The Welfare State has come under attack from economists, particularly in Western Europe, who argue that it is responsible for poor economic performance, and that public spending should be reduced. The present paper seeks to clarify the nature of the charges leveled against the Welfare State and the mechanisms by which it may adversely affect economic performance. The first section considers the aggregate empirical evidence. Not only is the evidence mixed, but also such an argument is difficult to establish. The second section of the paper describes a number of the problems with aggregate cross-country evidence. In particular, the interpretation depends on the underlying theoretical framework. The third and fourth sections of the paper examine a selection of the theoretical mechanisms, distinguishing between those that affect the level of output, taking a model of the labor market, and those that influence the rate of growth, drawing on recent developments in growth theory. An important role is played by the institutional structure of benefits, which can significantly change their impact on economic behavior.
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