Financial Systems and Public Welfare Portfolio in the Developing World

Abstract

Governments can supply welfare to a given constituency in a number of ways. What explains the variation in the way welfare is provided? I categorize the different ways of welfare provision into two distinct “modes”. One mode is the financing of income maintenance programs (e.g., public pensions, health insurances, and unemployment benefits). The other mode is the creation of welfare-enhancing infrastructures (e.g., public housing, health care, and education). I refer to the composition of a government’s budgetary spending between the two modes of welfare provision as public welfare portfolio.

I argue that a developing country’s financial system determines its public welfare portfolio. This is because the private sector’s welfare provision potential varies by the type of external financing available. The marginal political return for the government is bigger when public provision fills in what is lacked in the private sector than when it duplicates the mode of private provision. I utilize a mixed-method approach, which combines large-N empirical analyses and comparative case studies of South Korea and Singapore. I provide evidence that governments prioritize public income maintenance in countries with relationship based financial system (RBFS), while public welfare-enhancing infrastructures are prioritized in countries with arm’s length financial system (ALFS).

Keywords: financial market, labor market, welfare policy portfolio