The facilities offered by the welfare state tend to be developed to excess. In the process they reduce economic growth and generate political conflict. Economic growth is hindered by the high taxes and pervasive regulations. The generous benefits may discourage work, investment and business start-ups. Risk-taking may be suffocated by the increased costs of doing business and the taxes on success. From a political perspective, once government benefits are accorded, whether as payments or as regulatory preferences, it becomes difficult to withdraw them. This condition of political rigidity may subvert prosperity and evoke popular discontent. Benefit cuts also tend to trigger discontent, notably in a weak economy when the poor are most in need of assistance.
Dismantling of welfare systems leads to abandonment of any full employment policy, accompanied by an erosion of rights to unemployment benefits; reduction in financial resources to alleviate poverty; reduction in the general level of social security; and reallocation of resources for the promotion of equal opportunities.
High wages and generous social programmes have become the civilized hallmark of much of western Europe since World War II. In 1990, social security payments as a percentage of GDP equalled 21% in France, 18% in Italy, and 15% in Germany, as contrasted with 12% in Japan and 11% in the USA. Social spending in Germany has risen from 26.5% of gross wages in 1970 to an estimated 40% in 1994. In France 44% of collected taxes is spent on welfare programmes. High wages and social costs, whether paid directly by employers or indirectly by taxpayers have eroded European productivity. OECD statistics indicate that industrial production in Europe is virtually at the same level in 1993 as in 1989, despite increases in wages of 7 to 8% per year. Per-unit costs of output in Germany in 1993 were 35% above those of Japan and 50% above those of the USA. Experts claim that as a consequence European workers have simply become too expensive.
The welfare state systems are becoming increasingly over-extended and it is expected that they will have to be cut back sharply. The dismantling is most advanced in the UK and the USA, although the process has profoundly affected the social landscape in Canada and western Europe, although until the 1990s these effects were kept within limits in Germany, the Netherlands and Scandinavia. The slow developments towards a social contract in Japan and Southeast Asia are now being curtailed. This is also true of the embryonic developments of a social contract in developing countries, notably those subject to structural adjustment programmes.
The welfare state system is not philosophically misconceived, but it was not designed to support one in eight of the workforce out of work. Their expense has inhibited governments from adopting expansionary economic polices or allowing the public sector to act as employer of last resort.
The welfare state is the source of costly and inefficient bureaucratization of economic life and creates questionable limits to free entrepreneurship. It can create new social inequalities and new forms of social dualism.