Was Hayek Wrong?

Or, alternatively is Jeff Sachs right on the success of welfare states?  In Scientific America, Sachs looks at the Nordic welfare states as compared to the English-speaking market economies and finds that the welfare states outperform on basic economic measures the market economies.

I am going to be looking into this a lot more closely, but my priors on any of these sort of comparative analysis is that aggregate measures both underestimate and overestimate the situation.  They overstate the extent of state interference in the welfare states due to the extent of tax evasion and underground market activity, and they understate the true extent of state interference in so-called market economies.

Regardless, Sachs raises an important empirical puzzle that we must explain.  I believe that his analytical perspective does not lend itself to addressing the puzzle effectively (and certainly his claim to be non-ideological is an act of self-delusion).  But we cannot answer this question with analytical debate only, but must dig deep into the historical record to get at the details of economic life in both the Nordic welfare states and the market economies of the US, UK, Australia and NZ.

What would be your alternative explanation for the "facts" that Sachs reports?

Read Sach's full article from his web-ste for the Earth Institute at Columbia.

Download ScientificAmericanNovember2006-WelfareStatesBeyondIdeology.pdf

Thanks to Mark Skousen for bringing this article to my attention.

10/24  -- UPDATE:

Thanks for the comments they point in a variety of interesting directions for further research.  I should point, however, that Sachs is also misreading Hayek's Road to Serfdom thesis --- a point which Samuelson did as well and had to eventually send Hayek a letter of apology and retraction for what he had written in his textbook.  Hayek has his own discussion of Sweden in the preface to the 1976 edition of The Road to Serfdom, and Ulrich Witt has a quite fascinating paper in Public Choice on the role of the endogenous public choice theorist in public choice analysis.  I have a paper which touches on these issues as well in the European Journal of Political Economy.

But lets take the challenge from Sachs head on.  Bob Subrick over at Stationary Bandit has looked at the numbers and raises some great points on Sachs's own terms which question his conclusion.

Comments

[Dennis]

I wrote about Sachs' article the other day, in Swedish so I guess it's not much of a help. I took issue with Sachs' claim that 'high taxation would be a "road to serfdom"', it seems to be oversimplified. As I see it, Sweden wasn't on a road to serfdom because the Social Democrats had already changed their mind regarding socialism at the time. There was a big debate about planned economies after the WW2, but the issue was more about Keynes than socialism, and the right wing used Hayek's Road to Serfdom as an argument.

[Jüri Saar]

Stefan Karlsson (a Swedish libertarian) gives his comments to the same article:

http://stefanmikarlsson.blogspot.com/2006/10/jeffrey-sachs-on-nordic-countries.html

I've written on the subject in Estonian for those who try to lift Scandinavian countires up as examples - as something Estonia should strive toward.

[Don Lloyd]

Peter,

I think we have to keep in mind the sense of Gorbachov's (?)quote that when Russia had conquered the world, he would have to keep New Zealand free to produce market prices.

No matter how successful Sweden may appear, you have to ask the question as to how successful it would be in a world made up of other Swedens.

A town in the US may prosper if it has a major plant of a successful multinational, but without the plant it would whither away.

The same for a retirement village in Florida. Its prosperity has little or nothing to do with how or how well its municipal government is run.

Regards, Don

[Nick]

Peter,
I agree that Sach's claim to be non-ideological is self-delusional. His analysis seems to be incredibly simple and I wonder how comparable the supposed market economies of the English speaking world are. For example, the UK is much closer to the Nordic model of the welfare state, than it is to a US style market economy. Public sector employment growth has outstripped private sector growth since the Labour government came to power in 1997. This has led to a bloated welfare state which has held back levels of entrepreneurship and growth in a similar way that has been seen in New Zealand (and was discussed in Frederic Sautet's paper Why Have the Kiwis Not Become Tigers?). To group the economies together in this way seems meaningless to me. But on the otherhand, doing so fits well with Sach's ideological agenda so he'll probably carry on doing it.

[Dan]

1) These are good government states that rely on institutions that could not possibly be exported wholesale anywhere else.

2) Anders Bergh has a paper (see http://www.google.com/search?hl=en&q=bergh+explaining+welfare+state+survival&btnG=Google+Search) that argues that these states have "bought" their welfare programs by being highly globalized and economically free in other ways -- more free than the US, Britain, and Australia in some respects.

[gg]

The major difference is in the poverty rates. The US has an ethnically diverse population with a persistent underclass.

Looking at Scandinavia vs the US is like looking only at 3rd generation white Minnesotans.

The Scandinavians -- until recently -- had very strict laws restricting immigration.

Over the last 3 decades, the US has had a large and steady stream of poor Hispanic immigrants who better themselves by entering the US but depress aggregate measures of income and worsen measures of inequality.

[Rafe Champion]

As others have noted, Britain and New Zealand for most of the postwar period were welfare states.

Australia from 1900 to the 1980s enjoyed a regime of high tariffs and possibly the most regulated labour market in the free world.

As for poverty in the US, high numbers are based on income figures, but look at the the expenditure figures for a reality check (and the things that the poor folk actually own).

Etc.

[Kurt]

Is it just me, or has the standard of SCIAM gone down drastically in the last 5+ years?

Intro of Sachs article: "Most of the debate in the U.S. is clouded by vested interests and by ideology."

End of Sachs article: "Von Hayek was wrong. In strong and vibrant democracies, a generous social-welfare state is not a road to serfdom but rather to fairness, economic equality and international competitiveness."

I think the only point proven in this article is that indeed most of the debate in the U.S. is clouded by vested interests and by ideology. Is Paul Krugman going to write an article for SCIAM next month?

[Rafe Champion]

Was it SCIAM that ran five reviews that were critical of Lomborg's book on the environment and did not print his rejoinder?

[Rafe]

For people who are interested in the anti-market institutions of Australia which were introduced in the early 1900s when Australia was just about the richest nation on earth, it may help to flag some on-line resources on tariff protection and central wage fixing. For protection, this is a chapter from a 1930 book by Keith Hancock.

http://www.the-rathouse.com/Revivalist4/RC_protect.html

An extract.

"With such unity of spirit subsisting between private interests, public opinion, and the Commonwealth Treasury, it is not surprising that the tariff has grown rapidly both outwards and upwards. A document prepared for the International Economic Conference of 1927 estimates the 1925 level of the Australian tariff as 145 per cent. of its 1913 level--an increase with which no other country can compete. But it is easier to illustrate the increase than to measure it. In August, 1928, the Australian Tariff Board reported: 'The tariff wall is markedly rising. In the Customs tariff, 1908, there were only eight items which provided ad valorem duties of 40 per cent. or over...In the existing Customs tariff there are 259 items or sub-items which provide ad valorem duties of 40 per cent. or over...'."

For wage fixing and industrial relations, this is the web site of the reform group called the H R Nicholls Society.
http://www.hrnicholls.com.au/

Their efforts over some decades have been rewarded with a piece of reforming legislation that runs to some 600 pages with a thousand pages of regulations to follow. As Kant might have said, "with deregulators like this, who needs regulators?".

[Renato Drumond]

The best book about Sweden I ever read is "How Bright are the Northern Lights? Some Questions about Sweden" by the great Mancur Olson.

http://www.mobergpublications.se/other/olson.htm

[FAS]

Echoing Dan's pricing comment. Questions like this are very hard to answer (even more than other questions in the social sciences, i.e., most people will agree that price increases will generally reduce demand ) because there are no isolated experiments. But the free rider perspective at least sheds some insight on this one.

For example, when I look at a country like Sweden, I wonder how much of the physical and social organizing technologies that are used on a day to day basis to generate their economic pie originated from the market process. Socialism is certainly good at distributing the pie more equally but, to me, its drawback has always been an inability to grow the pie over long periods of time. Hence, to me, countries like Sweden basically sit back and let the “messy” market create great ideas. They then incorporate them without the associated, admittedly sometimes painful, creative destruction. Best of both worlds for them but not really applicable for all (i.e., Kant). A similar example can be found in the funding for pharmaceutical R&D.

[Tom]

Pete-
Having glanced at Sachs' article (short version) it sounds compelling. However, I offer my own, albeit anecdotal evidence. I have friends from Finland and Norway. Both echo Sachs when they speak of the quality of life. Undoubtably, Sachs is right when he says that the social safety nets reduce certain costs. However, I think he is selective in what the benefits and costs are. In the Socialist Calulation Debate, Hayek argues that no social planner has the knowledge needed to set prices. Likewise, I believe no social planner has the ability to effectively tweak the markets' incentive structures to mimic market practices in a welfare state. Sachs talks about the spending on R&D, but is this alone enough to offset taxation and redistribution? My friends would argue otherwise. Despite their espousing of the healthcare system, they both recognize and dislike the negative incentives in place. They have all spoken of the loss of choices and individualism that comes under such a system. If tax monies are being redirected into R&D artificially, then they are not being used in the most efficient manner. In reading of the full article, I hope to find Sachs addresses two things: the negative market distortions these redistribution policies cause and the cost of the type II errors that are so prevalent in the welfare state.

[Tim Piatek]

Thank goodness someone blogged on this - I just saw the article a few hours ago and have been itching to give my two bits. I still might, but I'm glad I have something to process to see what I've missed before so doing.

[PrestoPundit]

Pete -- won't you send a letter to _Scientific America_ and get this "Road to Serfdom" error corrected? This is a sort of scientific "journal of record" and such errors should not stand.