What is the nature of social safety nets? What are their economic effects? Do they aid or impede structural reform? This paper, by the Organisation for Economic Cooperation and Development (OECD), looks at the impact of safety nets on output and employment and on the ability of economies to absorb adverse shocks. It also briefly addresses political economy issues and the impact of safety nets on saving and current-account imbalances. It is argued that safety nets protect citizens against hardship. By offering compensation, they may help overcome the political resistance to structural reform, but can also weaken the incentives to work and save. Depending on their design, safety nets may also ease or impair adjustment to changing economic circumstances.
Safety nets are in place in all OECD countries. They generally include an unemployment benefit programme, incapacity-related benefit programmes, early retirement provisions and a variety of welfare programmes for working-age individuals. Employment protection legislation shields employees from job losses and thus has features in common with social safety nets. Safety nets are expensive, but are only a subset of social expenditure. In calculating the level of social support in countries, measures such as taxes paid by beneficiaries and tax breaks for social purposes should also be considered.
The document’s main conclusions are as follows:
- Safety nets act as an income shock absorber and as such contribute positively to economic welfare. Yet poorly designed safety nets can have negative economic impacts and subsequent social costs. For example, those that allow indefinite entitlement to high unemployment benefits impede the adjustment of real wages and can create supply distortions by reducing job-search intensity.
- Such negative incentives can be offset by activation policies such as making unemployment benefit conditional on job searching and training.
- Unemployment spells and the associated welfare costs may increase in OECD countries in the future. This is because safety nets based on passive income transfers are less effective at dealing with permanent supply shocks such as those induced by technological change and the emergence of developing economies.
- Safety nets reduce hardship in the short term during economic downturns. Yet they can also allow affected people to delay adjustment to new economic circumstances and may lead to the persistence of below-par activity (high unemployment) and reduced growth.
- The impact of safety nets on business investment and household saving, and by extension the current account balance, is not clear-cut. In theory, they act as a substitute for saving as they provide insurance against negative income shocks. Yet the situation is complicated by age and the various tax systems used and thus the empirical evidence to support the theory is rather scant.
Future policy should account for the following:
- In attempting to reform safety nets, many countries have tightened work-availability requirements and eligibility criteria for unemployment benefits, or have made benefits conditional on more active job-seeking. Yet, with a few exceptions, reform has proved difficult. This suggests political economy forces may work against reforming social safety nets.
- By offering compensation, safety nets may help overcome the political resistance against trade liberalisation and structural reform. However, to the extent they serve to protect the interests of insiders, they may also harden political resistance.
