## Redesigning the Welfare State

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**Canonical URL:** [Redesigning the Welfare State](https://www.imf.org/en/publications/fandd/issues/2018/12/redesigning-the-welfare-state-barr)

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## Bibliographic details
- Authors: NICHOLAS BARR
- Published: December 1, 2018

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### Overview
- Over decades, the welfare state has evolved in response to changes in economic, demographic, and social circumstances.
- Continued social changes mean the welfare state must evolve on a more fundamental level.
- Nicholas Barr, professor of public economics at the London School of Economics and Political Science, argues that dramatic social changes make the welfare state more necessary than ever.

### Purposes of the welfare state
- Assist the poor.
- Address market failures documented in literature on the economics of information, behavioral economics, incomplete markets, incomplete contracts, and optimal taxation.
- Support economic growth (Ostry, Berg, and Tsangarides 2014).
- Act as a device for optimal risk sharing:
  - Seen as insurance at birth against unknowable future outcomes to help relieve poverty.
  - Seen as a response to market failures, particularly relating to unemployment, medical risks, and social care.
  - In sharing risks, it contributes to economic growth by enabling entrepreneurship while avoiding excessive risk protection that stifles initiative.

### Risk versus uncertainty — rationale for social insurance
- Distinction between risk (known enough probability distributions for actuarial insurance to work) and uncertainty (probabilities not well known).
- Actuarial mechanisms work for risk (example: auto insurance rated by driver age and car type).
- Social insurance can address both risk and uncertainty because government can require universal participation in a single risk pool and can adjust contributions over time.

### Changes in families, labor markets, and skills — implications for social policy
- Family and demographics:
  - In earlier postwar years most people got married and stayed married; the wife was caregiver and husband breadwinner.
  - Today, more women are highly educated and in paid work; more divorces; parenthood less tied to marriage.
  - Implication: policies to widen choices between paid work and family obligations, including affordable childcare and equal pay legislation.
- Labor markets:
  - Lifetime employment no longer the norm; labor markets increasingly fluid and employment more precarious.
  - Workers have more spells of part-time work, self-employment, unemployment, or time outside the formal labor force.
  - Employer-based organization of social security and private pensions is less effective in providing coverage.
  - Future technological change, including spread of artificial intelligence, may increase employment precariousness.
- Skills and education:
  - Postwar assumption that a set of skills would serve workers for life no longer holds.
  - Rapid technological change requires a more highly skilled workforce; skills have a shorter shelf life.
  - Need for more education and training, more diverse content and delivery methods, larger role for firms, and repeated retraining throughout working life.
  - Large-scale financing required for these activities.

### Systemic risks and uncertainties
- Social welfare systems must also guard against systemic risks:
  - Trade wars or economic crises
  - Political instability
  - Environmental damage caused by climate change or nuclear accidents
  - Changing age structure
- Many of these are uncertainties as well as systemic risks, reinforcing the centrality of the welfare state.

### Policy responses: income risks during working life
- Provide income to the jobless and restore/expand earning opportunities through training and childcare.
- Universal basic income (UBI):
  - Feasibility depends on level of benefit and distribution of income.
  - Because distribution is skewed toward lower incomes, net beneficiaries would outnumber net contributors.
  - A high average tax rate necessary to finance a large UBI would create major work disincentives.
  - If machines guided by artificial intelligence raise growth rates and expand the tax base, fiscal constraints might ease and such a benefit might become important for social and economic stability.

### Policy responses: retirement and pensions
- Move away from reliance on contributions based on employment status.
- Implement flat-rate, noncontributory pension plans financed from taxation and awarded on the basis of an age and residence test, without a contribution requirement.
  - Such plans are spreading in more advanced economies, including Canada, Chile, the Netherlands, and New Zealand, and in developing economies.
  - Twin advantages: relieve poverty and reduce retirement income gaps between men and women.
- Parallel change: increase minimum retirement age over time as people live longer.
  - Choices about the level of noncontributory pension and retirement age should relieve poverty without discouraging work and saving.
- No single best pension system for all countries (Barr and Diamond 2009).
  - Earnings-related plans that work well come in a variety of guises.
  - Example: Sweden’s notional defined-contribution plan pioneered in the 1990s (pay-as-you-go but provides benefits closely related to cumulative contributions); also adopted in Latvia, Norway, and Poland.
  - Individual accounts, if part of the broader system, should be organized through simple, cheaply administered savings plans (mandatory or with automatic enrollment) offering limited choice and a good default (Barr and Diamond 2017).
  - Electronic payments open the possibility of basing pension contributions on consumption spending rather than earnings.

### Policy responses: health risks
- Intractable market failures make private actuarial insurance a poor fit for medical risks in most advanced economies; the United States is unique in its reliance on this approach.
- Intervention at the scale necessary to address technical problems faced by actuarial medical insurance based on individual risk leads to an arrangement that is de facto social insurance with everyone in a single risk pool (Barr 2012).

### Policy responses: skills mismatch and education/training
- Recognize increasing complexity of providing appropriate education and training.
- System should have at least three strategic attributes:
  - Emphasis on early childhood development given research showing early gaps in cognitive and social development are hard to make up.
  - Flexible choices for individuals over subject, method, and speed of skills acquisition and over pathways through vocational and academic training.
  - A system of financing to support such delivery methods, including a mix of taxpayer money and, where possible, a well-designed system of student loans, as in Australia, New Zealand, and the United Kingdom.

### Financing and the role of individual contributions
- Earnings-related benefits clearly must be contributory.
- Where primary purpose is insurance (health care) or poverty relief (basic pensions), contributions organized through employment are less effective and can discourage formal employment.
- Health care and similar benefits may be better financed from broadly based taxation (Levy 2008) or from a dedicated source of revenue unrelated to employment status (for example, a portion of consumption tax proceeds).
- Distinguish structure of service delivery from financing:
  - If no substantial market failures, market allocation complemented by income transfers is generally superior.
  - Financing choices depend on a country’s fiscal situation and political economy (example: Scandinavian countries vote for higher taxes to finance more and better public services, which may be politically infeasible in the United Kingdom or the United States).

### Why state involvement?
- Good social policy requires market and state activity to be mutually reinforcing and policy design to align with economic theory.
- Use technical solutions that respect market failures, changed labor market conditions, family structures, and behavioral economics (for example, automatic enrollment as a "nudge" to save).
- All pension designs involve significant state involvement in financing and regulation and often in delivery.
- Health care delivery can be private (Canada), public (Scandinavia), or mixed (France and Germany); financing can be national, subnational, or nonprofit-based.
- Systems that work well are based on social insurance or tax financing, not private actuarial insurance.
- Ideology should set objectives ("what"); the "how" (roles of market and state) should be treated mainly as a technical matter related to extent of market failure in the face of major risks and uncertainties.

*Source: Redesigning the Welfare State — F&D Magazine, December 2018 (Nicholas Barr).*

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_Source: https://www.imf.org/en/publications/fandd/issues/2018/12/redesigning-the-welfare-state-barr_