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The Rise of the Socialist Welfare State by Sven R. Larson

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The Rise of the Socialist Welfare State

Many countries in Europe are stuck in perennial economic stagnation, with systemic problems that they do not seem to be able to break free from. I have pointed to several examples: Portugal, Spain, Greece, and Germany, but also the European Union as a whole

There are exceptions to the trend of stagnation, one being Hungary with its strong economy. The Hungarians have also reconfigured their welfare state in a conservative direction, a point that is important in the context of how well the country’s economy performs in comparison to almost every other in Europe.

Economic stagnation has many causes, with the euro-zone structure being one of them. Its influence, however, is limited compared to that of the socialist welfare state. Over a period of decades, this socio-economic structure has reconfigured the economies of Europe (and to a slightly lesser extent North America) and become so entrenched that it is now taken for granted. 

Even Switzerland, known historically for small government and low taxes, has its own version of socialist welfare. Universal political consensus has washed away any doubts about whether or not government should engage in all the spending that comes with the welfare state: single-payer health care, income security for families, retirement security, child care, etc. 

Not all welfare states are socialist in nature though; the Hungarian version has strong conservative character traits, and there are still other countries that demonstrate less systemic deviations from the standard socialist template. The health-insurance reform in the Netherlands is a good example: a decade and a half ago, private insurance plans took over the responsibility for 75% (later almost 80%) of the funding for Dutch health care. The reform had measurably positive effects on the quality, accessibility, and cost of health care.

As Gøsta Esping-Andersen has explained (The Three Worlds of Welfare Capitalism, Princeton, 1990), there is an intricate system for classifying welfare states ideologically. However, even its most rigorous application leaves most of Europe with welfare states that are entrenched in the socialist tradition. 

How did this happen? How did Europe end up with some of the largest governments in the world?

The answer to this question is an intriguing story of intellectual prowess and ideological fervor. It is a story that is essential to understand for anyone interested in helping Europe break free of its shackles of economic stagnation. 

Social democracy goes to work

In the early 20th century, the socialist movement in Europe stood at a watershed: follow the Leninist, revolutionary path to socialism, or accept the peaceful gradualism of political progress offered by parliamentary democracy. 

The choice was not new. Socialist movements all over Europe had been debating reform vs. revolution since the Paris Commune in 1871. The reformists long held the upper hand, relying on such prominent names as Eduard Bernstein, a German socialist advocating peaceful progress. Social democrats formed parties in many European countries with the aim to win elections—and to show that socialism provided a peaceful path to progress. 

As parliamentary democracy evolved into the early 20th century, the reformists began slowly seeing progress. Unfortunately, World War I, or the “Great War” as it was called at the time, tipped the scale in revolutionary favor: the Soviet Union provided revolutionary socialists with a full-scale example of their success. 

In the years after World War I into the early 1920s, little was known about the atrocities of the Soviet regime. The revolutionaries were emboldened; the reformists clamored for systematic policy solutions of a caliber that could peacefully put socialism to work. Bluntly, their problem was a gap between their ideology and the toolbox of legislative initiatives that would manifest their progress. 

A plethora of new ideas were born, with politics and academia cross-breeding in ways that may seem strange to the 21st century student of public affairs. 

On the political front, reformist efforts gravitated toward political parties known as “social democrats.” Those parties, which came to define the pursuit of systemic socio-economic reforms, predominantly had their roots in the late 19th century and were, at least in the Nordic countries, closely affiliated with the labor union movement. Concentrating on issuing parliamentary reforms that advanced socialism, the social democrats gained considerable political credibility. 

It is a thesis in itself to account for the rich literature, both scholarly and political, that carried social democracy to the forefront of the European political landscape. Generally speaking, though, the work of the social democrats to peacefully implement socialism was timely in one sense: it coincided with the economic depression immediately after World War I and, even more so, with the deeper and more devastating depression of the 1930s. 

Two branches of thought, one policy solution

The literature that, in various forms, carried the welfare-state idea forward, breaks down into two branches:

  • One that springs from political economy. This literature was primarily concerned with economic crises, especially depressions, and how to break free of those crises.
  • The other is defined by socialist political theory and is therefore concerned with what is known in modern parlance as “economic inequality.”

These two branches, formally independent as they are, became interconnected and created synergetic effects in terms of policy reforms. Politics and academia overlapped, with cross breeding between the two environments: it was not unusual to see scholars pursue political office, bringing their academic background into legislative work. At times, they also returned to the academic world, influencing scholarly research with what the harsh reality of policy making had taught them.

In terms of political economy, research that came to favor the welfare state emerged primarily in Britain and Sweden. John Maynard Keynes became the best known among the Brits, emerging as the poster child of welfare-state economics. His status was both unintended and undeserved: both Keynes—and others close to his line of thinking in economics—were appalled at the social and economic consequences of the depression that struck after World War I. Out of a policy-oriented debate in the 1920s came a body of thought which was ripe and ready for systematic application right as the Great Depression struck. Their goal, albeit not always explicit, was to insulate the economy against depressions in the future.

Simultaneous with the advances in political economy, socialist reformists were on the lookout for new policy solutions of a more systemic character than had been attempted before the establishment of the Soviet Union. Their concern was not with managing business-cycle swings, as much as it was with legislating away economic inequality. Their reasoning was logical—from a socialist viewpoint: according to Marxist theory, recessions and, especially, depressions are inevitable under capitalism. By creating the means to redistribute income, consumption, and wealth, the social democrats hoped to gradually weaken the forces of capitalism and, the argument went, the impact of economic crises on people’s lives. 

Over time, these two branches of socio-economic reformist thought approached a policy solution that we today know as the welfare state. Figure 1 offers a schematic explanation:

Figure 1

Misrepresenting Keynes

The policy solutions that came to fruition in the socialist welfare state have often been said to be inspired by Keynesian economic theory. This was partly true in the early stages of the welfare state’s evolution. But over time, considerable distance has evolved between the economic practice of welfare-state policy and the Keynesian foundation upon which it is said to stand. 

As mentioned, Keynes did not deserve to be branded as a welfare-state economist. His original theory is often misrepresented in modern literature: while conventional wisdom suggests that Keynes developed a theory of how to manage business cycles, his actual contributions as seen in (primarily, but not solely), The General Theory of Employment, Interest and Money, were concentrated on how to pull an economy out of a depression. 

There is a considerable difference between sparing a society from depression and maintaining business cycles. When government is given an active role in ending a depression, it does not automatically—or even desirably—have any other economic role to fill. While Keynes often persuasively argued for active fiscal policy in general terms, he never made the analytical case for a government that continuously intervenes in the economy. 

The idea of a government that continuously stabilizes the business cycle, which has been attributed to Keynes, is for the most part newer than him. The only contributions contemporary with Keynes came from the so-called Stockholm School of Economic Thought (not to be confused with the business college Stockholm School of Economics). It became influential in terms of policy only years after the publication of Keynes’s major work. While inspired by Keynes, crucial members of the Stockholm School formulated the thesis that government not only could, but ought to have a permanent presence in the economy. The goal, they said, was to ease recessions and moderate growth periods.

The problem for the Stockholm School was that for government to successfully stabilize the economy over time, it would need permanent policy-managing institutions. They had two sources of inspiration to turn to; one was President Franklin D. Roosevelt. In an effort to pull the U.S. economy out of the depression, Roosevelt got congressional approval for a range of new welfare programs (and exceptionally high marginal income taxes) and public works programs.

Slightly behind Roosevelt in time, the second inspiration arose from Gunnar Myrdal, a Swedish economist and leading scholar of the Stockholm School, who took the stabilization effort much farther than Roosevelt did. Myrdal stood with one foot in academia, the other in politics; being just as much a socialist theoretician as a political economist, Myrdal merrily drank the Marxist elixir and let it inform his ideas for policy reform. 

Out of Myrdal’s fusion of Keynesian economics with economic redistribution came the idea of economic redistribution as the key to economic stability. He wanted, and helped build, a welfare state that was purposely designed to eliminate all economic differences between individual citizens. 

Incentivizing economic stagnation

In theory, the post-Keynes version of Keynesian economics that was adapted for business-cycle management became an indispensable tool for those who wanted to build and maintain a welfare state. They could propose progressive income taxes; higher rates on higher incomes worked not only as a tool for economic redistribution, but also as a dampener on strong growth periods in the business cycle. By contrast, when people’s incomes decline in a recession, they pay lower taxes on average; the tax system keeps more money in consumers’ pockets and therefore helps the economy recover again.

A similar argument was made for entitlement programs that provide income security: by paying out relatively more benefits to lower-income households, these programs not only redistribute the power to spend money, but supposedly also help keep the economy out of deeper downturns. 

In practice, the merger between mainstream Keynesian economics and welfare-state policy was exactly what drove most of Europe into its current state of stagnation. The entitlement systems and the progressive taxes that were meant to stabilize the economy and advance socialist ideology rewrote the incentives structure across the economy. High marginal income taxes and phased-out entitlement benefits discourage workers from pursuing higher-paying jobs, better careers, and even entrepreneurship. When the workforce overall is stimulated to stay in relatively low-paying jobs, its overall productivity also remains low. 

With lower productivity comes slower growth in tax revenue; with lower-paying jobs comes higher government spending on the welfare state: structural budget deficits, for short.

Given the central role of the socialist welfare state in bringing the European economy into its present state of economic stagnation, the debate over its future is notably absent from the public discourse. Ironically, given that Europe’s political landscape is a mosaic of ideological affiliations, the lack of debate over the welfare state is evidence that democratic socialism has indeed been successful.

Hopefully, for the good of the future of Europe, this will change. Hopefully, going forward we can have a productive debate over what lies beyond the socialist welfare state. 

Sven R. Larson is a political economist and author. He received a Ph.D. in Economics from Roskilde University, Denmark. Originally from Sweden, he lives in America where for the past 16 years he has worked in politics and public policy. He has written several books, including Democracy or Socialism: The Fateful Question for America in 2024.