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On the Feasibility of a Liberal Welfare State: Agency and Exit Costs in Income Security Clubs


This paper investigates whether individuals might voluntarily join and remain members of a state in which high levels of social insurance are provided. That is to say, are there plausible circumstances in which a social welfare state can be regarded as “liberal” in the sense that it has the universal support of its citizens?

As a point of departure, the paper demonstrates that risk-averse individuals in a setting of substantial income or health uncertainty will voluntarily join private income-security clubs. Private income-security clubs, however, cannot be entirely voluntary because they must solve the problem of adverse selection, as with entry or exit fees. The paper demonstrates that individuals may opt for governmental provision of income security services, when there is uncertainty about the quality of private club services, because naturally high exit costs allow national governments to economically address the problem of adverse selection. The analysis also suggests that liberal income security programs may have constitutional or quasi-constitutional status because of the nature of the long-term nature of the insurance contract.

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Fig. 1


  1. Tullock (1981), for example, argues that transfer programs reflect the interests of those receiving the transfers, advancing rent seeking, rather than utilitarian interests. Kotlikoff and others (1988) suggest that intergenerational transfer programs are social contracts between the old and young. The present analysis takes the middle ground between the utilitarian and the rent-seeking explanations for state-sponsored income-insurance programs. Even nonaltruistic voters, may have an interest in broad programs that reduce income and health uncertainty (Congleton and Shughart 1990), although they may be opposed to income-equalizing redistribution.

  2. Recall that G =  (tω Σ W j )/N which, when N is large, can be written as tω [(1−P)w(H,ω,t,N) + Pw(S,ω,t, N)]. The income guarantee is the average amount of tax revenue collected.

  3. Note that each component of Eq. 12 is a utility function optimized with respect to time spent working. Thus, the envelope theorem implies that all partial derivatives with respect to W* can be ignored (e. g., net out to zero).

  4. Note that risk aversion may partly explain the emergence of salary-based compensation schemes in private industry, more than piece rate-ßased schemes, in which salaries are not affected by sick days below some threshold.

  5. This provides one explanation for the provision of health care insurance by employers rather than individuals. Most employees will be healthy on a given day, but firms normally “force” their employees to contribute toward their insurance policies regardless of their personal health as part of the standard wage contract. The choice of basic coverage is made collectively rather than individually. Shifting between firms having insurance to those without is evidently sufficiently costly that individuals do not pursue the day’s optimal wage and insurance combination: no insurance on healthy days and complete coverage on ill days.

  6. In cases in which the unavoidable cost of leaving a nation with an ample income security program when healthy and returning when ill is not sufficient to avoid the adverse selection problem faced by a national income security program, it still tends to be the case that any new exit fee that must be introduced tends to fall below those required by local governments and private clubs, which have far lower “natural” exit costs. On the other hand, if the anticipated quality of national management is significantly below that of local government or private management, individuals might still prefer local or private income security programs to national ones even though overall exit costs increase.

  7. For the purposes of the present analysis, it is assumed that both democracy and income security programs are feasible over the time horizon of interest. The fact that income security programs are as old or older than universal suffrage in many European countries suggests that social security programs are no less “feasible” than is democratic governance, itself. (See Congleton [2003] for a discussion of income redistribution dilemmas that democracies have to solve to be viable.) In the very long run, it is possible that income security programs undermine cultural support for markets and democracy (Linbeck 1995a). Such effects would also reduce the political attractiveness of the policies themselves and the democratic polities that adopt them. However, it bears noting that the Scandinavian countries, which are widely known for their income security programs, have relatively high income levels, relatively low unemployment levels, and generally receive relatively high marks for civil and economic liberties (Lindbeck 1997b). (Skeptics might, nonetheless, note that extensive welfare states are less than two generations old.)

  8. Natural period of coverage again means that the time period (sample) is long enough that the average outcome is close to the expected value of the random event of interest. In the sickness and health case modeled, the period should be sufficiently long that the anticipated income realized (sample average) approaches the asymptotic statistical average for the illness of interest.

  9. Figure 1 implicitly assumes that the cost savings of the public program are sufficient to cause all individuals to prefer some uniformly provided public provision to the available private clubs. This geometry is implied by the discussion of exit costs in the previous section of the paper. A more expensive private income security program may be preferred to a less expensive governmental alternative by individuals who find the public program far too small. This problem can (and often is) be reduced by linking benefit levels and contributions to income levels. In such cases, support for public provision tends to increase insofar as desired benefit levels and income are positively correlated.

  10. Low demanders of insurance in the liberal case receive (and pay for) more insurance than they would have purchased in the private market, but at a sufficiently lower cost to make them better off. High demanders may “top up” their public insurance by purchasing joining private supplemental insurance clubs.

  11. See Fong (2001) for evidence of the importance of such beliefs in determining social insurance levels.


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Correspondence to Roger D. Congleton.

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Previous versions of this paper were presented at the European Public Choice Society meetings in 2006 and at a seminar at the Ratio Institute in 2007, where several very useful comments and suggestions were received

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Congleton, R.D. On the Feasibility of a Liberal Welfare State: Agency and Exit Costs in Income Security Clubs. Constit Polit Econ 18, 145–159 (2007).

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