The Determinants of Social Protection Expenditures and Labor Market Flexibility

This paper examines the determinants of social protection expenditures empirically focusing on the influence of labor market flexibility. Using data on 55 developed and developing countries, and fixed and random effects models to account for country specific effects, the paper finds that the perception that labor market flexibility would increase demand for social expenditures is unfounded. Among the labor market flexibility indicators, linking pay to productivity reduces social protection expenditures. This result is robust to the inclusion of unemployment rate and the degree of income inequality as two social protection risks in the empirical model. It is also robust to the inclusion of more risks, proxied by the Human Development Index. Given the large country sample adopted, the paper improves our understanding of the most important determinants of social protection expenditures, and highlights the importance of labor market flexibility to government expenditure policy.