Economic Competitiveness and Social Policy in Open Economies

ABSTRACT

While many studies have shown that greater trade openness affects the overall size of social spending, this study emphasizes that it also affects types of social policies that a government prioritizes. When faced with deepening trade competition, governments tend to use different policy measures to address the opportunities and challenges stemming from their economic competitiveness in the international market. Policy makers in countries with high relative labor costs are likely to privilege social insurances and income transfer. This is because as high labor costs make their workers more vulnerable in the trade competition, governments seek to protect skilled labor in order to maintain their economic advantage in advanced industries. In contrast, when relative labor costs are low, human capital investment programs are likely to be emphasized to enhance productivity and the quality of labor to capitalize the cost competitiveness of a country’s workers. The findings from empirical analyzes of 26 OECD economies from 1991 to 2012 support these arguments.

KEYWORDS:

• Economic competitiveness
• labor costs
• OECD
• social policy
• trade openness

Acknowledgments

The author thanks Tim Hellwig, Will Winecoff, Trish Gibson, and anonymous reviewers for helpful comments. The usual disclaimer applies.

Supplemental Material

Supplemental data for this article can be accessed on the publisher’s website

Notes

¹ These two dimensions are often labeled with different names by different researchers. Productive policies are also called investment-oriented policies, social investment, or supply-side policies. Protective policies are sometimes referred to as consumption-oriented policies, social insurances, or demand-side policies.

² Wibbels and Ahlquist (2011) suggest a somewhat contrasting argument according to which a government’s choice of development strategy is conditioned by labor endowment in the context of a closed international trading system, which in turn shaped the government’s welfare policies. This is true, particularly in Latin America during the period when countries used the import-substitute strategies (See Collier and Collier 1991; Hirschman 1968; Kurtz and Brooks 2008). Nevertheless, this finding does not necessarily challenge the cases where the government’s strategic use of social programs in open economies.

³ Unit labor cost in this article is defined as a ratio of total labor cost to real output. In this study, I am mainly concerned with unit labor cost in the industrial sector.

⁴ This calculation is based on the sample of 26 OECD countries from 1991 to 2012.

⁵ Some argue that economic downturn and increased unemployment rate since the 1990s curtailed welfare efforts in Nordic Europe. While these countries experienced some cutbacks in social expenditures and they have strengthen productive, public spending in this region remains to be much higher than other advanced economies. Its emphasis on labor protection also has remained to be higher than the average level of other economies, maintaining relatively strict regulations on the labor market and a higher amount of spending on labor market programs. For a discussion on path of Nordic welfare model in face of globalization, see Steinmo (2003).

⁶ For more detailed information about countries included in the analysis, please see the online appendix.

⁷ Iversen and Cusack (2000) measure deindustrialization as 100 minus the sum of manufacturing and agricultural employment as a percentage of the working-age population. Data are from the OECD Labor Force Statistics.