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Disentangling the Links Between Welfare Spending
and Market Expansion in Developing Countries
Nita Rudra University of Pittsburgh rudra_at_pitt.ed
u
Irfan Nooruddin Ohio State University
nooruddin.3_at_osu.edu
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1. Introduction Puzzle

• Focus of recent scholarship whether government
  welfare spending in less developed countries
  (LDCs) must be sacrificed at the altar of
  globalization?
• We do not know why LDC governments would comply
  with such reforms.
• Domestic politics supporting government reduction
  in welfare commitment is treated rather
  abstractly.
• Assumption owners of mobile capital and export
  producers motivated by profit maximization are
  uniformly demanding welfare reforms to reap
  economic benefits.

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1. Introduction (cont) Research question

• Does the expansion of welfare spending in less
  developed countries affect their integration into
  todays dynamic and highly competitive global
  markets?

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1. Introduction (cont) Broad implications

• If welfare spending has no noticeable effects on
  international market prospects, then existing
  logic of the RTB demands immediate
  re-evaluation.
• If it is confirmed that the size of the welfare
  budget does negatively impact prospects for
  international market expansion, the RTB logic
  holds, but existing models suffers potential
  endogeneity problems.
• If welfare spending actually encourages market
  integration (by improving productivity, the stock
  of human capital and/or overall stability), the
  logic of the RTB hypothesis would have to be
  fundamentally reexamined.

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2. The existing literature

• RTB hypothesis
• Pressure to compete in export and financial
  markets
• Government welfare spending viewed as
  unaffordable (raises production costs and
  inhibits sound macro fundamentals)
• Leads to RTB Neighboring states want to maintain
  competitive parity
• Non-issue in OECD countries (Garrett 1998, Hicks
  1999, Iverson and Cusack 2000, Kwon and Pontusson
  2007, etc.)
• Issue in LDCs b/c theoretical mechanisms linking
  global economic pressures with cutbacks are
  vaguely specified (Rudra 2002, Kaufman and Segura
  1998, Wibbels 2006).

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2. Existing literature neglects causal logic
of RTB

• Kaufman and Segura (2001) Secular shifts in the
  preferences and relative power of business
  sectors exposed to increases in international
  competition curb social spending over the long
  term.
• Wibbels (2006) Under tight macroeconomic
  conditionstradables are likely to have a
  dominant interest in fiscal retrenchment at the
  expense of spending on human capital.

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3. Identifying hypotheses

• The links between export-oriented firms and
  welfare spending
• H1 Increased welfare spending leads to lower
  exports and trade. H1 confirms World Bank
  hypothesis and causal logic of RTB.
• H2 increased welfare spending leads to higher
  exports and trade H2 confirms ILO perspective
  and the RTB logic needs to be reexamined.
• H3 increased welfare spending has no effect on
  exports and trade H3 suggests that the RTB logic
  needs to be reexamined.
• The links between mobile capital and welfare
  spending
• H4 Increased welfare spending leads to less
  capital inflows H4 confirms the pull hypothesis
  and confirms the causal logic of RTB
• H5 increased welfare spending leads to more
  capital inflows H5 confirms pull hypothesis and
  challenges the logic of RTB.
• H6 capital flows are more responsive to external
  factors rather than the level of welfare
  spending H6 confirms the push hypothesis and
  challenges the logic of RTB.

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4. Models - PRELIMINARY

• Model I Panel Vector Autoregression (Love and
  Zicchino 2006)
• Assesses effects of spending variables on
  globalization
• Regresses each variable on its own lags and lags
  of other variables in the system (Exports, net
  capital flows, net FDI, economic growth, SS and
  welfare Spending, education Spending, healthcare
  Spending)
• Model II TSCS model
• Regresses globalization vbles (exports, net k
  flows, fdi) on welfare variables (SS, education,
  health)
• Controls growth, market Size, IMF loans,
  democracy, interest-rate spread, size of skilled
  labor pool
• Year and country fixed effects included

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5. Results -PRELIMINARY

• Results from Model I (VAR)
• Exports and FDI granger-cause each other
• Exports and FDI are granger-caused by economic
  growth
• None of the spending variables affect either
  Exports or FDI
• Results from TSCS
• None of the spending variables has any effect on
  either exports or FDI
• Rather, exports and FDI are affected by economic
  growth, size of the skilled-labor pool (exports),
  and cost of borrowing capital relative to world
  market (FDI)
• Period and Unit fixed effects are strongly
  significant, suggesting importance of common
  intl push factors historical legacies
  respectively.

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6. Interpretation of Results

• Governments and business are using globalization
  as an excuse for long-needed domestic welfare
  reform
• Business incentives weaken labors bargaining
  power in the workplace
• ISI strategy gt buy cooperation of urban labor
  groups in key sectors
• Form distributional coalitions to insist that
  this type of state intervention continues (Olson
  1979)
• Generous pension benefits and job security are
  examples of common labor benefits that have
  persisted in developing countries way past the
  ISI period.
• Whether or not the cuts actually affect their
  bottom line, successful reform is an advance
  towards loosening privileged labors political
  leverage and capital has more room to move

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6. Interpretation of Results (cont)

• Government incentives weaken labors
  bargaining power in formal political arena
• Welfare spending in LDCs tends to be regressive
  and inefficient (World Bank 2001, Rudra 2004)
• The welfare budget is affecting large budget
  deficits.
• Governments eventually turn to favor reform since
  it will be harder to earn rents
• Privileged Labors incentives war of
  attrition (Alesina and Drazin 1991)
• Losing credibility with globalization
• Media and policymakers underscore link between
  improving competitiveness and labor reforms

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7. Conclusion PRELIMINARY

• Causality between globalization and welfare is
  unidirectional international market expansion is
  correlated with welfare retrenchment but this
  policy change in turn is not improving the
  international economic standing of LDCs.
• Conventional RTB wisdom that internationally-orien
  ted business is uniformly demanding that
  government lower spending because it affects
  export competitiveness and their incentives to
  invest.
• We propose that policymakers are using
  globalization as an excuse for domestic welfare
  reform.
• In IPE Difference between ends and means