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Unbundle the Welfare State

by Jim Manzi

The next step in capitalism’s evolution

The fundamental issue of political economy in the Western world has been the same for at least the past 200 years: drawing the right lines between government authority and individual initiative. In the broadest terms, freedom has been winning. What the West has invented through Burkean trial and error has not been a libertarian utopia, however, but a workable hybrid that emphasizes freedom while creating a significant role for the government in domestic politics.

The United States, the European democracies, and the other free nations have not converged on a single solution; instead, they have created variations on a theme that change over time, often in response to new or localized challenges and opportunities. This complicated reality makes it hard to deduce answers to most practical political questions from theory alone. But it can be helpful to look at the big picture in order to establish the context for our more fine-grained debates.

The long-term course of broadly capitalist societies is one of higher and more rapidly rising living standards than those found in societies with different methods of social organization. On the evolutionary timeline, however, the commercial republic is a brand-new invention. One should expect social evolution’s outpacing of biological evolution to create profound conflicts.

Certain aspects of capitalism accord with our commonsense understanding of evolved human nature. One important example is the right to property, which in the primitive sense of “mine, not yours” appears in legal codes, myths, and stories as far back as we have writings. It is in the archeological record before that and has antecedents even in the territorial behavior of many animals. It is fair to describe the sense of property as an instinct. Another example is that both archeological findings and modern cognitive experiments have provided strong evidence to support Adam Smith’s famous assertion that some “propensity to truck, barter, and exchange one thing for another” is inherent to human beings.

Capitalism can channel potentially destructive human characteristics — including greed, envy, and the need to establish personal and group dominance over others — into benign and socially productive work. This is because capitalism allows expression of these urges without violence as markets transform our baser motivations into general progress.

Other aspects of capitalism, however, appear to conflict with human nature. The deep anxiety created by the choices offered to individuals in a free society was noted at least as early as ancient Athens, and a modern, extensive capitalist economy exacerbates this condition greatly. We simultaneously seek autonomy and desire to be part of an organic community. Further, while human beings are skilled at the social tasks required to act upon exchange within small face-to-face groups, it is unnatural to build alliances, judge intent, form emotional bonds, and trust others across a vast, impersonal modern market economy.

The West has built an edifice of markets and free political institutions through a combination of luck, work, foresight, and painful trial-and-error learning, and this has produced once-unimaginable prosperity. But that achievement faces a constant undertow of resistance. It is essential for those who defend market institutions not to mistake this resistance for a defective temperament or malign intent on the part of those who display it, but rather to realize that it is, in part, an inevitable manifestation of human nature. This tension sits at the root of the debate about the line between government authority and individual initiative, and a contemporary capitalist democracy must find a way to manage it.

Governments in advanced democracies have deployed several overlapping strategies to ease the anxieties of capitalism. Among the most important are appeals to patriotism and other non-economic bases of social cohesion, explicit support for non-market institutions such as traditional families, and investments in the development of human capital. All are useful, but this combination of strategies never works perfectly or completely. Hence the creation of the welfare system, a complex of government-funded programs including pensions, health-care subsidies, transfer payments, and unemployment insurance. Public schools are dual-purpose institutions; they build human capital but also perform many social-welfare functions.

The welfare system represents the majority of government spending in most modern, advanced nations. Even in the United States, with its ideological commitment to capitalism, spending on pensions, health care, education, and welfare accounts for a majority of the primary public budget across the total of federal, state, and local governments.

The problems of the welfare system are well understood by conservatives. First, there is the moral hazard created by providing for needs such as retirement savings that individuals could otherwise meet on their own. Another is provider capture, in which the public servants become important political players in their own right, as witness teachers’ unions that use the public-school system for their own narrow, self-interested ends. Still another problem is the habituation of the people to protection from uncertainty by a benevolent external power, a condition that can result in broad corrosion of initiative and the partial conversion of an entrepreneurial culture into a managerial one. In sum, the welfare state can undermine the very capitalist system it is intended to support.

There is an obvious conflict between the methods for managing the tension between markets and human nature that conservatives prefer (appeals to patriotism and reliance on private institutions, such as families) and those that contemporary liberals prefer (welfare programs). Should conservatives simply advocate unwinding the whole apparatus of the welfare state in favor of exclusive reliance on private institutions and patriotism? Should we not only repeal Obamacare, but also eliminate Medicare and Medicaid? Instead of privatizing Social Security, should we get rid of it?

It is possible, of course, that the development of the modern welfare state has been the result of a terrible wrong turn. Had it not reached full flower in Europe as various Marxian and other collectivist ideologies were being promulgated, or had the United States somehow avoided the “contamination” of the New Deal, perhaps the welfare state as we know it would never have come into being. Alternatively, one might argue that the welfare system was useful or necessary in years gone by, but that today’s higher level of absolute wealth, technological achievement, and social evolution has made it obsolete. But it would be foolhardy, from a conservative perspective, to eliminate a system so central to day-to-day life and long-term planning — and especially to do so all at once, acting on an unproved theory.

While it is always possible that some future society will find a way to cultivate widespread wealth and stability without a welfare system, or that existing welfare systems will wither away, the welfare state appears to be concomitant with the growth that capitalism creates. As far as can be determined from history, the idea of an advanced capitalist society without a welfare system is misplaced nostalgia — or more accurately, an anachronism. It is like wishing for a commercial jet aircraft without wing stabilizers.

If it is not advisable to eliminate the welfare system, we can at least understand reforms to it as attempts to create a check on a check. We want a welfare system as one part of a political economy that manages the conflict between capitalism and human nature in a fashion that achieves our shared goals, while putting a minimum of drag on market productivity and growth.

We should develop a set of goals to guide our efforts at reforming the welfare system. First, the primary purpose of the system should be to support capitalism, not to oppose it. Second, we should seek the system’s maximum alignment with the elements of human nature that make us want it in the first place. Together, these two criteria simply mean that we should be as informed as possible about the costs and benefits created by the welfare system as we seek the greatest possible benefit for each unit of theoretically forgone growth that we invest in it. Third, we should attempt to shoot ahead of the duck by modifying the welfare system in a fashion that anticipates foreseeable changes in society and technology while leaving us maximum flexibility to respond to unforeseeable changes. This flexibility should include the possibility of dissolving our current welfare system or transforming it into programs that would be unrecognizable to us today.

America is a very different place than it was in the first half of the 20th century, and this has led to severe dislocations between the original design of our welfare programs and today’s needs. For one thing, we are vastly wealthier. The simple lack of available food and shelter that in America persisted into the Great Depression is extremely rare today for any physically and mentally competent person who is willing to abide by the most basic social norms. Individual conduct is the primary driver of contemporary deprivation. Further, the ratio of old to young is crucially different. The money to pay for retirement spending (including late-life health care) must either come from one’s own accumulated savings or be taken from somebody else. When the latter approach takes a tiny bite from many younger people’s paychecks, it is not a critical political problem, but if the cost becomes an appreciable share of income as the ratio of workers to non-workers rises, it becomes politically unsustainable. We are fast approaching that point in the United States today. What are often called “promises” to workers are in fact merely current entitlement rules changeable at any time by any future Congress, and they cannot go unaltered without massive tax increases. As the private sector has already realized, we are moving from a “defined benefit” to a “defined contribution” world.

Another important development is greater diversity in the population, across many dimensions. There is far less agreement on how people should live their lives today than there was among the politically relevant population 50 years ago. In practical terms, this has meant the dissolution of the traditional family model for large swathes of American society.

A final relevant change is that Americans, especially the middle class, are far better educated than they were decades ago, and are used to having and managing many more choices enabled by information and technology.

What hasn’t changed is the basic rationale for the welfare state: It is a way of managing the tension between human nature and capitalism. All of the major elements of the welfare system — pensions, health care, education, and welfare payments — share a common architecture that combines them. Unbundling these five components — and understanding each one separately — can open up the path to achieving the goals of the welfare state in a modern environment.

First, welfare programs provide a safety net: a fail-safe provision of important goods that represents some roughly agreed-upon minimum baseline of subsistence for any member of the society. Second, they incorporate some element of risk pooling (and, more generally, economies of scale) beyond what is implied by the safety net: spreading out the costs of falling victim to some horrible disease in old age, for example. Third, these programs also may require prudent behavior on the part of beneficiaries. For example, Social Security requires that wage earners forgo some consumption today in order to provide funds for retirement. Fourth, the programs may redistribute wealth beyond what is required by the first two goals. Fifth and finally, they may be a mechanism for the government to provide certain goods directly, as in the case of traditional public schools.

Even if it made sense to bundle these functions in 1935, does it today?

The first two components — provision of a safety net and the exploitation of economies of scale, such as risk pools — are legitimate government functions. But bundling them has an enormous drawback: It hides the transfer of wealth from the prudent to the imprudent. This is especially problematic in the modern environment. The safety net and risk pools should be different programs.

For example, Social Security provides a safety net for old people who have been extremely unlucky, unwise, or unproductive. It is also a mechanism to force almost all workers to save for retirement — prudently consuming less today — and pool their savings. These two components were bundled to build a political coalition for the program, but the bundling obscures the income redistribution from richer workers to poorer ones that is embedded in Social Security’s benefit schedules, which provide higher returns on the first dollars of worker earnings and lower returns on the last dollars. This, in turn, exacerbates the moral hazard of the program.

Instead, we should have a defined-contribution pension program requiring individuals to contribute a reasonable proportion of their income (though some flexibility should be allowed) to an array of investment vehicles to which they hold property rights. In addition, the government should offer a safety net specifically for those who end up destitute in old age. Unlike a safety net for people of working age, it should not have a work requirement. It should also not attempt to guarantee for all the income of those who have prudently saved for retirement but instead be a true minimum safety net. This is welfare for old people, and should not be conflated with a pension scheme.

Whether the government should engage in the fourth component — pure redistribution of wealth for reasons of equity or justice — is a thorny philosophical question. In practice, the contemporary American electorate has a very limited appetite for it. But to the extent that such redistribution is desired, it should be done explicitly and outside the other programs of the welfare system.

Finally, when it comes to the fifth component — operation of a government bureaucracy to deliver goods — it is often useful to separate the specification of welfare benefits from their provision. For several decades, a goal of the libertarian Right has been to voucherize social programs so that the government provides the cash but allows private firms to compete in markets to provide the services. But this is not always as practical as it sounds.

School vouchers, for example, are premised on the idea that a marketplace for K–12 schools will both increase productivity (i.e., allow us either to increase the measured performance of schools at any given level of expenditure, or to achieve a given level of performance at lower cost) and provide a greater diversity of options to better meet different students’ needs. One can imagine a wide array of specialized schools — with an arts or a mathematics focus, for example. Further extension of this idea would upend the model of school as a building that students in homogeneous age groups go to each day. By the voucherizing logic, students (or at least families) know their own needs and can better meet them than the state can with its one-size-fits-all approach — a reason to allow trial-and-error learning, which will improve the overall system with time.

This sounds fantastic, and it is, in both senses of that term. It leads to the obvious question of why we should limit school spending to whatever some government entity decides to call “education.” If individuals are the best judges of their welfare, why not let them decide how to spend this money? Taking the logic to its conclusion, we should ask: Why bother even to have such categories as school subsidies, health-care subsidies, and all the rest? Instead, why don’t we estimate the costs of a safety-net income, plus the costs of buying catastrophic insurance, and provide that amount of money to everyone in our society?

This idea has arisen again and again, on both the right and the left, beginning in the 1960s. Examples of such proposals include Milton Friedman’s negative income tax (1962), Robert Theobald’s guaranteed income (1966), James Tobin’s guaranteed income (1965), R. J. Lampman’s subsidy plan (1967), Edward Schwartz’s guaranteed income, the negative income tax proposed by President Johnson’s Income Maintenance Commission (1969), President Nixon’s Family Assistance Plan (1969), George McGovern’s $1,000-a-year plan (1972), and HEW’s Income Supplementation Plan (1974). The idea constantly resurfaces even today in academic discussions, and is being pursued seriously by the current coalition government in the United Kingdom. The key reason we haven’t implemented such a scheme in the United States is that we are afraid that many recipients would not work and then would blow the money on Cheetos, beer, and big-screen TVs. In more academic language, the moral legitimization of the welfare system requires that the recipients earn their benefits and use them in a way that comports with the idea of the good life held by the taxpayers who provide the funds.

Though this logic is most relevant for safety-net functions, which tend statistically to have the most irresponsible recipients, it also applies to the provision of welfare benefits to the middle class under the rationale of risk-pooling and economies of scale. To return to the example of K–12 schools, the focus on true privatization has been both doctri­naire and artificial. If school choice ever grows beyond Tinkertoy demonstration projects, taxpayers will appropriately demand that a range of controls be imposed on the schools they are funding. Would we allow families to use vouchers to send children to schools that taught no reading or mathematics, but only bomb-making, or that offered lavish “support payments” to parents that were, in effect, bribes? No, we would inevitably — and justifiably — have a fairly detailed set of regulations, along with inspection, adjudication, and enforcement mechanisms. At that point, what would be the difference between such “private” schools and “public” schools that were allowed greater flexibility in hiring, curriculum, and student acceptance, and had to compete for students in order to capture funding? Little beyond the label.

Publicly funded private schools is an oxymoron, but greater flexibility to meet different needs and to improve general performance through market competition can nonetheless be found in a public-school system involving parental choice and the freedom of schools to operate outside of collective-bargaining agreements and other restrictions. The most basic institutional requirements of a market would be present: consumer choice and widely distributed buying power on the demand side, capacity and flexibility on the supply side.

With such reforms under way, the next role for the government would be to provide information and truth in labeling, a classic market support. Suppose the federal government established a comprehensive national exam by grade level to be administered by all schools and universities that receive any federal money, and required each school to publish all results, along with detailed data about its budget, performance, and so forth, each year. Secondary, profit-driven information providers, analogous to equity analysts, would arise to inform decision-making. The federal role in education would be very much like that of the SEC in securities markets: to ensure that each school published accurate, timely, and detailed data.

The next logical extension would be to let schools make profits and thereby pay returns to investors. One reason the market scaled up Starbucks from a mere idea to thousands of stores within about one decade, while promising education innovations proceed glacially, is that a fire hose of capital could be aimed at Starbucks once it demonstrated its profitability. While ongoing, massive public expenditures on education can partially serve this purpose now and in the future, the free flow of investment would replace the existing capital stock of school buildings and equipment faster than would normal political processes. Such schools would become something like publicly regulated utility companies that can issue debt and equity instruments to raise capital while still having to meet defined regulatory objectives.

We would, in the end, get something like a partially privatized school system, but we would have to go through the hard work of building market institutions rather than just waving a magic wand of vouchers at the problem. The trick is to be able to execute a sequence of steps each of which must both make progress toward the goal and demonstrate practical improvement in and of itself. The sequence I propose is: 1) allow parents to choose among public schools, with funding following students, and reform the chartering process so that it is far easier to establish new schools without collective-bargaining agreements; 2) institute consistent national annual testing for all schools that receive government funding, and publish the results along with other performance information; and 3) allow schools to operate at a profit in order to create incentives for private investment. More precisely, this is the vision that would animate the first steps of the journey. We could modify our plan of action as we proceeded and learned what worked and what did not.

The same basic argument applies to each major welfare program. Conservatives often argue that we should privatize Social Security. But we would surely regulate what investment vehicles would be allowed — otherwise, I could “invest” in a retirement portfolio of Cheetos, beer, and big-screen TVs. As with government-funded schools, we would need a set of regulations and a means of enforcing them. If we wanted to replace Medicare with health-savings accounts, we would face a similar problem.

Obviously, there will be challenges unique to each of these programs. For example, the degree of existing government entanglement varies widely. In the United States, the lack of an enormous government-operated physical-delivery infrastructure for health care and pensions (outside of specialized areas like the VA hospital system) means that such a transition should be logistically simpler with health care than it would be with education. But for each of the programs we would face the same need to create market institutions that produce the benefits of freedom, competition, and trial-and-error learning, while to some degree regulating conduct in a way that is consistent with our vision of the good life.

– Mr. Manzi is a senior fellow at the Manhattan Institute and chairman of an applied-artificial-intelligence software company.

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