Social Investment Policy, Economic Growth, and Welfare States: Channels of Growth Effects

Social investment policies have been prominent on the European Union’s policy agenda. Other advanced industrial countries outside Europe also pursue those policies, though to a lesser extent. Governments hope that those policies will promote productivity and economic growth by creating high-skilled labor forces that can adapt to the imperatives of the new knowledge economy and technological advances, or that can create new technologies themselves. The policies are also hoped to address new social risks, such as single-parent families and workers in unstable, precarious employment. While there is some literature that studies the nature and origin of social investment policies, there are few studies that investigate the effects of those policies. This paper examines whether social investment policies actually bring about the economic benefits that their proponents hope such policies will bring, by analyzing their effects on economic growth and the channels of economic growth—physical capital investment, labor input (employment), and multifactor productivity (roughly technological progress). I will show whether social investment policies promote economic growth, how they affect the individual channels of growth, and through which channels of economic growth those policies affect economic growth. I provide a human capital investment perspective to explain how we can expect social investment policies to promote economic and productivity growth. I also explain that while there is theoretically good reason to expect those policies promote productivity and economic growth. Social investment policies should have varying effects on different components of economic growth. The empirical analysis uses time-series cross-national data from OECD countries between 1985 and 2010. I examine four dependent variables—real per capita GDP growth, growth in physical capital stock, growth in labor input (labor utilization, i.e., total hours worked), and multifactor productivity (MFP) growth. Social investment policies that I analyze as independent variables are—education policy, family support policy, active labor market policy, and some forms of redistribution. Government R&D spending is also included. The results show that family support, education, and active labor market policy spending is positively associated with per capita GDP growth, and the effect is mainly via those policies’ positive effects on MFP growth. Thus, those social investment policies indeed promote the productivity or efficiency of advanced industrial economies, and through that channel, they enhance economic growth. The social investment policies are also associated with growth in labor utilization and employment rates and physical capital stock, though to a lesser extent than in the case of MFP growth. So some of the social investment policies do affect physical capital and labor inputs, but their effect is more limited. The results remain the same in robustness checks, including different estimation techniques, the length of time periods of unit of analysis, and measures to alleviate endogeneity concerns. If it turns out that social investment policies do affect economic growth and its components, it will mean that politics affect the performance of the national economy in an important way, because different welfare states (or partisan governments or welfare production regimes) implement distinct social investment policies.