The Poverty of the Welfare State

April 11, 2007

By Serhan Cevik | Istanbul

Breaking away from the legacy of welfare state, Israel has achieved faster income growth. Two factors — the lack of political direction to resolve territorial conflicts and the burden of an ever-growing welfare state — have kept the Israeli economy below its true potential. Even though a comprehensive peace deal with the Palestinians still remains in a distant future, structural reforms and prudent fiscal management in recent years have helped to rationalize Israel’s welfare system and thus reduce its burden on the economy. With intensifying political pressures over the decades, the cost of welfare expenditure and transfer payments to households increased from 31.5% of GDP in 1980 to 42.2% in 2002. As you would have thought, such an extravagant level of social spending not only worsened public finances, but also distorted economic incentives and lowered the economy’s growth potential. Realizing the extent of structural strains, especially on income growth in the private sector, the authorities have finally started moving away from the legacy of welfare state and dealing with institutional constraints. Accordingly, the burden of welfare spending and transfer payments declined rapidly to 36.5% of GDP, helping to lower the overall budget deficit to 0.9% of GDP at the end of last year and giving a significant boost to the economy. continue...