Does social security spending protect the economy?

It was once received wisdom in economic theory that social security had a beneficial effect on the economy, because it increased at times when demand was deficient. This is from a book published in 1960, Richardson’s Economic and Financial Aspects of Social Security (I have it on my bookshelf):
“The two main benefits that fall in prosperity and rise in depression are unemployment insurance and public assistance payments. They put a brake on books and reduce the severity of depressions. … If social security benefits are paid, business will not decline as far as it otherwise would.”

I referred to this argument briefly in a recent interview, and a note from Adrian Sinfield has encouraged me to look at it a little further. A couple of days ago, the IMF conceded that it has got the multipliers wrong – the extent to which changes in government spending stimulate or depress the economy. (The issue is explained on the TUC’s Touchstone website.) The multipliers are probably between 0.9 and 1.7; they were formerly assumed to be 0.5-0.6. If government spending stimulates the economy, it needs to be increased during a depression; cuts lead to economic decline. The multipliers say how big the effects are. And the size of the error means IMF has been underestimating both the benefits of increased spending, and the harm to the economy caused by cuts.

Social security benefits are not, however, quite the same as public spending – treating them as if they were is one of the central confusions of current policy. Most are transfer payments, meaning that someone gets money which otherwise someone else would have had. Transfer payments should be assumed in the first place to be neutral; they stimulate the economy if the people who receive are more likely to spend it than the people who are paying. It’s likely that this condition will be met, because people on very low incomes can’t save, but the effect is not the same as either government spending financed in other ways, or as spending on infrastructure. Spending money on unemployment assistance makes a modest contribution to stabilisation; spending it on public works or job creation stimulates the economy far more.

One comment

  1. Regina Serpa

    There is an important economic theory that is touched upon here that I would like to elaborate on called utilitarianism. Spicker states that the rationale behind income redistribution is to transfer money from one person who may not spend or save it to someone that will and would otherwise been unable to spend or save. The concept of ‘utility’ goes one step further explaining that monetary value is not the same for everyone. For instance, if I give 20 pounds to Bill Gates I may not even have bothered. What is Bill Gates going to do with 20 pounds? What utility does Bill Gates assign to 20 pounds? The answer to both questions- not much. But, if you give that 20 pounds to someone who is struggling to make ends meet, they assign a much higher utility to that 20 pounds and therefore they can do a lot more with it, like purchase food they need and was previously unable to get.
    Unfortunately, fiscal conservatives have a well rehearsed argument against utilitarianism. For example, the reason why the tax system is so regressive in the US (the more you earn the less proportionate tax you pay) is that wealthier people can maximise the economic value of money- they can invest it, whereas poorer people would just spend it. They would argue that economic value trumps all other types of utility. But, this logic becomes self-defeating as an economic policy and you only need to look at the US to see why this race to the bottom- who can offer the most incentives, lower taxes and less regulation- fails when taken to its ultimate conclusion.

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