The Online Library of Liberty

A project of Liberty Fund, Inc.

• Introduction
• Part 1: Rights, Property, and Markets
• Property Or “property Rights”? *
• “design Faults” In Locke’s Theory of Property Taint Ownership With Guilt *
• Is Ownership a Myth? *
• How to Get a Free Lunch? Just Apply For It *
• The Problem of Contract Enforcement *
• The Public Goods Dilemma *
• Trying the Free Market *
• The Statist Legacy *
• Part 2: The Common Sense of Non-economics
• The Yakoubovich Syndrome, Or Lies, Damn Lies, and Economic Policy *
• Winning Policy Battles But Losing the War Against Economic Realities *
• Paying Ourselves More of Their Money *
• The Doctrine of “unequal Exchange” the Last Refuge of Modern Socialism? *
• Corporate Managers Are They Going to Kill Capitalism? *
• When the Economy Needs Morals *
• The Political Economy of Force-feeding *
• Hostile to Whom? *
• Mannesmann’s Courtesy Could Prove Rare *
• Part 3: French and Russian Tragicomedies
• Can Putin Build a Real Economy From Oil and Rigor? *
• Russia and the New Europe Growing Apart *
• Russia Hopping Along On Clay Feet *
• The French Tragicomedy *
• How the French “social Model” Could Self-destruct *
• A Little Bit of History Repeating *
• There Is No French Exception *
• The Hobbling of Private France *
• Part 4: The Capitalism They Hate
• The Capitalism They Hate *
• Striving to Get Richer and Poorer *
• “bread and Circuses” In the Modern Welfare State *
• Who Minds the Gap? *
• Float Or Sink? the Millstone of the “social Market” In Germany *
• How Germany and France, the Sick Men of Europe, Torture Themselves *
• Shall We Borrow From the Children? *
• Low Pay *
• Freedom to Strike Or Right to Strike? *
• Part 5: Creating Unemployment
• Stamp Your Feet and Demand a Fair Deal *
• Paternalism and Employment *
• The Things Labor Unions Are Up to *
• The Instability of the Welfare State *
• Some Bad News Could Be Good News *
• Built-in Unemployment Social Protection Costs More Than It Is Worth *
• Let ’s Throw This Model Away *
• How to Stifle Employment By “social Protection” *
• Workable Alternatives *
• A Tale of Two Models *
• A Vicious Circle of Social Kindness *
• Part 6: The Future of Europe
• The Economic Consequences of a United States of Europe *
• A Giant Free-trade Area Or a Political Counterweight to America? *
• European Crosscurrents and the Federalist Drift *
• How Confederacy Could Turn Into a Federal Superstate *
• Majority Rule By Any Other Name *
• What Now For “europe”? Why the People Failed Their Masters *
• Free-riding On the Euro *
• Some Democratic Economics *
• The Soviet Legacy *
• A War of Attrition Between Economic Reality and Political Dreams *
• A Brightening of the Economic Skies Over Brussels? *
• Turkey Knocking On Europe’s Door *
• Turkey and the Eu Club *
• Europe More Secular and More Islamist *
• A Bill of Rights Europe Did Not Need *
• Europe’s Social-democratic “government” *
• Power Corrupts, So Let ’s Make It Less Absolute *
• Part 7: Economics, True and False
• On the Economics of Protecting Employment *
• The Costly Mistake of Ignoring Opportunity Costs *
• “globalization” and Its Critics Mutual Gain Vs. Cloud-cuckoo Land *
• Are High Oil Prices a Form of Exploitation? *
• Immigration What Is the Liberal Stand? *
• More Nonsense On Stilts Mr. Bentham Is At It Again *
• Risk, Value, and Externality *

BUILT-IN UNEMPLOYMENT

SOCIAL PROTECTION COSTS MORE THAN IT IS WORTH*

A generation ago, unemployment was understood to be a cyclical phenomenon, not quite as regular as the four seasons of the year but rather like periods of wet and cold following periods of balmy sun. However, unlike the weather we could not change, we have found ways that promised to give us control over unemployment. We were taught that the awful years of the 1930s need never return. We could largely smooth out fluctuations in activity by commonsense methods of demand management. Fiscal and monetary policies, with an occasional nudge from exchange rate manipulation, were powerful enough to prevent major swings, while the human cost of the minor ones that could not be avoided was alleviated by social insurance, a small burden society could easily bear and broadly approved.

Those confident times are gone—it would seem irrevocably so. By the mid-’70s, “smoothing out” ceased to function as the books said it should. Unemployment became significant again, and its social cost began to be felt. By the ’90s, both economic and political alarm bells started to keep up a shrill music, social safety nets were spread in haste, shedding labor was made ever more difficult in order to keep the employed at work, but blocking the exit discouraged the entry and the unemployed numbers went on rising. Today in Germany and the other core countries of the euro-zone, for every ten or eleven members of the active population, one is out of work. Though some of those are suspected of not trying very hard to get harnessed, there is little doubt that the bulk is involuntarily idle. For a little green man just landed from outer space, this situation must be wholly incomprehensible. For us, it is a matter for shame, a proof that we have ruined a mechanism of economic adjustment by trying to fix it. Unemployment looks to have become endemic, stable. What makes it so grave is that no realistic observer expects it to be reversed in the foreseeable future. Something must have gone very wrong.

Let us shift the perspective for a moment. Between the fifteenth and seventeenth centuries, when wage labor in industry was in its infancy in England and the money economy was displacing payment in goods, the payment of wages in kind was fairly widely practiced and just as widely detested. In handloom weaving, framework knitting, the making of nails and other hardware, though nominally there was a customary wage fixed in shillings and pence, many masters paid their men in kind, choosing goods they could procure cheaply, goods that were a little shoddy, or indeed some of their own products. Two griefs were felt by the workers against this “truck” system. The basket of goods they got instead of the money might be counted by the master at more than it cost him—he made a profit out of imposing payment in natura. But even if he gave full value, the basket of goods was worth less to the worker, because he lost the freedom to buy exactly what he wanted in the exact quantities that most suited him. He was deprived of the advantages of a money economy and the value of consumer choice.

Parliament tried to outlaw this practice by Truck Acts in 1604, 1621, 1703, and 1831. Ordinary market forces helped more than legislation to do away with truck, for the best workers could only be hired for cash wages. Nevertheless, as late as 1871 a royal commission into truck still found cause to condemn the “outright compulsion” involved in the deprivation of consumer choice. A lesser degree of compulsion subsisted in the United States into the 1930s, especially in the mining industry, where some wages were paid in “company scrip” the miner could only spend in the company store. By and large, however, truck as a substitute for money wages has withered away before World War II . . .

. . . Only to be reborn, a thousandfold bigger, in our day.

And, as the saying goes, this explains that.

A German worker earning, say, 3,500 euros a month is paid about 2,100 euros in cash before income tax. The remaining 1,400 is paid directly by him or indirectly on his behalf by his employer in premiums into various social insurance schemes, notably against sickness, accident, disability, old age, and unemployment. Generally, the greater part of the premium is called an “employer’s contribution,” the smaller his own contribution, but it has all been earned by his work. Though purely formal, this distinction between the two contributions has some psychological significance—it tacitly suggests that the employer gives the employee some kind of extra bonus on top of the wage. In reality, all social insurance premiums represent money that is the counterpart of the employee’s work but that he does not get to take home and spend as he and his wife would choose.

Instead of the money, he gets the various kinds of insurance against most of life’s risks that may or may not materialize (including the “risk” that he does not die before age, fatigue, or the rules in his branch of industry induce him to stop working).

Whatever else this is and whatever it may be called in our day, this is a system of payment of wages in kind, once known as “truck,” and it is done on a gigantic scale. It may well be a marvel of universal, wise, and caring social protection. It is nonetheless a case of “outright compulsion,” to cite the pithy judgment of honest nineteenth-century English liberals, for the worker is forced to accept a large part of his earnings in kind (i.e., in social insurance) unless he is prepared to dive down into the illegal “black” economy where he gets all-cash wages. Compulsion is applied to both him and his employer. The latter pays in kind not because he profits from it, but because the law says that he must. The law, in fact, is a sort of Truck Act turned upside down.

Since the scheme works on an all-encompassing, gigantic scale, it would be surprising if its effects were not comparably vast. Yet the strange fact is that economists and sociologists seem to pay little attention to what the massive shift from the cash nexus to the truck system may have done to the “European social model.” There is lively debate about the virtues and vices of the welfare state, about rewarding failure and punishing success, about forcing the strong to help the weak, about the economic effects of redistribution in general. None of this debate takes into account the likely effect of forcibly moving two-fifths of all wage incomes from the money economy into the economy-in-kind where one good or service is exchanged directly against another and where the range of available goods is limited to one or two. What would be disposable income in the former takes the form of “social” insurance cover in the latter.

It is perhaps worth reflecting a little on what the most basic economic theory can tell us about the implications for unemployment.

For two nights in a row, an economist had a nightmare. The first night, he dreamt that a mad dictator had ordered all employers to pay him a payroll tax of 40 percent and had ordered all the money so collected to be paid out to the wage-earners as a supplement to their wages. The economist then woke up abruptly, rubbed his eyes, and found that if he had continued his dream to its conclusion, the employers would have started paying only 60 percent of the original wage, but the workers would still be getting 100 with the state supplement, so that nobody would end up either worse- or better-off. Things maintained their old equilibrium.

The next night, his nightmare took a different turning. The mad dictator again collected the 40 percent paytoll tax, but did not pay out the money to the wage-earners. Instead, he gave them insurance cover against sickness, disability, old age, and unemployment. The cover cost just 40 percent of the previous payroll to provide. The provider was the dictator’s own insurance company that was no more inefficient than most private insurance companies and did not make any profit. Waking up again abruptly, the economist worked out how the dream would have ended. The employers again tried to reduce wages by 40 percent, arguing that 60 in wages and 40 in payroll tax made 100, the wage cost level at which it just paid them to keep employment at the previous level. However, the wage-earners could not accept this, for they were doubtful about how much the insurance cover was worth to them. Some said it was a useful thing to have and worth buying for 40. Most, however, said that if they had their initial 100, they could always buy the full insurance cover for 40, or a part of it for 25, or not buy it from the dictator’s insurance company, or not buy any insurance at all and spend the money on a great variety of other things. If they were really forced to accept the cover provided by the dictator, they would not give up 40 of the wage for it. Maybe a deduction of 30 would be acceptable, leaving a money wage of 70.

This second nightmare would thus end with the employers’ wage costs per employee rising from 100 to 110 in order to give the marginal employee the same total wage (cash plus insurance cover) as before, i.e., the equivalent of 100 in cash. The economist would conclude that wage costs in reality would settle somewhere midway between 100 and 110 and employment would fall below its previous equilibrium level. Unemployment would result, and it would be “built in,” perfectly stable as long as social insurance remained universal and compulsory.

He would find this prognosis confirmed by the facts he found, even though they had not come about by the same process as in his dream. The fundamental cause would be the same in both dream and reality: providing universal and mandatory social protection costs more than it is subjectively worth to the beneficiaries. The difference is a net loss, a deadweight burden on the economy.

Beyond the loss of economic welfare, which we cannot objectively measure because much of it is a matter of the subjective value individuals place on the basket of goods available to them both when they can freely choose its content and when they cannot, and both when they are employed and when they live on unemployment relief, there lurks another intangible yet real loss.

Replacing a part of the cash wage with social protection also has an ethical dimension. It is just as important to clarify it as the economic one, and we can hardly get much clarity if we do not simplify it just as brutally as we did the economic aspects.

The ethical problem has two main components. One is the curtailment of free disposal of incomes, which is prima facie objectionable. However, even in modern libertarian doctrine, compulsory social protection is not unanimously condemned. Hayek, for example, thinks it is a lesser evil, and as such he accepts it. The reason is the threat of a particularly noxious form of “moral hazard.” Moral hazard infects all kinds of insurance, for if you are compensated in case of a loss (e.g., the loss of your job), you try less hard to avoid the loss. Apart from this more or less “normal” moral hazard, voluntary social insurance throws up a different, nastier version. If you are not forced to insure yourself, you may quite cynically and coldly leave yourself uninsured in the safe knowledge that if worst comes to worst, the state will not allow you to suffer too much misery but will rush to your rescue at the taxpayers’ expense.

Since this is very likely to be the case, only two choices are left. One is to resign ourselves to living with the stifling machinery of universal protection and bear its severe and degrading economic consequences. The other is not to rush to the rescue of the irresponsible and the cynical when, lacking insurance, they get into trouble, but pour encourager les autres, let them suffer and scramble for private charity. This could be politically very difficult to do. But if it were done for a period, lessons would be learned and the problem would progressively diminish.

The second hard-to-digest lump in the ethical problem has to do with the question: “Do people know what is good for them?” If allowed freely to spend their money as they choose, won’t many of them bitterly regret their choice a month, a year, or half a lifetime later? It is quite likely that many in fact do regret having spent some of their income on life’s little luxuries rather than on more generous health insurance or a private pension. Orthodox theory considers, reasonably enough, that each person strikes a balance between present and future goods according to his time preference, and nobody has any business striking the balance for him. But is today’s young buyer of the shiny motorcycle or the designer dress really the same person as tomorrow’s sick patient or pensioner? And if these young buyers somehow become different persons with the passage of time, what is the moral status of the decision of the young that affects not only their own well-being but also that of their future alter ego?

Each of these questions can spawn dozens of more subtle ones. The literature of modern utilitarianism is overflowing with them, and each is more sophisticated than the one before it. A clear view over the entire complex seems more and more unattainable. Some clarity can nevertheless be had if instead of trying to assess “utilities” arising from free and unfree consumer choices, we pursue a simpler question: “Who is entitled to decide for another?”

Forcing someone to do something for his own good is immensely widespread, and its tradition is as old as humanity. Fathers and mothers have been doing it to their children ever since fathers, mothers, and children have existed. Nothing can seem more natural, more in tune with our sense of the right order of things.

When we do it to grown-ups, we still call it “paternalism,” though we cannot claim paternity. The word nevertheless lends our action an air of benevolent wisdom, of knowing better and “tough love.” However, while we may have the force to force those whose happiness we try to further, we simply do not have the innate authority for it that parents have traditionally had over their children.

[* ]Reprinted from L’Homme libre: Mélanges en l’honneur de Pascal Salin, ed. Mathieu Laine and Guido Hülsmann (Paris: Les Belles Lettres, 2006), 324-28. Reproduced by permission.