How should our government assure that its citizens have enough to get by – enough food, enough shelter, good enough health, etc.? It is easy to forget that today’s fiercest political battles ultimately revolve around this simple question.
The question is “how,” not “whether.” It sometimes may appear otherwise, but both the political left and the political right agree on these precepts: that a minimum level of welfare should be guaranteed to everyone, and that the state should assist in its provision.
Consider, for example, the great Austrian economist Friedrich Hayek, an icon of free market libertarians. It’s widely assumed that his ideas amount to social Darwinism, but Hayek himself believed in a basic safety net, and said so directly in his popular 1944 book The Road to Serfdom, which warned against encroaching socialism. “In a society which has reached the general level of wealth which ours has attained … there can be no doubt that some minimum of food, shelter, and clothing, sufficient to preserve health and the capacity to work, can be assured to everybody,” Hayek wrote. “Nor is there any reason why the state should not assist the individuals in providing for those common hazards of life against which, because of their uncertainty, few individuals can make adequate provision.”
But Hayek’s disciples in the conservative movement and those on the left have very different ideas about the means to achieve those ends.
The venerable columnist John Kay of the Financial Times recently expressed one view in a piece titled “The welfare state’s a worthy Ponzi scheme,” namely that those with resources to spare should transfer them to those in need, in anticipation that others will do the same for them. In response, a Financial Times reader named Deri Hughes submitted a letter outlining another view, namely that resources should be transferred to the needy only insofar as they have voluntarily entered into contractual agreements covering the contingency of needing that transfer. These two perspectives provide sufficient background to explore the matter in depth.
John Kay’s view is encapsulated in the following excerpt, in which Kay is reacting to a talk that Tom Palmer, a Senior Fellow at the libertarian Cato Institute, recently gave in London. Palmer’s message was that the welfare state is a Ponzi scheme that will eventually lead to national bankruptcy.
The content of these rants is familiar. Levels of welfare provision are unaffordable; government finance is a huge Ponzi scheme. A common conclusion is to provide an estimate of the discounted value of the cost of some hated item of expenditure if its current provision were continued into the indefinite future. Mr. Palmer reported that the present value of unfunded liabilities of US medicine and social security is $137 [trillion].
Social security is a means of inter-generational transfer. The only bread fit to eat is bread baked today: but why should today’s bakers feed the retired bakers of yesteryear? Why should we look after old people, who can no longer do anything for us?
The obvious answer invokes Kant’s categorical imperative: it would be good for everyone (including ourselves when we are old) if everyone acted in this way. We feed the generations of our parents and grandparents in the expectation future generations will come along and do the same for us. But the consequences of this arrangement do have the character of a Ponzi scheme. One day, the world will end and the last generation of workers will have been cheated of their expectation of a peaceful retirement. In the meantime it is possible to calculate enormous measures of unfunded obligations, and it doesn’t matter. The value of these obligations is offset by the implied commitments of future generations.
Notice that there’s nothing in these lines about providing for one’s own needs by investing for retirement or purchasing insurance. It’s about transfers from the younger generation to the older in the case of social security, and from the less needy to the needy in the case of other minimum welfare needs, like medical care.
The rebuttal
Kay’s respondent, Deri Hughes, offers this rebuttal:
In Mr. Kay’s model of the welfare state, the state decides how, and to what extent, the active segment of the population should support the inactive. The state then transfers resources, on pain of criminal sanctions, from the active to the inactive. In other words, it uses its powers of taxation and patronage. However, there is an alternative, and rather different, method of enabling the active to support the bulk of the inactive segment.
In order to illustrate the operation of such an alternative method, we need only consider pensions. After all, all pensions, whether public or private, funded or unfunded, are a claim by the inactive, whether current or prospective, on the active. However, there is a significant difference between an unfunded public pension scheme and a funded pension scheme; the former is funded by coercive means, whereas the latter is funded as a result of a complex series of voluntary contractual arrangements and interactions. Furthermore, funded pension schemes are important accumulators and allocators of productive capital, whereas tax-funded pension schemes are simply a means to facilitate forced redistribution.
Therefore, it is misleading to claim, as Mr. Kay appears to be doing, that curtailing or eliminating the current welfare state would amount to intergenerational neglect, for individuals and private organizations are more than capable of making their own arrangements for intergenerational transfers. The state should welcome, encourage and facilitate such arrangements, rather than displacing them.
The crux of the matter
The core of the argument is Hughes’ distinction between state coercion and voluntary private contracts.
A “funded pension scheme,” in Hughes’s usage, is a scheme in which an individual has voluntarily entered into a contract that transfers resources to that individual in case of contingencies, such as the individual’s longevity in retirement or the individual’s health care needs. The contract may have been explicitly entered into by the individual, or may have been packaged with the individual’s freely-chosen employment. Let us call that a “private” scheme.
An “unfunded scheme,” by contrast, is a scheme in which resources are transferred to an individual in the case of contingencies, in spite of the individual’s not having chosen to enter into a contract to cover those contingencies. Let us call that a “public” scheme. In a public scheme, every individual is assumed to have entered into a contract solely by virtue of being a citizen of his or her country.
Is there really so clear a difference between these two approaches? This is the crux of the issue. Why is a private scheme a complex series of voluntary contractual arrangements and interactions, while a public scheme is coerced? Are social contracts, such as those between governments and citizens, not also complex and, ultimately, voluntary?
The question could be debated at length; the answer is not obvious or trivial. If a citizen does not like the social contract into which he or she was born, the citizen could, in theory, give up citizenship and move to another country – but how feasible is that in the real world? One could argue that the social contract is thus more coercive than contracts entered into between individuals, however complex those voluntary personal contracts may be.
But we are all bound by the social contract, many of whose strictures we have not individually chosen, in its entirety, and we benefit from the whole. Why, among this interlocking web of obligations and benefits, should transfers from those who are sufficiently well off to those who do not meet Hayek’s standard of minimum welfare be singled out as coercive? Many people would think that the obligation to help others who are in dire need is, or should be, part of the social contract. Is it really necessary to enter explicitly into “a complex series of voluntary contractual arrangements and interactions” in order for that obligation to be met?
A red herring
Is any of this productive? This debate often plays out in the media as a debate between those who believe that in principle the rich owe something to the poor, and those who believe nobody owes anything to anybody, oversimplifications and extreme positions that thwart productive discussion. (The battle often takes place between those who believe viscerally that government is anathema and those who believe viscerally that corporations are anathema, exacerbating the problem.)
What if this debate is merely a red herring, distracting from the more important issues?
After all, neither of the two extreme principles is necessary to favor either the public model or the private model. The real question is merely a choice between two pragmatic methods for transferring funds from those who can spare them to those who are in need.
Meanwhile, the battle between two unnecessary, visceral principles distracts from what was, or should have been, the main point of Palmer, the Cato Institute Senior Fellow to whom Kay’s column was a counterpoint. The point is that the projected costs of providing for what is held to be the minimum welfare exceed the projected resources available. This could be true no matter what the funding method is – and it could be rectified by any method, too.
Zealots of one or the other of the two principles will argue that the system cannot cover the necessary costs unless it adheres to their chosen principle. But this is untrue. Means – however complex – can be devised under either system to hold costs in check and foot the necessary bill.
How high the safety net?
But there is another issue embedded here. Hayek distinguishes two kinds of security, “the security of minimum income and the security of the particular income a person is thought to deserve.” The first he believes, as already stated, should be provided with the assistance of the state. The second he believes calls for no state involvement at all.
But how does one define the “minimum of food, shelter, and clothing, sufficient to preserve health and the capacity to work?” Obviously, it will be different in different countries – consider minimal standards in the United States versus those in Bangladesh – and in any country different people will have different opinions about precisely where the bar should be set. Almost everyone would agree, however, that if the safety net is strung too high, it will either bankrupt the country or remove all motivation to work, or both, as it did in the Soviet Union, prior to its dissolution in 1991.
Wouldn’t it be more productive, then, to form the debate around the question of exactly how high the safety net should be? This discussion is particularly urgent in the area of medical care, where costs are projected to skyrocket. Does a minimum safety net require that extreme end-of-life measures be taken to preserve life, as technically defined, even if this preservation means extended misery or unconsciousness for the dying, and medical expenditures made in the last year of life comprising one fourth of the total?
Answering this question may be a task best tackled by private medical insurance contractors, though government can do it too, as it does, for example, in the UK. Private insurers could offer medical insurance at a lower premium, contingent on the insured signing a Living Will stipulating that life is not to be prolonged by specific extraordinary means.
The current atmosphere, in which we debate social welfare only on the basis of muddled principles and not on the basis of practical issues, is not conducive to solutions. The problems with our safety net will not be easy to solve by any means, but the discussion would gain clarity if everyone could agree at the outset that a minimum level of security should be guaranteed to all – ultimately, of necessity, by the state – and what we’re really searching for is a precise definition of what exactly that minimum level should be.
Michael Edesess is an accomplished mathematician and economist with experience in the investment, energy, environment and sustainable development fields. He is a Visiting Fellow at the Hong Kong Advanced Institute for Cross-Disciplinary Studies, as well as a partner and chief investment officer of Denver-based Fair Advisors. In 2007, he authored a book about the investment services industry titled The Big Investment Lie, published by Berrett-Koehler.
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