Welfare, innovation capacity, and economic performance: Evidence from American federalism

Date01 July 2019
Published date01 July 2019
AuthorGeiguen Shin
Subject MatterArticles
Welfare, innovation
capacity, and economic
performance: Evidence
from American
Geiguen Shin
School of Public Affairs and Administration, Rutgers University-
Newark, USA
Despite years of increased federal welfare spending, it is unclear how federal financial
investments in welfare areas influence state economies. Based on the theory of func-
tional federalism, this paper examines the impact of federal welfare spending on state
economic performance. Employing error correction models, this research finds that
state economic growth and volatility are directly observed by the long-term impact of
welfare spending. The results also show that increased federal welfare spending
boosts state economic performance indirectly, by motivating states to generate
higher innovation capacity, especially, in knowledge-based economic development
programs. This research extends our understanding of the determinants of state
economic performance by addressing intergovernmental redistributive transfers, and
state government’s innovation capacity.
Economic performance, functional federalism, innovation capacity, welfare policy
Since the 1930s, modern federalism has expanded federal responsibility, especially
in the area of human services. Although the era of New Federalism has been a
critical period for advocating devolution, the federal government has continued to
play an active and at times a resurgent role in redistributive areas (Bovbjerg et al.,
2003). Since 1960, the share of the country’s spending on welfare programs at state
Public Policy and Administration
2019, Vol. 34(3) 349–381
!The Author(s) 2018
Article reuse guidelines:
DOI: 10.1177/0952076718796104
Corresponding author:
Geiguen Shin, School of Public Affairs and Administration, Rutgers University-Newark, 111 Washington
Street, CPS Room 319, Newark, NJ 07102, USA.
Email: geiguen@gmail.com
and local levels has steadily declined, while federal government expenditures have
more than doubled in those areas, since 2000. For example, in 2007, the federal
government spent $1.45 trillion (almost half of all federal spending) on redistribu-
tive programs, such as Medicaid, housing assistance, unemployment compensation,
and food stamps (Miron, 2011).
In recent years, policy makers have utilized a model of federalism that shares
functional responsibility for major policy issues with states. While the federal gov-
ernment has transferred a vast amount of funds, particularly to redistributive pro-
grams, state governments have also allocated considerable f‌inancial resources to
economic development programs. The federal government’s comprehensive meas-
ure in dealing with an economic recession involved spending a signif‌icant amount
of money in welfare areas, in part, to rehabilitate the sluggish economy.
In contrast, state governments have remained passive in investing in welfare pro-
grams, not only because state politicians fear that their states will become ‘‘welfare
magnets,’’ but also because they cannot af‌ford to adequately f‌inance large welfare
programs (Peterson, 1995; Peterson and Rom, 1990). Instead, market forces and
political pressure have forced state governments to focus their ef‌forts on stimulat-
ing economic development (Brace and Mucciaroni, 1990; Eisinger, 1989). However,
due to the increased f‌inancial burdens incurred by welfare programs, and limited
revenue streams, many states’ resources are inadequate for stimulating innovation
capacity that would further economic performance (Shin and Hall, 2018). It is
reasonable to expect, therefore, that the federal government would help states
increase economic performance by transferring welfare resources.
Surprisingly, scholars of American federalism have not yet systematically exam-
ined and tested the relationship between the federal ef‌fort on welfare programs and
the overall economic outcomes in the American states. This research identif‌ies
expectations regarding how federal welfare spending impacts state economies,
both theoretically and empirically. In this paper, I suggest that federal welfare
funds spur state economic performance indirectly, by increasing slack resources
that state governments can utilize, which would increase the state government’s
innovation capacity in the economic development programs, especially knowledge-
based strategic programs. It is also suggested that federal welfare funds can
increase state economic performance directly, by improving labor productivity in
ways that assists people who are temporarily living in poverty, but are eligible and
capable to work, and to f‌ind employment (Aghion et al., 1999; Conley, 2010). In
order to measure the intervening variable, this paper develops an index of state
innovation capacity by creating composite variables that are based on overall
state expenditures (both knowledge-based newer development programs and
more traditional development programs). State economic performance is examined
by measuring both quantitative and qualitative economic outcomes, which are
operationalized by two indicators: economic growth measures (gross state product
(GSP) and personal income) and economic volatility measures (a standard devi-
ation of GSP growth rate and a standard deviation of personal income growth
rate), respectively.
350 Public Policy and Administration 34(3)
The results of error correction models (ECMs) show that state economic growth
and volatility are directly observed by the long-run impact of federal welfare spend-
ing. Results also show that increased federal welfare spending boosts state economic
growth, not state economic volatility, indirectly through increasing state innovation
capacity particularly in knowledge-based economic development programs. The
f‌indings support a fundamental assumption that federal welfare funds would lead
to higher economicgrowth and lower economic volatility withinthe American states.
The federal government’s functional responsibility in
redistributive programs
A large number of studies examining state and local governments in America
focus on the economic impacts of two broad economic policies: locational-model
policy and human-capital development policy. For instance, studies that focus on
the locational model—that is, on government policies that can af‌fect the location
decisions of business and industry—investigate the ef‌fect of tax incentives and
government expenditures on economic growth (e.g., Brulhart and Schmidheiny,
2015; Crain and Lee, 1999; Poulson and Kaplan, 2008; Prillaman and Meier,
2014). In contrast to this, some studies focus considerable attention on how
human–capital development policies, such as education, job training, and
health programs impact state economic growth (e.g., Deskins et al., 2010;
Feiock, 1999; Murphy and Topel, 2016). Economic growth can also be explained
within policy, management, and political boundaries. Many studies have exam-
ined the ef‌fect of institutional power, management, party control, and ideological
dif‌ferences, on economic development policies (e.g., Bae et al., 2012; Brace, 1993;
Howell-Moroney, 2008; Rigby and Wright, 2013). Additionally, a signif‌icant
number of scholars have examined the relationship between the level of f‌iscal
decentralization of American states and state economic growth (Akai and Sakata,
2002; Shin, 2018; Xie et al., 1999).
Based on the extant literature, conventional wisdom on state economic growth
holds that American states have been the primary engines of economic develop-
ment ef‌forts not only because states compete with one another to provide competi-
tive economic environments, but also because state governments can receive more
information about ef‌f‌icient policy choices from the marketplace. However, this
does not necessarily mean that the federal government remains silent when it
comes to state economic performance. Saiz (2001) notes that the devolution of
power from Washington to state and local governments not only produces policies
of questionable ef‌f‌iciency, but also limits innovation. He suggests that studies of
economic development should include the ef‌fect of federal government action on
reducing the negative ef‌fects of interjurisdictional competition in pursuing eco-
nomic development. Indeed, economic performance at the state level is ‘‘set
within the context of national forces that inevitably af‌fect state opportunities
and create state economic development opportunities, as well as challenges’’
(Eisinger, 1989: 301).
Shin 351

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