Globalization and welfare spending across 21 transitional economies

Abstract

This article explores the impact of globalization on welfare spending in transitional states. Based on World Bank and International Monetary Fund (IMF) cross-country data sets 1990–2005, I test two leading hypotheses: the first of which predicts a negative relationship between global-economic embeddedness and welfare spending, and the second of which predicts a positive relationship between democratization and welfare spending. Using a cross-section time-series analysis, my findings suggest that the experiences of the transitional economies do not confirm either hypothesis. During the 16-year period of analysis, established globalization factors showed conflicting influence on welfare state arrangements. In addition, my analyses demonstrate a positive correlation between the use of IMF credit and welfare spending in transitional states. This finding contradicts the structural adjustment literature, which largely views policy-based conditional lending as a negative influence on receiving countries’ welfare expenditures.

Keywords

Public expenditure transitional economies welfare states World Bank and IMF

Introduction

Two decades after the disintegration of the former Soviet Union, countries in the former Soviet bloc are still experiencing the repercussions of this great transformation. Economic growth, unemployment, and welfare continue to be battlefields of public discourse. In many transitional states, governments prioritized macroeconomic stabilization and institutional restructuring. Directed by World Bank and International Monetary Fund (IMF) policy guidelines, transitional states commenced fundamental shifts from centrally planned economies to market-based economies. For United Nations (UN) reports and the World Economic Surveys, the UN created a new country grouping, ‘economies in transition’, defined as economies shifting away from centralized planning and toward market structures.¹

Differing from poorer developing economies, most transitional economies inherited established social welfare programs, characterized by a wide range of social benefits, including old-age pensions, employment-related benefits, and subsidized entitlements like housing and utilities. These benefits were embedded in the industrial system and administered through centralized bureaucracies. The distribution of these benefits was virtually universal, at least to urban residents.² Only a few benefits were means-tested. As World Bank and IMF became more involved in the process of lending to transitional economies, they sought to reform these elaborate social protection systems through a series of financial and advisory operations.

The history of the welfare state in Western Europe and the Untied States suggests that public programs that cushion individuals against the dislocations of the market contributed to the political and social stability necessary for a capitalist economy to function effectively (Garrett, 1998; Haggard and Kaufman, 2000: 4; Lindbeck, 2000: 158). Thus, successful welfare reform and progressive welfare state development have tremendous significance for the future of transitional states.

Significant scholarship delineates the mechanisms behind the evolution of welfare states, including agents of reform (Haggard and Kaufman, 2000), policy-making processes via the lens of new institutionalism (Inglot, 2008; Muller, 1999), and exogenous and internal influences on reform (Cook, 2007; Haggard and Kaufman, 1992; Inglot, 2008; Peet, 2003). Inglot (2008) suggests that the standard theoretical framework for Western welfare states should be adapted to address the unique experiences among welfare states development in transitional economies. Such adaptation is evident in the literature on varieties of capitalism and Central and Eastern Europe, which clearly articulates the ramifications of capitalist transition and differentiates the ‘retrenchment’ and ‘compensation’ arguments among transitional states. For example, Bohle and Greskovits (2012) suggest three possible welfare state outcomes in Central and Eastern Europe: neoliberal capitalism, embedded neoliberal capitalism, and neocorporatist capitalism.³ Fully aware of such empirical diversity, this article builds its theoretical framework upon the major debates on welfare states’ responses to various international and domestic influences, summarized by the division between ‘retrenchment’ and ‘compensation’.

Globalization and the ‘efficiency’ argument

Globalization in the present context means economic globalization, commonly measured by cross-border trade and capital flows. The efficiency argument represents one of the leading theses on the interaction between globalization and welfare state arrangements. The efficiency argument is grounded in economic theory, which emphasizes the path of cost minimization and profit maximization (Sherer, 1988: 69). Within the context of post-communist transition, the efficiency argument is exemplified by the structural bias in the European Union (EU) toward liberal economics over social welfare (Hay and Wincott, 2012: 191–192). The EU tends to privilege economic over social priorities for cost minimization, and it generally promotes market liberalism for profit maximization. In short, the ‘efficiency argument’ suggests the retrenchment of government welfare spending in order to enhance productivity, efficiency, and global competitiveness.

Evidence from advanced Western democracies

During the 1970s, the world witnessed two oil shocks and the end of the gold standard. Under such circumstances, neoliberal economic practices and ideologies championed by the United States gained increasing popularity among developed Western democracies. Starting in the 1980s, the decline of the Fordist model of industrial production and the rise of flexible specialization (Toyotaism) accelerated economic globalization (Deyo et al., 2001; Dicken, 2003; Gereffi, 1994; Hirst and Thompson, 1999; McMichael, 1996; Mittelman, 2000). Flexible specialization is an approach to industrial development that emphasizes diversity and specialization of production rather than mass production (Forsyth, 2005: 244). Piore and Sabel (1984) first theorized this concept by arguing that Fordist mass production would be followed by a regime based upon ‘flexible specialization’. This transformation is best captured by what Fröbel and colleagues call the ‘new international division of labor’ (Fröbel et al., 1982), which is expressed by deindustrialization and the exodus of manufacturing jobs from developed to developing countries, while technology and innovation stay in the developed countries, reinforcing the global-economic hierarchy.

In this new global division of labor, components are made and assembled in the countries that offer the most profitable combinations of capital and labor, leaving other countries and even regions or sub-regions, especially their subaltern classes, in a changed, often less protected, position in the globalization matrix (Mittelman, 2000). These new realities suggest that minimum labor costs, mean and lean management,⁴ and reduced government spending are essential to competitiveness in the global market (George and Wilding, 2002: 3–4).

Influenced by the primacy of efficiency and competitiveness in an increasingly integrated global economy, a wide range of government activities, including welfare and public spending policies, gradually came to be evaluated by external standards of efficiency and profitability. The welfare state in advanced liberal democracies, in Europe in particular, increasingly came to be judged in economic terms (Hay and Wincott, 2012: 97). Accordingly, social welfare programs redirected their missions from mitigating the affliction of surplus labor to promoting efficiency and competitiveness in the global market. A salient characteristic of this transformation is the move from universal and publicly delivered benefits to market-oriented and privately delivered welfare provisions emphasizing individual responsibility (Gilbert, 2002: 4). There are many examples of such transformations in advanced industrialized countries. In the United States, workfare replaced welfare. Sweden initiated partial pension privatization. Germany also encouraged citizens to open private pension accounts. The causal relationship between economic globalization and welfare spending became a central question for debate.

In addition, increasingly mobile capital contributes to the fear of ‘capital flight’. It not only cripples states’ abilities to intervene in the ‘race-to-the-bottom’ in regard to human welfare, but it also makes states less capable of sustaining social safety nets when tax revenue is no longer secured within their borders. All these changes lend credibility to the view that state sovereignty is on the wane and the idea that global markets and transitional politics have become major forces in shaping the policy landscape, on matters from monetary to welfare policies.

As a result, concerns over state autonomy in welfare policies led to the heated debate over the ‘crisis of the welfare state’, as policymakers reformulated the basic principles of social protections, and a dramatic drop in the welfare index⁵ was observed in a number of advanced industrialized democracies (including the United States, England, New Zealand, Denmark, Finland, Norway, and Sweden) following the golden era (1960–1980) of welfare state expansion (Gilbert, 2002: 12–13). Similar trends were also observed in some Latin American countries.

Evidence from LCDs in Latin America

Starting in the late 1990s, scholars began to evaluate the efficiency argument in societies that lacked powerful organized labor and interest groups, whose political and economic institutions were less democratic and open. Studies were conducted on middle-income countries (Garrett and Nickerson, 2001), less developed countries (LDCs; Rudra, 2002; Rudra and Haggard, 2005), and subgroups of LDCs like Latin America countries (Kaufman and Segura-Ubiergo, 2001). Latin America’s experience showed unanimous support for the ‘efficiency’ argument, with globalization negatively associated with government spending. For example, in Mexico, since the debt crisis in 1982, social provision was guided by efficiency criteria, designed to make social spending compatible with neoliberal adjustment strategies (Kurtz, 2002: 294, 304). Market-oriented reforms restricted the availability of state resources to buy off party factions and electoral support (Diaz-Cayeros et al., 2012: 53), which is a key feature of Mexico’s clientelistic state–society relations. As a result, left-wing parties reduced state-dispensed social protection programs and discontinued their long sponsorship of full-employment and workers’ benefits, leaving workers to their own devices (Solinger, 2005). Kaufman and Segura-Ubiergo’s 2001 study suggests such negative impact operates primarily in the area of pensions, rather than health and education within the 14 Latin America nations.

The Latin American experience shares several key characteristics with transitional states: vulnerability due to financial openness, external influences from international financial institutions on social policy, and the erosion of social protections by other means (Mishra, 1999: 68), making it a good point of reference for transitional states’ responses to globalization.

At the same time, transitional economies differ from Latin America LDCs in several important respects: transitional states are experiencing a difficult transition from state socialism toward an open market economy, this transition is taking place against the backdrop of a well-developed system of social protection, and the impact of exogenous forces is significant (Mishra, 1999: 68–69).

In summary, evidence from the advanced Western democracies and LDCs in Latin America suggests the declining role of the state and the growing primacy of the free-market ethos in shaping the future of welfare spending policies. Such evidence of the retrenchment of the welfare state under the forces of globalization, especially economic globalization confirms the ‘efficiency’ hypothesis (Garrett, 2001; Garrett and Nickerson, 2001: 3–4; Kaufman and Segura-Ubiergo, 2001: 554):

Hypothesis 1A. Efficiency argument – transitional states experience retrenchment of the welfare state under pressures of economic globalization. In other words, there is a negative correlation between economic globalization and government welfare spending.

Evidence from transitional states

As the transitional states mature, more and more scholarly effort focuses on the varieties of capitalism born out of this unprecedented transformation (Bohle and Greskovits, 2012). Experiences from Central and Eastern Europe suggest that different types of capitalism emerge from the conflicts and tensions that torment leaders in transitional states: the pursuit of market efficiency and the imperative to sustain social stability (Bohle and Greskovits, 2007), for example, by avoiding cutting too many social provisions. Szelenyi and Wilk (2010) address a similar inconsistency in the logic of economic and welfare institutions among the socialist countries of Central and Eastern Europe. They argue that during the early stages of transition, economic reorganization dominates institutional change, including post-socialist welfare provision.

Globalization further complicates the transition to capitalism. Its impact on transitional states may represent a variant of the ‘efficiency’ argument discussed above. Transitional states need to abide by the new rules of the game in order to survive and prosper, even though these rules contradict the fundamental ethics of human welfare in socialism. These ethics were exemplified by state-sponsored cradle-to-grave welfare provisions, which were long touted as symbols of socialism’s superiority over capitalism (Chow, 2000: 19). The socialist welfare state is in essence a form of social contract (Haggard and Kaufman, 2000: 2; Polanyi, 2001; Stiglitz, 2001 in Polanyi, 2001: xiv): ‘so long as citizens do as they are told they will have not a care in the world, because the party and state will see to everything’ (Kornai, 1992: 57). Over the years, such social contracts contributed to the paternalist nature of the Communist state. Such a social contract guaranteed citizens’ economic security, which in turn contributed to the social and political stability necessary for socialist industrialization. Even after the capitalist transition, many citizens expected the continuation of benefits, without realizing the extent to which paying for them would reduce net earnings (Haggard and Kaufman, 2000: 5).

Almost all socialist states had mature welfare systems constructed during the socialist era. Some followed the Soviet model, in which states act as the sole providers and financiers of welfare programs. Others developed welfare institutions before the Soviet period, for example, in Eastern European countries (Inglot, 2008). Welfare institutions during the socialist era are characterized by universal coverage, eligibility and distribution of benefits via work organizations in a full-employment economy, and a strong sense of entitlement to welfare programs by the citizens (Cook, 2007: 3, 194; Mason and Kluegel, 2000: 19), free health care, education, childcare, as well as heavily subsidized consumer prices, housing, food, vacations, and other cultural goods and services (Kornai, 1992: 54; Mishra, 1999: 69). While full-employment and universal health care are common in advanced western welfare states, consumer price subsidies and food rations are often features of rudimentary welfare states in LDCs. Thus, socialist welfare states have elements found both in advanced and rudimentary welfare states.

When the unprecedented transition to capitalism began in 1989, leaders of transitional governments were desperately looking for policy guidance and much needed cash to balance payments. The World Bank and the IMF became the uncontested authorities to provide the exact services they were seeking. From the very beginning, these two international organizations advised and assisted transitional states in the restructuring of fiscal and monetary policies and administration, with a special emphasis on welfare state reform as a necessary prerequisite of economic stabilization (Inglot, 2008: 5).

The IMF’s prescription for countries in transition came packaged with the dominant Western ideology of neoliberalism. Transitional countries were advised to implement radical reforms and to open themselves to the world economy, which later came to be known as ‘shock therapy’ (Esping-Anderson, 1996; Mishra, 1999: 69). The guiding principles behind the IMF’s policy included fiscal austerity, reduced public expenditure, and greater selectivity in social programs (Mishra, 1999: 70). The World Bank (2002) in close cooperation with the IMF continued to monitor macroeconomic policies, in particular fiscal management, measured by success in ‘containing public expenditure’ (p. 35).

These policies, similar to the Structural Adjustment Programs (SAPs) carried out in less developed nations, aimed at rationalizing the allocation of resources and strengthening the export sector to meet balance of payments obligations and maintain price stability (Haggard and Kaufman, 1992: 5). These policies required debtor governments to open domestic markets, cut public spending, privatize public utilities and state-owned enterprise, favor multinational corporations, and allow access to the country’s workers and raw materials at rock bottom prices. These conditions laid out by the IMF were designed for cost minimization and profit maximization, the centerpiece of the efficiency argument.

Several recent studies view the globalization of economic systems and international lending agencies, especially the World Bank and the IMF, as influential external forces that shape policy trajectories (Inglot, 2008: 39–40; Peet, 2003). In this literature, analyses of exogenous influences on welfare spending largely focus on policy-making processes via the lens of new institutionalism (Inglot, 2008: 40; Muller, 1999), but little quantitative research examines this influence.

I argue that welfare state development among countries in transition presents a variant of the ‘efficiency’ argument discussed earlier. While both emphasize neoliberalism, they differ in the mechanism behind the effect. The mechanism behind the retrenchment of welfare states in Hypothesis 1A is a general free-market ethos. The same retrenchment effect in transitional states is caused by direct dependence on global financial institutions.

Hypothesis 1B. ‘Efficiency argument’ (a variant) – global-economic integration and financial flows from international lending institutions have a negative impact on welfare spending. In other words, transitional states who receive a large amount of IMF credit experience retrenchment of the welfare state.

Globalization and the ‘compensation’ argument

The ‘efficiency’ argument, laid out above, began to come under attack in the 1990s, as more and more scholars found evidence suggesting that politics, public opinion, and democratization also matter in the outcomes of welfare spending (Brooks and Manza, 2007; Huber and Stephens, 2001; Pierson, 2001; Swank, 2002). The main idea is that organized labor and the voting public pressure governments to enact policies that compensate people who experience social dislocations due to the well-known imperfections in privatization, marketization, and democratization processes.

One line of criticism focused on organized labor movements, challenging the conventional notion that public spending and economic growth were a zero-sum game. As early as 1978, Cameron analyzed the relationship between economic openness and the expansion of the public economy in 18 member countries of the Organisation for Economic Co-operation and Development (OECD). In his study, economic openness is measured by the sum of exports and imports as a percentage of the gross domestic product (GDP). Public economy is defined by the extractive aspect of the government and measured by the ratio of all governmental revenues to GDP (Cameron, 1978: 1244). Findings revealed a mechanism behind the extremely high correlation between the openness of the economy and the expansion of the public economy: economic openness leads to high industrial concentration, which results in high unionization and broad collective demands for increased government spending on income supplements (Cameron, 1978: 1256). This study was influential. Economic openness and the strength of organized labor are still key variables in many of the recent studies on the relationship between economic globalization and welfare spending. For example, based on the experiences of 14 OECD countries, Garrett (1998) also questions the pessimistic visions of capital dominance over labor and state policy by arguing that through negotiation between the political power of the left and organized labor, globalization could lead to social policies protecting the disadvantaged from the economic dislocations associated with globalization, thus reducing market-generated inequalities and external risks.

Additional evidence challenging the conventional wisdom on globalization and domestic welfare policies comes from the political realm, particularly voting processes within Western democracies. Using data from Britain, the United States, Germany, and Sweden, Pierson (1996) suggests that the political impulse to avoid blame for unpopular policies combined with strong constituencies of support for established welfare programs, making retrenchment an issue of extreme political sensitivity. In a similar vein, Brooks and Manza (2007) underscore the role of public opinion in explaining the resilience of the welfare state. Brady et al. (2005) state, ‘globalization triggered political dynamics that result in generous welfare programs and corporatist labor market institutions’ (p. 923). It is worth noting that so far in the literature reviewed above, the key mitigating factors of welfare state retrenchment – well-organized labor, powerful interest groups, constituencies, and voters – are consequential mainly in advanced democracies. Public opinion also matters most in democratic environments. All these suggest a positive relationship between a country’s level of democracy and welfare spending, at least within advanced industrialized nations. Some degree of democratization is also expected in post-communist transitions (Linz and Stepan, 1996). More recent scholarship based on the experience of Central and Eastern Europe suggests the pertinence of democracy in determining welfare spending in post-communist states, at least in countries where democratic social institutions are better crafted (Bohle and Greskovits, 2007, 2012). This pertinence suggests the co-existence of both neoliberalizing and democratizing pressures in transitional economies. Democratization – the increased role of elected officials in policymaking – suggests the possibility of increased welfare spending in transitional states. Another possible outcome is that political preferences expressed in voting leads to less consensus on state welfare spending policies.

This type of interaction between globalization and the expansion of the welfare state is referred to as the ‘compensation’ hypothesis, since states compensate for the losses associated with economic integration (Garrett, 2001; Garrett and Nickerson, 2001: 3–4; Kaufman and Segura-Ubiergo, 2001: 554). Thus, in the face of globalization, the welfare state is not only a competitive advantage, it is a competitive necessity (Hay, 2001: 52–53).

Hypothesis 2. ‘Compensation argument’ – transitional states with democratic institutions experience welfare state expansion regardless of the pressures of economic globalization. In other words, there is a positive correlation between democratization and welfare spending.

The governments of transitional states that are the focus of my analysis here clearly faced pressures from both domestic and international levels: while the World Bank and IMF expected further privatization and cutbacks in public expenditure as part of structural adjustment, citizens and organized stakeholders demanded the continuation of welfare provisions in the transition to capitalism. This dilemma forms the centerpiece for my analysis below.

Data

This article explores welfare spending in 21 transitional states during the period from 1990 through 2005. Welfare spending data are reported by the IMF. Some transitional countries entered the IMF too late to have sufficient data reported. For example, The Federal Republic of Yugoslavia, which later was renamed Serbia and Montenegro, became a member of the IMF on 20 December 2000. For the time period covered in this article (1990–2005), there were hardly any data reported on the country. Due to lack of data, not all transitional economies are included in the sample. Those included are 7 countries in Central and Eastern Europe (Albania, Bulgaria, Czech Republic, Hungary, Poland, Romania, and Slovak Republic), two of the six successor states of the Socialist Federal Republic of Yugoslavia (Croatia, Slovenia), ⁶ three Baltic States (Estonia, Latvia, and Lithuania), and 9 of the 12 Commonwealth of Independent States (CIS; Azerbaijan, Belarus, Georgia, Kazakhstan, Kyrgyzstan, Republic of Moldova, Russian Federation, Tajikistan, and Ukraine).⁷

It is worth noting that China and Vietnam could be included in the sample since both countries were undergoing market-oriented reforms during the same time frame. China began its economic reform in 1978. Vietnam’s market-oriented economic reform (known as doi moi) started around 1986. However, these two Asian countries differ from the rest of sample in important respects: political-institutional history, the onset of the transition, and most strikingly the size of welfare expenditures. Welfare spending in the two Asian countries was much lower than spending elsewhere. In regard to the onset of transition, neither Asian country experienced a ‘collapse of the entire political and economic framework’ as observed throughout the rest of the sample (Rodlauer, 1995: 96). The advantages of the European-only sample are (a) that the European countries directly share a good deal of political-institutional history and (b) that the literature conventionally groups them together.

Variables

Dependent variable

The dependent variable is welfare spending relative to GDP. Welfare spending summarizes government expenditures on services (e.g. childcare and elder care) and transfers (e.g. pension and unemployment insurance) provided to individual persons and households as well as expenditures on services provided on a collective basis (e.g. the formulation and administration of government policy). Welfare spending does not include health and education expenditures, which are treated separately by the IMF.⁸ Expenditure choices relate not only to the short run, but to longer-term institutional questions, including privatization, the administrative reorganization and streamlining of the government, and the permanent reduction of the number of public employees (Haggard and Kaufman, 2000: 4).

It is worth noting that there is a growing body of literature that challenges the appropriateness of using aggregated level social expenditure data to measure welfare states, since components of individual welfare state spending might differ substantially (Clausen and Siegel, 2007: 5–6). Esping-Anderson’s seminal study suggests types of welfare states itself could be an explanatory variable for welfare states outcomes. For example, the major difference between the Nordic and the Continental welfare states was not primarily their size but the type of welfare state (Esping-Andersen, 1990). When we use an aggregate level dependent variable, it is difficult to delineate the kind of welfare spending governments are prioritizing, for example, active versus passive, services versus transfers of payments, unemployment versus pensions, and so on. As a solution to this dependent variable problem, whenever possible, studies would disaggregate welfare states expenditure into particular policy domains to better understand variation in terms of policy-specific welfare states outcomes (Castles, 2004; Huber and Stephens, 2001). Regardless, the amount of money spent on social welfare provision continues to be a popular parameter to measure welfares state variations between and within countries in the more traditional ‘variable oriented’ (as opposed to disaggregated level at policy dimensions) quantitative comparative studies of welfare states development (Clausen and Siegel, 2007: 7).

The extremely diverse components of welfare states among transitional economies, coupled with country-specific public policies, make it impossible to find a better measure other than aggregate welfare expenditure to study post-socialist welfare states commitment. Thus, in this article, I follow the mainstream literature and measure welfare states commitment (the dependent variable of the study) using aggregate level data on welfare expenditures.

Independent variables

In the analysis below, I include independent variables to measure the economic and political changes associated with globalization as well as variables measuring the endogenous characteristics of the transitional states.

Trade and capital flows

Cross-border trade and capital flows are common indicators of economic globalization (Garrett, 2001; Garrett and Nickerson, 2001). They are identified as the top two indicators of economic globalization among OECD (2010) countries (pp. 58, 84). Cross-border trade, measured by the volume of import and export of goods and services, together with inflows and outflows of financial capital reflect a country’s overall openness and integration into the global economy. In addition, foreign aid and external debt are also elements of cross-border capital flows. The variable Aid denotes the amount of foreign aid received per capita. The variable External Debt is also included in the model to see if external debt affects government welfare spending.

Following the mainstream literature, the variable Trade in this article is the volume of imports and exports divided by GDP. Cross-border capital flows mainly come from three sources: foreign direct investment (FDI), foreign aid, and external debt (Garrett, 2001). Brady et al. (2005) differentiated the impact of inward and outward FDI on welfare spending in the developed world. This differentiation, however, was not realistic in this article due to the minimal outward FDI from the 21 transitional economies. Thus, this study measures FDI by the amount of investment capital flowing into the country in proportion to GDP.

To test Hypothesis 1B, I include the variable Use of IMF Credit to measure the influence of the IMF on transitional states’ welfare spending. IMF (2003) credit and loans include purchases and drawings under Stand-By, Extended, Structural Adjustment, Enhanced Structural Adjustment, and Systemic Transformation Facility Arrangements, together with Trust Fund loans. In this study, the use of IMF credit is measured by the amount of IMF credits in proportion to GDP.⁹

Democracy

The variable democracy captures the democratization process in transitional states. The balance of political power between supporters and opponents of liberal reforms in governmental, state, and party structures and civil society at large may be a determining factor of welfare state outcomes. Types of government (left, right, or religious), constitutional structure, and union density are established variables in this path of inquiry (Bolzendahl and Brooks, 2007; Brooks and Manza, 2007; Cook, 2007; Garrett, 1998; Garrett and Nickerson, 2001; Huber and Stephens, 2001; Kaufman and Segura-Ubiergo, 2001; Pierson, 1996, 2001). More recent scholarship on the experience of Central and Eastern Europe’s post-communist transition suggests the pertinence of democracy in determining welfare spending, at least in countries where democratic social institutions are better crafted (Bohle and Greskovits, 2007, 2012). Thus, I use Freedom House’s democracy ratings to capture the influence of democracy on welfare spending. Freedom House’s democracy scores (numeric ratings) are published yearly based on analyses of electoral process, civil society, independent media, national democratic governance, local democratic governance, judicial framework and independence, and corruption (Freedom House, Various Years). The ratings are based on a scale of 1 to 7, with 1 representing the highest and 7 the lowest level of democratic progress.¹⁰

Control variables

In the analyses below, I also include several control variables, which have been shown to be relevant to welfare spending.

Gender-related variables

Female labor force participation (Huber and Stephens, 2001) and the number of Women in legislature (Bolzendahl and Brooks, 2007) have been established as major explanatory variables for welfare state outcomes in advanced industrial democracies. Female-oriented public policies, such as maternity leave and childcare subsidies, lead to higher welfare expenditures. Following this literature, I measure female labor force participation by the number of women in the labor force as a percentage of the female population aged 15–64, and I measure number of women in the legislature by the percentage of seats in the national legislature held by women.

Unemployment

Unemployment is a key demographic control variable. In transitional states, unemployment, which was hidden before, becomes open and rampant. Skyrocketing unemployment appeared in many parts of Central and Eastern Europe, as well as in Central and East Asia.

Conventional wisdom argues that high employment corresponds to a more generous welfare state as contributors outnumber those who draw on the system. But high unemployment rates also create pressures for retrenchment as generous benefits create large budget deficits (Huber and Stephens, 2001; Nelson and Stephens, 2008). Evidence from Latin American countries further suggests that large pools of surplus labor significantly weaken labor power, thus resulting in the retrenchment of the welfare state (Rudra, 2002). Union density is a common indicator of labor power in advanced democracies. This variable, however, is not available to majority of the transition states in the data set. OECD reports ‘Trade Union Density’ from 1999. By the time of this study, only six countries (26% of the data set) were accepted as members of OECD: Czech Republic, Estonia, Hungary, Poland, Slovak Republic, and Slovenia. And the significance of unions continued to decline following the privatization of state-owned enterprises (SOEs). Thus, I did not include this variable in my models.

Aging

The variable Aging captures the aging of society by measuring the percentage of population over 65 years of age. It is another key demographic control of the model. The graying of national populations challenges the sustainability of social welfare systems worldwide. Large chunks of government expenditure are directed to fund pension schemes in affluent Western democracies. Transitional states face the same problem. For instance, the dependency ratio in Ukraine, Belarus and Russia is fewer than three potential workers per pensioner (2.49, 2.76, and 2.91, respectively; Buckley and Donahue, 2000: 260; World Bank, 2007), whereas in Central Asia (Kazakhstan, Azerbaijan, Tajikistan, and Turkmenistan), a younger labor force helped to make the Soviet old-age pension system viable for a longer period of time.

Aging in this article is measured by ‘percentage of population over 65’, as in the mainstream literature. It is worth noting that many of the countries in Central and Eastern Europe have lower retirement ages than 65. Under such circumstances, the ‘age dependency ratio’ becomes a better measurement for aging population. I tried age dependency ratio as the aging variable in the model: while other findings are substantially the same, age dependency ratio is not statistically significant. Thus, I kept the mainstream aging variable – percentage of population over 65 – in the analyses.

Economic performance

The existing literature also suggests that government spending on welfare and social protection is influenced by economic performance, commonly measured by GDP per capita. This measure first emerged in studies related to modernization theory, which showed a positive relationship between welfare spending and GDP per capita (Wilensky, 2002). In this article, GDP per capita is adjusted with purchasing parity power (PPP) to ensure comparability across countries.

In the statistical analysis, I treat Female labor force participation, Females in legislature, Aging, GDP per capita, and Unemployment rate as the control variables. They form the base model. Table 1 presents coding and descriptive statistics for all the variables.¹¹

Table 1.

Coding, means, and standard deviations for dependent and independent variables.

Variable	Description	1990	SD	2005	SD
		Mean		Mean
Dependent variable
Welfare spending	Government spending on welfare and social protection (% of GDP)	12.556	2.20	13.31	5.46
Economic globalization
Trade	Imports and exports of goods and services (% of GDP)	76.70	31.92	114.03	30.55
Foreign direct investment	Foreign direct investment, net inflows (% of GDP), logged	−3.23	3.96	1.47	0.81
External debt	Total external debt (% GDP), logged	3.23	1.85	3.79	0.57
Aid	Aid in proportion to capital formation, logged	−.39	1.46	1.95	1.72
Dependence on global financial Institutions
Use of IMF credit	Use of IMF credit (% of GDP), logged	−0.08	0.10	0.70	1.01
Democratization
Freedom house	Freedom house democracy scores	3.86	1.73	3.86	1.71
Controls
Female labor force	Female labor force as % of female population ages 15–64	67.88	6.63	60.98	6.29
Female legislature	Percentage of women in legislature, logged	2.26	0.69	2.53	0.48
Aging	Percentage of population over 65 years old, logged	2.19	0.39	2.49	.40
GDP per capita	Per capita gross domestic product, purchasing power parity-adjusted, logged	8.83	0.55	8.90	0.80
Unemployment	Unemployment rate, total (% of total population), logged	−.51	−0.51	2.12	0.74

IMF: International Monetary Fund; GDP: gross domestic product; SD: standard deviation.

Methods

The data in this study are yearly observations at the country level from 1990 to 2005, a typical time-series data set. Pooled time-series models best deal with situations like this when one has observations on N units (such as individuals or countries) at T points in time (such as monthly, yearly, or every N years). The main strength of the longitudinal design in the time-series model is that it allows for the control of heterogeneity bias due to the confounding effects of time-invariant variables omitted from the regression model. Baseline cross-national differences in the size of the welfare state are likely to be invariant over time, because they are influenced by structural conditions that develop slowly and hold steady over long periods. Time-series models solve this problem by taking into account the important distinction between the analysis of cross-national differences and the analysis of changes within individual countries over time. With time-series models, the causes of such differences are best assessed statistically through analyses in which the key explanatory variable, for instance, Use of the IMF credit, is expressed as long-term properties of the whole system.

However, time-series models are known to suffer from heteroskedasticity and serial correlation in the error terms. These are conditions that violate the two fundamental assumptions of conventional ordinary least-squares (OLS) regression (independent errors and constant variance), rendering OLS estimates problematic. Thus, I started with a more conservative route by running generalized least-squares fixed effects (FE) models. The FE specification represents a more stringent test of the key independent variables. FE estimation is the equivalent of including country dummies to deal with omitted variable bias (Beck and Katz, 1996). I report the results in Table 2.

Table 2.

Fixed-effects (FE) estimates of internal and external factors on welfare spending.

Variables	Model 1	Model 2	Model 3	Full model
	Base model	IMF impact (H1B)	Compensation argument (H2)	Efficiency argument (H1A)
Economic globalization
Trade				−0.056***
				0.014
Foreign direct investment				0.279
				0.233
External debt				−0.323
				0.362
Aid				−0.262
				0.29
Dependence on global financial institutions
Use of IMF credit		0.905***	.874***	0.816***
		0.264	0.279	0.306
Democratization
Freedom			0.109	−0.101
			0.297	0.321
Controls
Female labor force	0.226***	0.258***	.262***	0.123
	0.07	0.068	0.069	0.082
Females in legislature	0.669	0.647	0.682	0.638
	0.49	0.437	0.449	0.453
Aging	7.655*	12.453**	12.383**	10.796**
	4.564	4.807	4.386	5.895
GDP per capita	−4.815**	−0.767	−0.967	1.22
	1.887	2.05	2.134	2.634
Unemployment rate	1.746***	1.660**	1.745**	2.612***
	0.511	0.656	0.699	0.724
Constant	15.32	−36.040**	−34.998**	−36.727**
	10.456	14.337	14.689	17.864
R² (within)	0.232	0.345	0.346	0.479
N	146	104	104	98

IMF: International Monetary Fund.

*.10, **.05, ***.001.

A random effects (RE) model on the other hand allows the intercept to vary across countries. The RE model assumes that the error of country intercepts and overall country intercepts are normally distributed, and that the overall intercept is right in the middle of all countries’ intercepts. Neither assumption holds in the present context. Therefore, the RE model is inappropriate for this research design. Statistically, the dependency within is controlled for in a FE model. Thus, in this article, I use the FE model as the primary model of analysis.¹² To check the robustness of the findings, I performed RE specification and OLS regression with robust standard errors (ROBUST).¹³ Results are reported in Table 4 of Appendix 1. Across these alternative formulations and specifications, the results remain substantially similar.

Another area that remains contentious in time-series modeling is whether or not to include a lagged dependent variable on the right-hand side of the equation. Some scholars argue that including a lagged dependent variable suppresses the power of other independent variables (Achen, 2000). Others recommend doing so when there is no obvious trend in the data (Beck and Katz, 1996). Recent opinion has turned against the use of the lagged dependent variable (Plümper et al., 2005: 330–334). In a later discussion, Beck and Katz (cited by Nelson and Stephens, 2008: 8) showed that correcting for first order auto-correlation actually captures the majority of what the lagged dependent variable was supposed to capture without the problems implied by using a lagged dependent variable. In other words, it would be redundant to include a lagged dependent variable when using ordinary least-squares estimation with panel-corrected standard errors and autocorrelation adjustment (PCSE).

In my data, a trend is observable, and the lagged dependent variable is highly correlated with the dependent variable (0.96). I decided not to include a lagged dependent in the model. However, as an additional check, I ran FE, RE, and OLS robust cluster models with a lagged dependent variable, which did not yield major differences.

The benchmark model

\begin{matrix} {WELFARE}_{i, t} = α + β_{1} {FemaleLabor}_{it} + β_{2} {FemaleLegislature}_{it} + β_{3} {AGING}_{it} + β_{4} {GDP}_{it} \\ + β_{5} {Unemployment}_{it} + β_{6} {IMFcredit}_{it} + β_{7} {DEMOCRACY}_{it} + β_{8} {TRADE}_{it} + \\ β_{9} {FDI}_{it} + β_{10} {DEBT}_{it} + β_{11} {ADI}_{it} + \sum (β_{j} X_{jit - 1}) + \sum (β_{1} {YEAR}_{lt}) μ_{it} \end{matrix}

Results

Trends in welfare spending

Figures 1 to 3 depict the trends of welfare spending from 1990 to 2005 in transitional states using geographical locations as the criteria for country groupings.

Figure 1.

Government welfare spending as percent of GDP in seven Central and Eastern European states, 1990–2005.

Figure 2.

Government welfare spending as percent of GDP in 9 of the 12 Commonwealth of Independent States (CIS), 1990–2005.

Figure 3.

Government welfare spending as percent of GDP in three Baltic states and two of the four successor states of Yugoslavia, 1990–2005.

Looking at the trends in welfare spending among 21 transitional states, one striking observation is that welfare spending appears to be fairly stable between 1990 and 2005, with limited anomalies. There is no general upward or downward trend.

Among Central and Eastern European countries (Figure 1), Poland and Hungary both experienced high welfare expenditures immediately after the transition. Poland experienced a second peak in 2003; Hungary, however, leveled out. Among CIS states (Figure 2), both Belarus and Ukraine experienced a surge of welfare expenditure in 2005. In Figure 3, welfare spending in Slovenia was quite stable, with little fluctuation. Croatia’s welfare spending peaked in 2001 and then slowly came down. The overall trajectories of welfare expenditures in the three Baltic states are almost parallel.

Correlations between variables

Table 3 of Appendix 1 reports the correlation matrix among the variables used in this study. A few pairs of independent variables are highly correlated, leading to concerns over multicollinearity: GDP per capita and foreign aid (−.74) and GDP per capita and IMF credit (−.70). Multicollinearity is a problem if we observe large standard errors and/or sign changes when we add new variables to the model. Neither situation applies in this study. In addition, I tried slightly different specifications of the models using the same data, for example, dropping different control variables from the models, and did not observe drastic shifts in the output.

In the correlation matrix, variable IMF credit is negatively correlated with welfare spending (−.18). This connection could be spurious before I control for other variables to identify a net effect. At that time, the direction of the effect is likely to change particularly when these are country-level analyses.¹⁴

Hypotheses testing results

Table 2 presents the coefficient estimates and panel-corrected standard errors for FE models of welfare spending among transitional states. Model 1 is the baseline model, which examines the domestic factors proven to be important in previous research. Model 2 tests a variant of the ‘efficiency argument’ (Hypothesis 1B) by analyzing the impact of dependence on global financial institutions, measured by use of IMF credit, on receiving countries’ welfare expenditure. Model 3 tests the ‘compensation argument’ (Hypothesis 2) by adding countries’ democracy ratings to the equation. Model 4 examines external factors, namely, economic globalization (Hypothesis 1A) on welfare spending.

Independent variables

Control variables

Starting with the control variables, we observe that Female labor force participation, a key variable in explaining welfare state spending in advanced Western democracies, also shows a positive correlation with welfare expenditures in transitional states from Model 1 to Model 3. In the base model (Model 1), the coefficient for variable Female labor force participation is positive (.23) and significant at the .001 level. When I add variable Use of IMF Credit in Model 2, I observe the same positive (.26) and significant relationship between Female labor force participation and Welfare expenditure. In Model 3, this effect remains positive (.26) and significant at the .001 level when I add the variable Democracy into the equation. In the full model (Model 4), when globalization factors (cross-border trade and capital flows) enter the picture, the sign for Female labor force participation remains positive, but the variable loses statistical significance.

Aging is a key demographic control of the models. It remains positive and significant with coefficients ranging from 7.66 to 12.45. This result suggests countries with an older population spend more on social welfare.

GDP per capita, a measure of economic security, shows a negative and significant correlation with welfare expenditures only in the baseline model (Model 1), indicating that the richer countries in this sample spend relatively less on welfare.¹⁵

Unemployment rate is another variable that remains positive and significant in all four models, with coefficients ranging from 1.66 to 2.61. This is a very robust finding that contradicts Latin America’s experience and also challenges the consensus in the literature that high unemployment creates pressures for welfare retrenchment as generous benefits create large budget deficits (Huber and Stephens, 2001; Nelson and Stephens, 2008). Instead, this finding supports a more straightforward interpretation: when demand is higher, spending is higher.

Dependence on global financial institutions

Use of IMF Credit measures a country’s level of dependence on global financial institutions. In Hypothesis 1B, the mechanism behind welfare state retrenchment is not the free-market ethos in general but direct dependence on global financial institutions. Model 2 tests this variant of the ‘efficiency argument’ (Hypothesis 1B) by adding variable Use of IMF credit to the base model. Results indicate a positive (.91) and significant relationship between use of IMF credit and receiving countries’ welfare expenditure.

Please recall in Table 3 of Appendix 1, correlation matrix reports a negative connection between IMF credit and Welfare spending (−.18). In Model 2, however, once control variables are present, the variable Use of IMF Credit changes sign to positive and is significant at .001 level. This is a typical scenario of ‘suppressor effect’ in regression, in which the inclusion of a moderator greatly strengthens the effect of another independent variable on the dependent variable.

I continue to observe the same positive and significant relationship between Use of IMF credit and Welfare spending when I control for a country’s level of democracy (Model 3) and external influences from economic globalization (Model 4). The coefficients range from .82 to .87 and remained significant at .001 level. This is a strong and robust finding that rejects the ‘efficiency argument’ proposed in Hypothesis 1B and provides evidence that use of IMF credit is associated with higher welfare expenditures in receiving countries.¹⁶ This finding contradicts the mainstream structural adjustment literature, which has presented evidence from various case studies suggesting a negative impact of IMF loans and credits. This model at minimum hints at an interesting partial correlation between welfare spending and use of IMF credit: welfare expenditures partially contribute to economic growth and social stability.

Democracy

In Model 3, I use the democratization factor to test Hypothesis 2: ‘compensation argument’. Democracy is a key explanatory variable for welfare expenditure among advanced western democracies as well as in Central and Eastern European countries whose democratic social institutions are more thoroughly institutionalized. Regression results, however, provide very scant evidence for the impact of democratization on welfare expenditure among these transitional economies. This variable was never significant and flips from positive to negative when I add globalization variables in the full model (Model 4). Results suggest that in the post-socialist context, at least, democracy is not a significant explanatory variable in welfare spending, which resonates with the alternative of Hypothesis 2: political preferences expressed in voting reduce consensus on state welfare spending policies and the expected positive correlation does not exist.

Economic globalization

Model 4 is the full model in which I add cross-border trade and various types of capital flows (incoming FDI, External debt, and Foreign aid) to test the impact of economic openness and global integration on domestic welfare spending. Among these variables, Trade is the only one that is statistically significant with a coefficient of (−.06). The negative sign of the coefficient lends support to Hypothesis 1A, the ‘efficiency argument’, in which economic globalization drives the retrenchment of the welfare state. In other words, the deeper a country’s ties to the global economy, the lower its spending on welfare.

Summary

Table 2 presents several robustly significant variables: Aging, Unemployment Rate, Trade, and Use of IMF credit. Findings suggest that economic globalization has counter-directional effects on welfare spending among transitional states: cross-border trade, an indicator of economic openness and integration, is negatively correlated with welfare spending, supporting the ‘efficiency argument’; use of IMF credit, an indicator of dependence on global financial institutions, is surprisingly positively correlated with welfare spending, a double challenge faced by all transition economies.

At the same time, we should not ignore the domestic factors which serve as powerful predictors of welfare expenditure among transitional states: countries with older populations and higher unemployment rates spend more on social welfare provision. Democracy, the variable designed to test the ‘compensation argument’ is never significant in the models. It shows democratization, at least within the post-socialist transition context, is not a significant factor in welfare expenditures.

Discussion

Coupled with the expansion of global capitalism, the disintegration of the former Soviet bloc has attracted tremendous interest in the domestic restructuring as well as transnational transfer of institutions to these transitional states. In this literature, debates centered upon the circumstances under which an institutional transition occurs, as well as to what extent this transition brings forth the predicted consequences to the transitional economies. Recent works on the interplay between globalization and post-socialist welfare states development are a prime example of such scholarship, which greatly enriches the existing comparative welfare states literature.

This article seeks to advance welfare states scholarship by examining the links between global capitalist expansion and welfare spending in transitional states. My theoretical framework is built upon the debate between the ‘efficiency argument’ versus the ‘compensation argument’ regarding globalization’s impact on welfare state expenditures. It also leverages the literature on the impacts of World Bank and IMF structural adjustment programs on developing and LDCs.

My findings suggest that transitional states do not fit easily into any existing welfare state models. Different dimensions of economic globalization showed conflicting influence on welfare state expenditures in transitional states. While cross-border trade shows the expected negative effect, cross-border capital flows in the form of IMF credits show a positive effect.¹⁷ The surprising finding on the impact of IMF credit challenges conventional wisdom and suggests a positive influence of supranational organizations, particularly the World Bank and IMF, on steering government welfare spending among countries in transition.

One of the keynotes of the World Bank and IMF’s policy guidance in transitional states is the adoption of neoliberal economic practices, which includes cutbacks in government public spending so as to enhance the competitiveness of a nation’s economy in an ever integrating global market. The path toward neoliberalism typically includes slashing public expenditure and shifting responsibility for welfare provision from the state to privatized schemes emphasizing individual responsibility. However, in this article, the cross-sectional time-series analysis suggests a different route: the use of IMF credit positively relates to welfare commitments among transitional states. This finding contradicts the structural adjustment literature, which largely views policy-based conditional lending as a negative influence on receiving countries’ welfare expenditures. At the same time, it is worth nothing that such finding is a partial correlation as there is no evidence in this article suggesting a causal direction between use of IMF credit and welfare expenditure. Furthermore, the non-significant and inconsistent effects of democratization on welfare spending cast additional doubts on the compensation thesis.

This partial correlation is unexpected but logical considering the onset of post-socialist transition. Central and Eastern Europe’s experience with IMF-supported programs provides a valuable point of reference to understand this positive impact of IMF credit on welfare spending, at least during the early stage of transition. From 1990 to 1993, the IMF played an important role in achieving the following tasks in Central and Eastern Europe: attainment of low inflation rate, reduction of short-term expenditure to boost revenues, reduction of enterprise subsidies, investment and defense expenditures, and budgetary wage restraint (Rodlauer, 1995: 99). All these measures largely avoided from drastic cutbacks in welfare expenditure. The rationale behind this ‘leniency’ lies in the IMF’s belief that a social safety net is essential to creating an ‘orderly underlying condition’ not only necessary for member states to fulfill their obligations stated in the IMF’s Articles of Agreement, but also a smoother transition by making the post-socialist transformation politically and socially sustainable (Rodlauer, 1995: 106). These obligations urge member states to support policies that promote macroeconomic stabilization and unrestricted trade and payments, and more generally, to promote international monetary cooperation (IMF, 2011 [1944]: 5). A prime example is the extension of social safety to cover the newly unemployed workers formerly protected under the institutional arrangements in a command economy. Implementation of these protective programs during the early stages of transition helps to explain why the transition was less politically explosive than many anticipated (Haggard and Kaufman, 2000: 4). In summary, the capitalist transition in post-socialist states does not always translate into immediate retrenchment of welfare expenditures. It is thus not surprising to observe an increase of welfare expenditure under IMF structural adjustment policy guidance during the early stages of transition (Mandelbaum and Kapstein, 1997).

In addition to the external pressures derived from the post-socialist transition, this partial positive correlation between IMF credit and receiving country’s welfare expenditure could also be explained by an internal factor: IMF’s rethinking of the nature of development and a reassessment of the appropriateness of the current development policies due to globalization (Paloni and Zanardi, 2006: 1). It is believed that problems with IMF’s much criticized ‘policy-based lending are largely due to design problems susceptible to reform, rather than problems which undermine the entire original concept’ (Mosley et al., 1991: 307–308). As a result, there are cases where the World Bank and the IMF provided adjustment lending not conditioned on future actions but rather on the basis of a strong past record of government commitment to policy reform (Michalopoulos, 1992: 282–283). In other words, the use of IMF credits will not automatically translate into welfare state retrenchment. Experience from Central and Eastern Europe also suggests conditionality can only play a rather limited role. It is more of the conviction and determination of governments to achieve program success (Rodlauer, 1995: 109).

This article suggests two directions for future research. First, include China and Vietnam in the sample to enrich welfare states literature. This inclusive sample acknowledges China and Vietnam’s aspiration towards a ‘post-communist’ transition and treats historical backgrounds and institutional structures as additional controls for welfare expenditures under the impact of globalization. Second, using quantitative techniques, however, does not preclude important insights that can be gained from finer-grained historical and qualitative scholarship. In the future, I will further reveal the intertwined relationship between domestic policymaking and international pressure by conducting comparative case studies on pension reforms in select transitional states.

Footnotes

Appendix 1

Table 4.

Random-effects (RE) and robust cluster (ROBUST) estimates of internal and external factors on welfare spending.

Variables	RE	ROBUST
Economic globalization
Trade	−0.057***	0.014
	0.012	0.025
Foreign direct investment	0.328	0.384
	0.213	0.538
External debt	−0.309	0.999
	0.313	0.779
Aid	−0.228	−1.806**
	0.270	0.782
Dependence on global financial institutions
Use of IMF credit	0.830***	0.668
	0.272	0.609
Democratization
Freedom	−0.165	−0.941
	0.276	0.575
Controls
Female labor force	0.091	−0.276**
	0.070	0.101
Females in legislature	0.652	0.559
	0.430	1.217
Aging	7.628*	−1.793
	4.376	3.678
GDP per capita	2.381	0.404
	1.971	2.499
Unemployment rate	2.602***	0.116
	0.683	1.670
Constant	−35.542**	27.649
	14.432	20.109
R² (within)	0.476	0.480
N	98	98

IMF: International Monetary Fund; GDP: gross domestic product.

*.10; **.05; ***.001

Acknowledgements

I am especially grateful to David J Frank for his extraordinary mentorship. I want to thank Feng Wang, Catherine Bolzendahl, Dorothy J Solinger, Yang Su, Tsui-O Tai, and Jonathan Templin who provided valuable comments during different stages of this article. Special thanks also goes to Alexander M Hicks for his valuable comments when I presented this article at 2010 annual meeting of the American Sociological Association in Atlanta, Georgia. I also want to thank the International Journal of Comparative Sociology (IJCS) editor and five anonymous reviewers for their comments and suggestions.

Funding

Initial research was supported by the University of California Institute on Global Conflict and Cooperation (IGCC) Dissertation Fellowship (2006–2007).

Notes

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