Reinforcing America’s Social Safety Net
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The Fiscal Times
January 17, 2011

The recent appointment of Bruce Reed, the Executive Director of President Obama's National Commission on Fiscal Responsibility and Reform, as Vice President Biden’s Chief of Staff is the latest signal that the administration plans to endorse many of the Commission’s recommendations. Since one target for deficit reduction appears to be Social Security and social insurance programs more generally, it’s essential to understand the important role that social insurance plays in the economy.

There is no economic system yet discovered that can outperform capitalism when it comes to producing a vibrant, growing, dynamic, and innovative economy. Capitalism provides the goods and services that people want, for the most part, at the lowest possible cost.

However, while capitalism delivers a high average rate of output growth, it is also vulnerable to business cycles, and the busts that inevitably follow the booms can be quite costly. People who diligently show up for work every day can suddenly and unexpectedly lose their jobs as poor economic conditions cause businesses to fail. In addition, technology, globalization, or changes in tastes can leave people jobless and without the means to support their families even though they did nothing to deserve such a fate. Social insurance is a way to ease the costs for the unlucky workers who are hurt by the tides of capitalism.

In a capitalist system, as people compete with others to try and get ahead, they are motivated in ways that yield benefits for themselves and for the larger society. This is part of the edge that capitalism has over other systems. However, some people are unable to compete on an acceptable footing due to illness or old age. Social insurance can help here as well.

When someone loses a job through no fault of their own, we provide relief through unemployment compensation. If someone is born with a condition that limits their ability to compete in a market system, society is willing to help. Similarly, when old age takes its toll and people can no longer compete effectively for jobs, jobs that are needed to pay medical and other bills, we do not turn our backs, instead we give help in the form of Social Security and Medicare.

Some people worry that social insurance programs such as Unemployment Compensation, Social Security, and Medicare take away the incentive to get ahead, the incentive that helps to make capitalism tick. Won’t those being taxed to pay for the programs work less, and won’t those receiving, say, unemployment compensation be less motivated to find work?

It is a common misconception that these programs necessarily reduce economic efficiency. In fact, to the extent that social insurance provides a service that people are willing to pay for but cannot get due to market failures, social insurance improves economic efficiency.

Insurance markets are plagued by market failures such as adverse selection and moral hazard, and when these problems are severe enough the private sector will provide much too little of the insurance. In such cases, there is a role for government to play in resolving the problem. Efficiency is defined, in part, as the economy providing the goods and services that people want and are willing to pay for. Hence, when the government intervenes and makes up for the failure of private markets to provide these goods and services in sufficient quantity, it doesn’t reduce efficiency, it increases it.

We cannot fully insulate people from every inequity or run of bad luck, and it is possible for governments to provide more than the optimal amount of insurance against life’s ups and downs. But even if social insurance programs are not executed perfectly by government, the important question is whether the benefits exceed the costs. One only has to look at our history – what happened to the elderly, the sick, and the unemployed before we had such insurance – to see its great value. We were much worse off, on net, before social insurance existed, and we would certainly be worse off without it today.

When Congress begins looking for ways to balance the budget, social insurance programs will be an easy target. But, if anything, we need more social insurance, not less. Globalization and technological change are making the world more uncertain, our experience with the Great Recession highlights the risk of busts in a capitalist system, and the problems associated with health and aging will always be present.

In addition, as we become wealthier as a society, we should be able to provide more help when illness strikes, when age slows us down, or when workers are cast aside as the economic system adjusts over time. And the moral argument for helping the unfortunate, especially in an era of ever increasing inequality, reinforces the economic reasons to help. As pressures to cut the budget continue to mount, we should not forget the important role that social insurance plays in easing the burdens that fate and time cast our way.

University of Oregon macroeconomist Mark Thoma writes primarily about monetary policy its effect on the economy. He has also worked on political business cycle models. Thoma blogs daily at Economist’s View.