Free market welfare: not this!

Out of all the think tanks in the world, probably the one that has the closest "fit" with the ASI is the Niskanen Centre in Washington DC. They share our pragmatic, compassionate, and neoliberal outlook, proposing liberal market-orientated policies that raise the wealth, and welfare, of the majority. But a recent article of theirs by Sam Hammond clarifies a major disagreement that nevertheless exists between our approaches.

Hammond, a friendly acquaintance and poverty researcher at Niskanen, makes the case for a "free market welfare system", asking "what is the welfare state for". So far, so good. And we do start with a lot in common. Hammond is right that spending and regulation are not necessarily intertwined, and that reducing regulation should be more of a priority for market liberals. He is right that redistribution can be a compensatory mechanism, paid out of the massive gains from free trade and relaxed immigration policies, to the minority who lose out. And he is right that, historically, the social insurance systems he describes, were not justified so much by their redistributive functions, but as social insurance systems.

But there is also a lot to disagree with.

Social Security retirement benefits, for example, represent a transfer from people who die young to those who live a long, long life — a structure that may even be mildly regressive in its first-order effects. Every year, thousands of millionaires collect unemployment insurance between gigs, having paid an outsize share of payroll taxes. And then there are infrastructure, policing, national defense, and all the other things the state provides out of general revenue, not due to fairness, but because they are public goods.

If Heath is right, the normative logic of the social safety net and the market are not at all in tension. States provide public goods for the very same win-win efficiency reasons that they enforce property rights and a robust legal system (public goods in their own right). We all benefit from things like national defense, but high transaction costs prevent us from organizing to provide them privately. We also all stand to benefit from the ability to insure against economic risks like the loss of a job — millionaires have bills to pay, too — even when information asymmetries make private-sector unemployment insurance a challenge. Too much insurance has costs, as well, like inducing overly risky behavior. Yet such “moral hazards” are a generic feature of all insurance, and an inevitable part of making trade-offs.

The upshot is that the welfare state is better thought of as a kind of democratic mutual insurance scheme rather than, as it is often portrayed, a nationalized form of private charity or a tool to soak the rich. We fail to realize this because the ex ante win-win nature of social insurance (and, indeed, insurance more generally) is obscured by the ex post win-lose transfer to the recipient. The Swedes’ concept of “the people’s insurance,” which developed alongside the construction of their own formidable welfare state, shows that this notion is not even foreign to the places that strong egalitarians look up to.

Firstly, the fact that some aspects of the benefits system are, considered alone, regressive, does not tell us much, because the overall system is highly progressive. Just look how the UK GINI coefficient shifts when you switch from market income and income after taxes and transfers. The UK government now does 30% of its spending directly on alleviating poverty and inequality, and most of the rest is in-kind benefits that achieve a similar thing. The US isn't much different. The fact that historically these systems were justified in the language of reciprocity and efficiency doesn't change this.

Secondly, there is a strange slide between public goods and "public goods". A public good is nonrival and nonexcludable, or close to. The combination of these two features, according to solid Econ101 principles, means it will be underprovided by the market. National defence is a very solid example. Defending me, by defending the country, doesn't defend my compatriots any less, and there is only rarely any way of excluding citizens from the benefits of the national defence. Lighthouses are another classic example. Vaccination for herd immunity is another. And clean air may be yet another.

But it's not clear at all that most policing is a public good: most of its features are straightforwardly rival and excludable. Maybe the government should provide policing for areas that can't afford it, and maybe it should subsidise it because some elements (deterrence) do have public good features. But at least two recent papers show private US police forces massively outperforming US government police.

Infrastructure only very rarely has public good features (roads, rail, cables, pipes, wires, and even electromagnetic spectrum are always excludable, and usually rival), which is why the UK was able to fund a gigantic railway network privately, as were most Western countries. Japan does it that way now. The UK also expanded its turnpike (toll road) network that way. And coal. And electricity. And so on.

Finally, social insurance certainly isn't a public good! My drawing from a fund is highly rival to yours, and highly excludable. This is why it's, historically, been quite easy to insure against the mishaps he worries about—if you have enough money. Even in the 19th century workers who were actually able to work could get unemployment, healthcare, and life insurance through friendly societies. Divorce used to be insured against with binding prenuptial agreements and tough marriage contractsboth scrapped. And millionaires insure against rent and bills risk by buying their house and saving money.

The problem was that this left a lot of people without. Some can't work at all. Some don't earn enough to support themselves. Some don't have parents. And some don't have what we consider enough for a decent life. The market can provide perfectly well for the majority, but, for others, state supplementation is necessary to avoid destitution, and allow freedom. There is a real cost to those paying huge fractions in, but it's outweighed by the benefit to those receiving. That's what we at the ASI call free market welfare.