Social insurance and unemployment

In a free labour market, the worker gets his marginal product.This is what his labour is worth to his employer and this is the equilibrium wage. With compulsory social insurance, the employer pays a part of this wage not to his employee, but to the insurance system on his behalf. This part is, with a clever turn of phrase, called the “employer’s contribution" although in effect it is money the worker should have got as part of his wage. From the remainder, the worker, too, must pay for his insurance. This is, with a straight poker-face, called the employee’s contribution (fraudulently suggesting that he is only contributing this part, although in effect he contributes both parts).  If this labour is worth 100 and costs his employer 100, the employer pays 20 in its own name and 20 in its worker’s name to the social insurance schemes. The worker takes home 60 and believes that his wage is 80. Some part of this, however, he gets not in cash, but in natura, in the form of social insurance. This is harking back to the 17th and 18th century when in some trades workers were paid partly or wholly in goods rather than cash. This system that cheated the workers was repeatedly outlawed and gradually went out of use until it was reborn in Bismarck’s Prussia as a measure of benevolent paternalism. It has, of course, become a standard feature of “social" policy in most countries.

Since cash is always worth more than what somebody else has chosen to buy for you for the same amount, workers would normally prefer to get their wage of 80 all in cash rather than partly in kind, ie. in insurance. If they realised that their wage is really 100 and they only get 60 of it in cash, they would be very, very upset and would insist that “social" legislation should stop treating them as children. Believing, however, that on top of their wage of 80 their employer is spending a further 20 to insure them more fully, they imagine that the system treats them quite well.

Be that as it may, the final result is that employing a worker costs 100, much of it spent on insurance that the worker  values at less than 100 and perhaps even less than 80 because however much he may value social insurance, he does not value it higher than its cash cost .Compulsory “social" insurance, which is a wage in kind to the worker, drives a wedge between what the employer pays for labour and what the worker really gets.

This wedge can be justified by the paternalist view that it is better for the worker if some of his money is spent as the state chooses rather than as he would choose. Nevertheless, it remains the case that thanks to this system, insurance is imposed at a cost that is higher than it is worth to the worker. Moreover, the cost of labour is pushed above, and the demand for labour below, the level at which workers are available for employment. With other things equal, unemployment must become the chronic tendency.

Extracts from a speech introducing Liberale Vernunft, Soziale Verwirrung, 27 January 2009 in Zurich.


Among my triad of perpetually repeated social mantras is the idea that society is a good thing if and because it functions as a mutual insurance association. It protects everyone from life’s unforeseeable ups and downs by indemnifying the losers out of the gains of the gainers. The association, being mutual, is programmed to break even, everybody has a random probability of being a gainer and paying a premium or being a loser and collecting compensation. Since losses reduce happiness more than gains increase it, everyone is made happier, – at least ex ante, which is what matters.

The fallacy of this schema resides in the obvious fact that due to different endowments and capacities, some people are always more likely to end up as gainers rather than losers and others are more likely to end up as losers rather than gainers. Mutual insurance where some always pay premiums and others always collect them is not just, at least not in the sense supposed by the fallacy of society providing equitable protection against risk.

There is, however, a real-life variant of this scheme that we find in most industrial societies, namely compulsory social insurance by payroll deductions. This system, quite apart from its morally dubious premises, is probably responsible for the tendency to chronic unemployment being more prevalent in modern industrial countries than the tendency to excess demand for labour.[Cont'd - click 'read more']