Benjamin Studebaker

Recently, Barack Obama was accused of “gutting welfare reform” in some of Mitt Romney’s ads of which the following is an example:

This has been widely recognised as a distortion; PolitiFact calls it a “pants on fire” lie. In reality, Obama is allowing state governments to waive certain parts of the welfare reform’s performance measures in favour of alternatives, provided that there is evidence that the state is achieving the principle aim of the reforms–putting people on welfare to work.

That’s all widely known at this point. What I’d like to talk about today is why we really would be better off if Obama had in fact gutted American welfare reform. It’s a bold claim, and not a very politically popular one in the times in which we live, but hear me out. I propose that a welfare system with no demand or encouragement to reenter the workforce is in fact better for the capitalist system.

Often times welfare in the United States is thought of as a safety net–if you fall on hard times, welfare is there to help you get back on your feet and get back in the workforce. This is in reality only a small piece of what welfare does. There are two other important things welfare can do, but only if it comes without the requirement that people on it seek employment:

Welfare provides a credible alternative to employment, and, in doing so, pushes up private sector wages and economic demand.

This assertion requires sound argumentative backing to be believable for many people.

The important thing to observe here is how the supply/demand relationship works at the bottom end of the wage scale. You have a lot of poor, unemployed, and underemployed people here competing for a much smaller number of jobs. How do we know that the number of jobs they compete for is comparatively small? This is because the wages are as low as they are legally permitted to be. Businesses feel no compulsion to raise wages above the minimum because they can easily hire labour because the supply of labour available is quite large. Were there no minimum wage, wages for these very poor workers would drop to near or below subsistence level (arguably, in many countries, the minimum wage is already at or below subsistence level).

Now, what impact does a welfare programme that does not require evidence of pursuit of employment or training and provides a livable, comfortable income do in this environment? It sets a minimum standard of living and a minimum level of comfort. No matter how little work you do in a welfare society, you will never be utterly destitute, on the street, without any of the comforts of civilised life. This provides you with a choice–you do not have to work. That choice makes all the difference. Firstly, it puts an end to wage slavery and all Marxist talk of exploitation. If you have a credible, comfortable alternative to employment, you are not compelled to work and any labour arrangement you enter into really is wholly voluntary.

This is the issue many people take with welfare in the first place–it discourages work. What these people are missing is that, by discouraging work, welfare does fantastic things for capitalism and for people who nonetheless do choose to work.

The first thing that happens with a strong welfare system is that now, employers have to compete with welfare. If you’re on welfare and the minimum wage is not really any higher than the money you’re currently receiving to do nothing, why work? This means that, if employers really need labour, they will have to raise wages in order to get people on welfare to feel that the additional income is worthwhile. It provides a competitive advantage for employees.

At this point you may very well be noticing that this will lead to the private sector hiring fewer people than it presently does–perhaps. There are studies that have found little or no change in employment in response to higher wages at the low end of the wage scale. But even so, even if fewer private sector workers are hired, the ones that will be hired will be paid a higher wage, and the ones that won’t be hired will receive what more or less amounts to a minimum wage through the welfare system. This means more money in the hands of the people at the low end of the wage scale.

Now, we know something else about people at the low end of the wage scale–their incomes are much lower than that of most workers. One of the ways this manifests is the savings rate; the more money you have, the more surplus money you have beyond your relatively basic needs, the more of it you can save and defer for later consumption. At the low end of the wage scale, a much higher percentage of the wages earned are needed to fulfill the basic needs. This means that, as a percentage of income, low-wage workers spend and consume the largest amounts of what they earn in the shortest span of time–as it’s commonly said, they “live paycheck to paycheck”.

This translates into higher demand. The poor will buy more and consume more. This will lead to higher sales for businesses, and in order to meet the demand for those higher sales, businesses will have to increase their supply, their manufacturing capacity. This will entail hiring more workers, and to pry them out of their comfortable welfare chairs, businesses will have to pay them a bit more than they presently do once again, demand increases, and the cycle continues. We may even find that unemployment tends to be lower, depending on the size of the demand gain.

Today, we’re seeing a demand-driven recession, with Americans unable to purchase enough without having to resort to credit and debt to sustain economic production. Demand needs to go up, and a wage increase can facilitate it. The demise of welfare without work has possibly played a role in pushing wage growth down. There’s statistical evidence to suggest it, or at least to not deny it. Welfare reform was passed in the United States in mid-1996, with statistical effects coming in in 1997.

An economist at the St. Louis Federal Reserve Bank complied this data on wage growth:

The tech boom of the late nineties is deceiving–once the tech bubble burst, inflation-adjusted wage growth plummeted. Correlation does not imply causation, and I don’t have definitive proof, but there is at least some evidence that welfare reform did not lead to any dramatic increase in the rate at which unemployment was falling in the nineties, which would be expected if present assumptions about the impacts of minimum wages were true. Here’s data from the Federal Reserve data:

In the three years before welfare reform, unemployment fell from just over 6.5% to around 5.3%, and dropped further to 4% in the three years after. This is a difference in rate of a mere couple tenths of a percent, and that’s with the tech boom pushing the rate down faster as well. It is important to note that it was impossible for people on welfare reform to reach the maximum life-time allotted welfare under the reforms until 2001, and that we can observe that, post-2001, unemployment rose and wage growth fell, even excluding the recent financial crisis, though again, the bursting of the tech bubble certainly plays a large role in those figures. It is, admittedly, very difficult to isolate what may in reality be a quite small impact–but of course that’s just the point. If the impact on employment is too small to see and is easily absorbed or blocked by other factors, it shouldn’t be decisive in determining our policy. Improvements to wage growth and to demand in a weak demand economy should motivate us all the more in consequence.

All of this is somewhat speculative, and I lack the data to definitively establish it at this time, but the theory is strong and the data does not blatantly contradict it. There are  capitalist reasons, independent of the socially compassionate emotional values to which welfare advocates historically appealed, to choose a welfare without work system. More data should be taken, more research should be done, but this should definitely be explored further. The consensus on welfare having to be a back-to-work system in the United States is neither theoretically nor empirically sound–to what degree, only further research  and argument can show.