Caritas in Veritate 25, By the Numbers

My co-blogger Tim recently highlighted the following statement from Pope Benedict’s latest social encyclical, Caritas in Veritate:

The global market has stimulated first and foremost, on the part of rich countries, a search for areas in which to outsource production at low cost with a view to reducing the prices of many goods, increasing purchasing power and thus accelerating the rate of development in terms of greater availability of consumer goods for the domestic market. Consequently, the market has prompted new forms of competition between States as they seek to attract foreign businesses to set up production centres, by means of a variety of instruments, including favourable fiscal regimes and deregulation of the labour market. These processes have led to a downsizing of social security systems as the price to be paid for seeking greater competitive advantage in the global market, with consequent grave danger for the rights of workers, for fundamental human rights and for the solidarity associated with the traditional forms of the social State. Systems of social security can lose the capacity to carry out their task, both in emerging countries and in those that were among the earliest to develop, as well as in poor countries. Here budgetary policies, with cuts in social spending often made under pressure from international financial institutions, can leave citizens powerless in the face of old and new risks; such powerlessness is increased by the lack of effective protection on the part of workers’ associations.

Now in this passage, the Pope makes a number of factual and causal claims. First, he claims that the global market has led countries to “attempt to attract foreign businesses” by adopting “favourable fiscal regimes and deregulation of the labour market.” Second, the Pope claims that these reforms (i.e. adopting “favourable fiscal regimes and deregulation of the labour market”) have led to “a downsizing of social security systems” and “cuts in social spending.”

The first causal claim seems plausible enough. It’s easy to see why developing countries would want to encourage investment by and trade with foreign governments (as Benedict himself notes, such investment and trade can have the effect of “reducing the prices of many goods, increasing purchasing power and thus accelerating the rate of development). My guess is that most people’s initial reaction would be to view deregulation of the labor market as a bad thing, but that of course depends on whether the regulations being repealed are good or bad. When I read accounts of the Licence Raj in India, or analyses of how labor market regulation in Europe is to higher unemployment and lower economic growth, it’s hard for me not to conclude that a lot of countries could really use a little deregulation of the labor market.

On the other hand, it’s hard for me to see how deregulation of the labor market is supposed to lead to cuts in social spending. How exactly is repealing the minimum wage, for example, supposed to lead to cuts in Medicaid? I confess I just don’t see it.

To see whether perhaps I was missing something, I did a few calculations comparing some key macroeconomic indicators with the level of labor market freedom given in the Heritage Foundation’s Index of Economic Freedom. I used the amount of foreign direct investment in a country as a proxy for the kind of competition among states the Pope describes (on the theory that if states were engaged in the sort of competition the Pope describes, those whose labor markets were most deregulated would attract the most foreign investment). As the chart below indicates, the Pope’s first claim (globalization leads to labor deregulation) is consistent with the data, as states with freer labor markets tended to attract more foreign direct investment:

While the data supports Pope Benedict’s first causal claim (globalization leads to deregulation), however, his second claim (deregulation leads to less spending) doesn’t fare so well. If the Pope’s account were right, we would expect labor market freedom to be negatively correlated with the level of government spending. In fact, the opposite is the case. Countries with freer labor markets tend, on average, to have greater amounts of social spending, not less (this, mind you, is true not only in absolute but also in percentage terms):

You might wonder why exactly this might be. A plausible explanation is that less regulated labor markets tend to increase a society’s prosperity:

while increased prosperity leads to increased social spending:

Whatever the answer, though, the data is not consistent with the causal claim that deregulation of the labor market somehow leads to cuts in social spending. That still leaves the Pope’s analogous claim about “favorable fiscal regimes,” but an examination of the evidence for that proposition will have to wait till my next post.

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