in the US is much lower than the welfare programs in other developed nations.
Country | Social Expenditures on non-elderly (as a percentage of GDP) | Total percent of poverty reduced |
United States | 2.3% | 26.4% |
Canada | 5.8% | 65.2% |
Germany | 7.3% | 70.5% |
Sweden | 11.6% | 77.4% |
Table 1 - Social expenditures and poverty reduction1
If perfect information was available for all economic activities we could isolate the costs incurred and costs avoided as a result of alleviating poverty. The best use of this data would be to compare the costs of the social expenditures, to the recovered efficiency created by poverty reduction. Or in the United States case, the lost efficiency as a result of poverty incurred in exchange for not allocating more funds to social expenditures.
One of the most popular welfare programs the United States has is Social Security. It provides a guaranteed income to all citizens over the age of 65.
In 2020, Social Security lifted over 20,000,000 people out of poverty.2 Social Security is seen as the most effective policy for reducing poverty.2 This gives us a good initial look at how welfare can positively impact citizens. However, we must note that this is just one program. What does the data look like when we view the impact of welfare in aggregate?
Now, let's look at the overall impact of welfare programs in the United States:
Fig. 1 - Poverty Rate in the United States. Source: Statista3
The chart above shows the poverty rate in the United States from 2010 to 2020. Fluctuations in the poverty rate are caused by significant events, such as the 2008 financial crisis and the 2020 COVID-19 pandemic. Look at our example above on social security, we know that 20 million individuals are kept out of poverty. That is approximately 6% more of the population that would be in poverty without it. That would make the poverty rate in 2010 nearly 21%!
Example of Welfare in Economics
Let's go over examples of welfare in economics. Specifically, we will look at four programs and analyze the nuances of each one: Supplemental Security Income, food stamps, housing assistance, and Medicare.
Example of Welfare Programs: Supplemental Security Income
Supplemental Security Income provides aid to those that are unable to work and cannot earn an income. This program is means-tested and provides a transfer payment for individuals. A means-tested program requires people to qualify for the program under certain requirements, such as income.
Means-tested requires people to qualify for a program under certain requirements, such as income.
Example of Welfare Programs: Food Stamps
The Supplemental Nutritional Assistance Program is commonly known as food stamps. It provides nutritional assistance to low-income individuals and families to guarantee access to basic food necessities. This program is means-tested and is an in-kind transfer. An in-kind transfer is not a direct money transfer; instead, it is a transfer of a good or a service that people can use. For the food stamps program, people are provided a debit card that can only be used to purchase certain food items. This differs from a money transfer since people cannot use the debit card for anything they want — they must purchase what the government allows them to purchase.
In-kind transfers are a transfer of a good or service that people can use to assist themselves.
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