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Are public and private social expenditures complementary?

Article Excerpt
Abstract

Most analyses of social protection are focussed on public arrangements. However, social effort is not restricted to the public domain; all kinds of private arrangements can be substitutes to public programs. OECD data indicate that accounting for private social benefits has an equalising effect on levels of social effort across a number of countries. This suggests complementarity between public and private social expenditures. But their distributional effects differ. Using cross-country data, we find a negative relationship between net public social expenditures and income inequality, but a positive relationship between net private social expenditures and income inequality. We conclude that changes in the public/private mix in the provision of social protection may affect the redistributive impact of the welfare state. (JEL D3, H22, H55)

Introduction

In recent years considerable progress has been made in empirical research on public and private social protection expenditures. Adema [2001] has recently done a comprehensive study on net social expenditure. His OECD data indicate that accounting for private social benefits and the impact of the tax system on social expenditure has an equalizing effect on levels of social effort across a number of countries. This suggests complementarity between public and private social insurance. However, cross-country differences in the public/private mix in the provision of social protection, and cross-country differences in social policy aspects of tax systems may have distributional effects. Do public and private arrangements in social protection systems have (dis) similar distributional effects?

In this paper, we will investigate the relationship, if any, between cross-county differences in the public/private mix in social protection and the distribution of income in 16 wealthy nations. We analyse both the effects of accounting for private social benefits, and the impact of the tax system on social protection statistics, and link both net public social spending and net private social spending to indicators of income inequality. Especially the link between income inequality and private arrangements (on average 9.4 percent of total net social expenditures across countries) is unclear at this stage. This relationship is also relevant from a policy point of view. In some countries welfare systems have been reformed fundamentally in recent years. For example, the Netherlands has changed the public/private mix of social protection rather drastically. Recent reductions in public benefit levels have, to a large extent, been offset by supplementary private benefits, often negotiated in collective wage agreements. As far as pensions are concerned, there is also a trend towards a higher share of supplementary private benefits in total income.

The scope of this paper should be clarified at this stage. Our purpose is to present a simple and intuitive analysis which elaborates on previous work. Caminada and Goudswaard [2001] studied the cross-country relationship between changes in inequality and changes in welfare state policies as measured by social expenditure ratios, and as measured by replacement rates, in the period 1980-1997. They found several countries that combined an above-average rise in inequality with a reduction in the generosity of the welfare system. In this paper we incorporate private social benefits and the impact of the tax system on social expenditure in our analysis. Ideally we would have taken into account the dynamic effects of change in this analysis as well because it is important to analyse the path of change across countries. However, we have to restrict the analysis to one moment in time because time-series on cross-county differences in the public/private mix in social protection are not (yet) available. This paper uses the only cross-country data available, for one moment in time (around 1997).

The aim of the paper is not to explain the household income distribution across countries, nor will we discuss the direction of the causality of the relationship between across country differences in income inequality and the levels of social spending. Such an analysis should be based on a theory which would have to address several cross-national differences explaining the household income distribution [Gottschalk and Smeeding, 1997]. Such a comprehensive approach is far beyond the scope of this paper.

The rest of this paper is structured as follows. The next section summarizes empirical results of the level of income inequality across countries. We then discuss the influence of cross-county differences in the public/private mix in social protection on the distribution of income. Next, we present the results of cross-country analyses on gross and net social expenditures. This is followed by an empirical analysis on (net) public and private social expenditures, and the distribution of income. The final section concludes the paper.

Empirical Evidence on Income Inequality at One Point in Time (1)

The best cross-nationally comparable collection is the Luxembourg Income Study (LIS) [Luxembourg Income Study, 1998]. LIS was created specifically to improve consistency across countries. The LIS data are a collection of micro data sets obtained from a range of income surveys in various countries. The advantage of these data is that extensive efforts have been made by country specialists to make information on income and household characteristics as comparable as possible across a large number of countries. The approach adopted by LIS overcomes most, but not all, of the problems of making comparisons across countries that plagued earlier studies [Smeeding, 2002].

This section summarizes the evidence on cross-national comparisons of annual disposable income inequality over 29 nations based on empirical evidence from Gottschalk and Smeeding [1997, 1998], Smeeding [2000], and others using data from the LIS. We summarize empirical results of the levels of income inequality across countries around 1997. Levels of inequality can be shown in several ways, e.g., by Lorenz curves, specific points on the percentile distribution (P10 or P90), decile ratios (P90/P10), and Gini coefficients or many other summary statistics of inequality. All (summary) statistics of inequality can be used to rank income inequality in OECD countries, but they do not always tell the same story.

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Figure 1 shows two summary measures of the...

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