The politics of social protection: social expenditure vs market regulation

It has been argued that the notion of a European social model is misleading and that there are in fact different European social models with different features and different performances in terms of efficiency and equity. In this paper, we look at the welfare state from a political economy point of view and interpret the different regimes as possible outcomes of a political process through which heterogeneous preferences of voters are aggregated. In our model, agents differ in two respects: income and socio-economic vulnerability. Policy-makers have to decide on two policies: a proportional income tax to finance a social transfer, providing equal benefits to all citizens, and a market regulation policy which benefits only vulnerable workers, providing them with additional protection against unemployment risk. Market regulation is inefficient because it decreases aggregate resources. Individuals' heterogeneity generates a conflict over policies. We feature the political process as a two-party electoral competition in a citizen-candidate model with probabilistic voting. We show that an inefficient equilibrium exists and that this outcome is more likely as income inequality and the proportion of vulnerable workers become greater. Intuitively, greater inequality raises the level of redistributive spending desired by the poor, making, at the same time, the rich more adverse to the welfare state. In this framework, both the rich and the poor, in order to win the election and realise the fiscal gain, have an incentive to support market restrictions, in the attempt to capture the votes of the vulnerable minority, who benefit from these policies.