America Subsidizes European Welfare States

Late last week a hearty debate broke out in the blogosphere regarding whether Americans or Europeans have a higher standard of living. Paul Krugman started it, and Greg Mankiw, Dan Mitchell, and many others responded.

Krugman argued that European economies are no less dynamic than America's and standards of living are comparable even though social welfare spending is higher. Mitchell explodes the idea that Europeans and Americans are similarly wealthy--average American consumption is much higher--while Mankiw suggests a number of factors that may account for the differences in per capita consumption and unemployment.

My own humble contribution is merely to point out that the U.S. subsidizes Europe (and others) in at least two significant ways: defense spending and medical innovation.

In a recent paper on medical innovation published by the Cato Institute, Glen Whitman and Raymond Raad point out that America leads the world in three of four general categories of innovation--basic science, diagnostics, and therapeutics--while the fourth category of business model innovation lacks sufficient data to draw clear conclusions.

Politicians and pundits often argue that we'll fall behind if innovations don't take place here. Not so. Once an invention happens, those who have carried none of the burden of its development--the diversion of resources from production to research, the costs of many dead-ends, and the risks of failure--can take as much advantage of it as those who sacrificed for it. It's the classic free rider problem: most of the beneficiaries carry virtually none of the cost. Clearly, expanding the frontiers of knowledge and productivity is necessary for continued progress, but the costs and benefits are not evenly distributed.

And so it is with healthcare and other sectors where American innovation predominates. America's disturbing distorted health care system at least provides incentives for individuals and organizations to develop better ways of treating illnesses and promoting wellness. U.S. taxpayers and consumers foot the research bill, and Europeans and the rest of the world benefit from the disproportionately American advances.

U.S. subsidies to Europe (and Japan, South Korea, Australia, and many other places) also take the form of our picking up some of the tab for their defense. According to the CIA World Factbook, the U.S. significantly outspends most European nations in terms of percentage of GDP, and that's with a higher per capita GDP, as noted above.

For those that spend a greater share of domestic output--Macedonia, Turkey, Bosnia and Herzegovina, and Greece--I have three words by way of explanation: location, location, location.

Here are the big six: UK (2.40%), France (2.60%), Spain (1.20%), Italy (1.80%), Germany (1.50%), and Poland (1.71%). None of them are even close to the U.S.

If those are the levels that they think are appropriate given their threat environment, fine, but that seems unlikely. The United States are bordered by two gigantic oceans and two weak and friendly nations and haven't been invaded by a foreign power since the 19th century. Europe is proximate to the Middle East and Africa and has a history of continent-wide wars.

And one suspects that Europeans rightly view the 78,000 U.S troops stationed there and ongoing commitments to the NATO alliance as a signal that they don't need to fully fund their defense needs. The U.S. will be there to bail them out.

Needing to spend less on their defense permits them to spend more on social services. It's that simple.

Even if Krugman were correct about similar standards of living in Western Europe and the United States, the fact remains that the U.S. is massively subsidizing the European welfare state through our defense umbrella of that continent and by producing a disproportionately high share of the world's innovation (especially medical) here. Absent those subsidies, Europe's current 'generosity' would be unsustainable.