The Expansive Welfare State, The 'Pate De Foie Gras' Fallacy, And The Impossible Trinity 2.0

US President Joe Biden’s sweeping Build Back Better agenda proposes to spend $2.2 trillion on a range of social policy and climate goals but the bill is currently stuck in the Senate for want of required numbers. If it does get to see the light of day, the US will move closer than ever to becoming a European style expansive welfare state.

While that prospect cheers many on the left, a question not sufficiently addressed is whether the US can afford sprawling welfare while continuing to outspend Europe by a mile on defence. The evidence suggests something’s got to give.

Indeed, I believe there are two factors at work, one following from the other, that are potential tripwires for the world’s leading superpower intent on going down the road of expansive welfare — the “pate de foie gras fallacy” and “the impossible trinity 2.0".

The pate de foie gras fallacy is an idea I’ve carried in my mind for some years now but a recent casual conversation in a WhatsApp group gave a new spark to it. A friend based in Germany wrote about how some people there went out of their way to welcome refugees and mentioned an incident where a lady he knew had donated jackets to an immigrant family. Not just any jacket, but expensive winter jackets of a name brand that would have cost at least 400 Euros each! I responded with the comment that this was a textbook case of the pate de foie gras fallacy in economics.

What Is The Pate De Foie Gras fallacy?

I begin with the proposition that in free market economies, the price mechanism is the key which ensures that scarce productive resources are put to their most efficient uses. The welfare component of the economy functions outside the discipline of the price mechanism and it will inevitably reveal inefficiencies arising from its disconnect with price realities. The larger the welfare component, the greater the drag on the wider economy. Therefore, over time, expansive welfare states shed dynamism and post lower growth rates than counterparts where welfare is held on leash.

In defence of this proposition, I’ll cite the example of the United States which is widely recognised as a more vigorous wealth creator than western Europe where the welfare state is a bigger leviathan. Now, going purely by per capita gross domestic product (GDP), the US is not a significant outlier. But once we adjust for its far greater military spending, the picture changes dramatically. In the six decades from 1960 to 2019, cumulative US military expenditure averaged 4 per cent of its GDP while European powers like UK and France rode piggyback on US military might, averaging barely 2 per cent.

What would US per capita GDP be today if it too had spent only 2 per cent on defence? A simple Excel chart calculation — assuming reinvestment back into the economy of the money saved — was a lesson in the power of compounding. The US today should have had a per capita GDP of over $ 100,000 against $63,500 currently. Decades of high military spending has taken a toll on its economy, yet it did not fall behind. Indeed, it continued to be among the richest and most dynamic economies of the world. How did the US shoulder the extra burden for so long with no evident wear and tear? More to the point, why didn’t the European powers pull ahead decisively over these years?

Without seeking to downplay the complexities — there are numerous studies on why the US economy scores over Europe — I’ll focus here on one factor that is not given the consideration it deserves. It starts with the drag on the welfarist economy from having a larger part function outside the price mechanism.

Typically, this shows up over many years, as with the centrally planned Soviet economy which disdained the price mechanism and still plodded on for over 70 years before falling off a cliff. Within the larger dynamic of this welfare drag — and this is the crux — there’s a subfactor at work which actively erodes the value of the economy’s output to further aggravate the drag. I’ll call it “the pate de foie gras fallacy” and it affects expansive welfare states that dole out an assortment of goods and services in kind.

When you serve a poor hungry person with a generous helping of pate de foie gras sourced from a high-end restaurant at great cost, say, $30, he will no doubt emerge with his hunger satisfied. However, given that the same level of satisfaction or even more could have been delivered by a burger meal combo costing, say, $6, the difference in cost between the two is effectively the value destroyed. No two words about it. This should not be hard to understand.

Imagine if the pate de foie gras was instead sold by the restaurant to a patron for its market value; from the proceeds we could have fed five hungry persons. What if you had given the money directly to the hungry person? Is it not likely that he would buy himself a burger meal which he may relish more at a fraction of the cost, and save the rest of the money for other pressing needs?

Simply put, welfare handouts in kind tend to err towards overkill that effectively amounts to value-destruction. Overkill in this context is when higher priced goods and services are given out to address an economic deficit that a lower priced variant could’ve done equally well. Overkill is also when free stuff is given out to those who have no pressing use for it — not unusual in the industrial scale one-size-fits-all welfare system — or when costly services are made available to beneficiaries who are incapable of paying back the cost from their future economic contributions.

Paradoxically, not only is this destruction of value not accounted for in the country’s GDP numbers but also the way things work, the satisfaction of hunger by the serving of pate de foie gras will be counted as increasing GDP by $30 while the burger meal alternative adds just $6. And this, even as $30 worth of output is effectively debased to a value of just $6 at the point of use. If GDP is supposed to represent economic well-being, in this example it was off target by $24.

It may be argued that the GDP metric concerns itself only with the measurement of output and not its subsequent use or misuse. Nevertheless, because we don’t measure something does not mean it won’t have consequences, especially when it is something systemic in nature. For years, China registered consistently high GDP growth rates riding on massive policy-driven investments in real estate. Today, its ghost cities and millions of unsold apartments are feared to be a ticking bomb.

Let’s run through some examples. Imagine you are a connoisseur of art and pay a good price for an exquisite hand-crafted tribal artefact in which you see value. What if you gift it to someone who accepts it unhesitatingly but goes on to use it as a paperweight? To improve scientific knowledge, a welfare-minded government spends extra money to offer free courses in rocket science to its citizens. When people without a grasp of basic algebra turn up to attend (the lure of the free!), all the money spent on their edification is as good as lost.

A free universal health care system pays for an expensive organ transplant for someone holding a low paying job or even no job. The patient lives on for a heart-warming story but the gains to the economy from his extended life is meagre and the cost incurred on the transplant is never fully recovered. The goal of equity is met but the goal of efficiency — the returns from the capital used up — is tossed out. The equity goal makes for touching news media copy but have no doubts, it’s the pursuit of efficiency that gives rise to the world-beating economy with military power to match.

When someone pays full price for a product or service, it means they have uses for it that deliver as much value to them as what they have paid for. When given out for free, it is accepted with glee, but many will go on to put it to sub-optimal uses that erode or destroy value. Since the provision of welfare happens on an industrial scale, the destruction of value also takes place on a substantial scale.

In the erstwhile Soviet Union, the price of bread was subsidised and kept artificially low as it was deemed essential to the common man. Soviet farmers who were allowed to tend to small garden plots within their collective farms responded by generously feeding bread to their pigs. In India, many states have started supplying generous quantities of food grains to people at rates as low as Re 1 per kilo and a good part gets sold in the market at very low prices or becomes cattle-feed when the quality is poor.

My hypothesis is that expansive welfare states that dispense generalised industrial-scale welfare will endure a pronounced ‘welfare drag’ with overkill and systemic erosion of value happening all the while but under the radar. The cumulative impact becomes visible after years of misallocation of resources, squeezing savings and investments. The difference can become stark, as when the US maintains an economic edge despite bearing the cross of its enormous military year after year.

In comparison, early welfare states with limited objectives would likely have delivered a welfare bounty. When people are poorer, thoughtful interventions can generate disproportionate short-term and long-term gains — examples like schools to rescue a generation from illiteracy with lifetime payback from more productive citizens, safe drinking water, essential medicines to combat infectious diseases etc. As welfare expands in ambition and scope, diminishing returns set in. The bounty fades and the fallacy comes into play.

The Impossible Trinity 2.0

Throughout the post-war years, the US led the world in economic and military heft while taking a backseat on welfare. Indeed, this is a sore point with left-leaning economists who have often picked on it to make unfavourable comparisons with Europe. But now the tide has changed with power passing onto those who would remodel the US on European lines.

In fact, but for one Democratic party Senator resolutely holding out, President Biden and his Democratic party’s Build Back Better bill would have become law by now. That bill has a long list of elaborate provisions meant for ordinary American families such as free universal preschool for three and four year old kids, four weeks of paid leave at 90 per cent of wages to all employees, free community college for all Americans (now dropped), more money for affordable housing and rental assistance to low-income households, free school meals for 9 million more students, hearing aids every five years for those on Medicare, and more.

As welfare and entitlements surge, the US will soon confront a difficult choice. In economics, the “impossible trinity” says that a country can have only two of the following three: a fixed foreign exchange rate, free movement of capital, and an independent monetary policy.

My restated version, the “impossible trinity 2.0”, says you cannot be a dynamic world-beating economy, the world’s leading military superpower, and an expansive welfare state all at the same time. If welfare must expand, either the military stands down or the economy loses its edge.

(Ranjan Sreedharan is an occasional writer whose area of interest in the interface between economics and politics. He can be reached on email at ranjansr@yahoo.com)