Martin-Luther-University Halle-Wittenberg School of Business and Economics

Bachelor Thesis
The Logical Foundations of Social Policy in a Liberal Society: Rethinking the Welfare State

Fanny Paschek Zschillestr. 1 01558 Groenhain Phone: 0172-9713883 fanny.paschek@hotmail.de

Advisor: Prof Dr. Ingo Pies Chair of Economics & Ethics Matriculation Number: 206209986 Submitted: 18th of September 2009

The Logical Foundations of Social Policy in a Liberal Society

Rethinking the Welfare State

Table of Contents

I. Introduction

II. Friedrich A. Hayeks Political and Social Philosophy 2.1. The Constitution of Liberty 2.2. The Logical Fundament of Social Policy in the Order of Freedom 2.3. The Welfare State under the Constitution of Liberty 2 4 7

III. James M. Buchanans Political Economy 3.1. Social Contract Theory and the Role of the State Within 3.2. The Logical Fundament of Social Policy in the Constitutional Order 3.3. The Reality of the Contemporary Welfare State 12 14 18

IV. Social Policy for the Market - Rethinking the Welfare State 4.1. Contract Theory as the Fundament of Social Policy for the Market 4.2. The Logical Evolution of the Social Order 4.3. Rethinking Social Policy as Overcoming Dilemma Structures 4.4. The Benefits of Cooperation 22 24 27 29

V. Conclusion

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List of Figures

Figure 1: Rethinking the Welfare State as a Social Dilemma with the Solution of Orthogonal Positioning

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Figure 2: Private and Public Institutional Forms

30

II

The true end of Man, or that which is prescribed by the eternal and immutable dictates of reason, and not suggested by vague and transient desires, is the highest and most harmonious development of his powers to a complete and consistent whole. Freedom is the grand and indispensable condition which the possibility of such a development presupposes; but there is besides another essential,intimately connected with freedom, it is true,a variety of situations.1 Wilhelm von Humboldt (1767-1835)

I.

Introduction Liberalism seeks to create a society of [f]reedom, democracy, peace, and private

property [...], as the external factors allowing for the promotion of happiness and welfare of all members of society. Through the satisfaction of all physical needs, the liberal society allows for its citizens to aim at the development of their inner life, which constitutes the ultimate end of the liberalist movement. The apparatus of the state plays a crucial role in the organization and continued existence of civilization. He assumes the task of the monopolist in coercion to enforce exclusive property rights and the citizens delimited private sphere, as these constitute the bases of freedom in society. Exchange in private markets becomes possible on these grounds, only. Furthermore, the state legitimately engages in the provision of public goods, which cannot be adequately allocated through the market mechanism. In this productive activity government is concerned not merely with the satisfaction of the needs of the collectivity, but it also aims at the reduction of unnecessary uncertainty, which every individual faces. Social policy constitutes but one part of the productive function of the state in the liberal order, yet, proving to be an essential factor in the workings of a market economy. Traditionally, the social state is reconstructed as substituting for the market where the price mechanism fails to achieve efficient allocation. This misinterpretation has let social policy to fail in its original purpose, the facilitation of market processes rather than their replacement. The idea of this thesis is to provide for a different view on social policy and its realization in the modern liberal society. In reference to The Constitution of Liberty (1960), the first section of this paper will illustrate the logic and design of the welfare state in the liberal order based on the political and social philosophy of Friedrich A. von Hayek. In the second part, the paper will shed light on the constitutionalist-contractualist legitimisation of the productive state, as proposed by James M. Buchanan. The third component of this thesis will, in turn, elaborate on the contemporary theory of social policy for the market, therein proposing a logical fundament on which we can rethink and ultimately reapply welfare politics in the realisation of a truly liberal social order.
1

Humboldt (1792)

II. Friedrich A. Hayeks Political and Social Philosophy The first author to be examined on his stance regarding the liberal order and the role of the welfare state within is Friedrich August von Hayek, an economist and social philosopher of the Austrian School. Aiming to advance the liberal theory remaining true to the mindset of traditional liberalism he joined his teacher Ludwig von Mises in the effort to revise and reintroduce the liberal doctrine and its values at a time when [f]reedom and liberalism [had] become terms [...] used to describe the exact opposite of their historic meanings. 2In this pursuit Hayek set out to restate the bases of a Constitution of Freedom. 2.1. The Constitution of Liberty The Liberal Order of Freedom and Knowledge Ultimately, liberalism strives to promote the welfare of society as a whole through creating the external conditions which allow for the internal development of all members of society. In his book The Constitution of Liberty, Friedrich August von Hayek depicts the liberal social order in which freedom itself is both mean and end of human cooperation. The facilitation of individual freedom is of greatest importance to Hayek as he designates this value to be the source of all progress. In his mind, [...] civilization begins when the individual in the pursuit of his own ends can make use of more knowledge than he has himself acquired [...]3, by employing mechanisms like trade and specialization. This readily available knowledge, although dispersed throughout the whole of society, grants each individual a degree of ignorance, which is of necessity when trying to efficiently realise individual objectives. From the unhampered exercise of personal liberty new knowledge beneficial to the whole of humanity may arise fostering the constant technical and intellectual progression of society as well as the enhancement of the general welfare of all citizens. This incalculable progress can be secured only by granting greatest possible freedom to all individuals as one can not foresee [...] what freedom a person might need in order to do things beneficial to society.4 Therefore, the liberal order seeks to establish and preserve an exclusive private sphere to each member of the collectivity. The Coercive and the Non-Coercive State The indispensable sphere of private action, and therefore the individual liberty, is especially endangered by the threat of coercion in human relations. Now, according to Hayek

2 3

Hayek (1939; p.1) Hayek (1960, 2006; p. 21) 4 Hayek (1960, 2006; p. 29)

in these situations [...] coercion of one individual by another can be prevented only by the threat of coercion.5 Hence, the free society is to appoint the state as the monopolist of coercion in order to warrant that only minimal coercion is carried out in the most objective fashion possible. As all monopolies this one, too, poses a danger to the freedom of individuals, which is why a general framework of rules is to govern the states exercise of its coercive powers. Such legal fundament is not merely of importance to allow for a constitutional safeguard against governmental arbitrariness, but rather for creating a legal environment within which individuals can plan their activities independently facing legal certainty as to what the implications of their actions are. Apart from the coercive activities of the state aimed at preserving the order and the individual freedom in it government also fulfils a wide range of pure service activities in liberal society. Hayek aptly circumscribes this non-coercive task as planning for freedom, conveying just how substantial government activity is in this case. In its non-coercive role the state is to employ reason in encountering the problems of social cooperation. Hayek, confines this purposeful planning to the design of a legal framework of rules that governs the game of social interaction, while [...] individual initiative is given the widest possible scope and the best opportunity to bring about effective coordination of individual effort 6 as the strategies within the game can be chosen freely. The essential purpose of such rules is to avert unnecessary uncertainty, which may encumber the rationally risk averse individual in the pursuit of his aims and objectives. Hayek especially warns of the dangers of central planning, although he admits that some such action may be required when it comes to the provision of public goods characterised by extreme jointness and non-excludability. However, in the same context the author ascertains that the price mechanism need not [...] be supplanted where the conditions for its working exist or can be created7 as the spontaneous collaboration inherent in the market may serve societys purposes much more efficiently. Hayek can therefore be classified as an advocate of ordoliberalism in his differentiation between loosely planning the rules of a game and the central planning involved in deciding on moves within the rules of the game. An important point to be taken notice of is that Hayek addressed the problematic of (social) justice with the same logic. It is not equality or justice in the ultimate outcomes of market of governmental action that his liberal programme strives for, but rather justice in the processes generating these outcomes. To him the determination of general rules equally applicable to all people and imposed for a long time period constitutes a just framework with just outcomes arising thereby.

5 6

Hayek (1960, 2006; p. 122) Hayek (1939; p.9) 7 Hayek (1939; p.13)

2.2. The Logical Fundament of Social Policy in the Order of Freedom The Scope of Government Action The political strand of the liberal doctrine has often been reproached for its antiinterventionist maxim and its advocacy of the minimal state. Hence, the author is determined to shed a very different light on the misconceptions involved. There is no denying that liberalism is to reject interventionist measures as it is to be feared that [...] the central direction of economic activity might involve the destruction of freedom and of democratic institutions.8 Hayek conforms in this conception with his teacher Ludwig von Mises, who reproached policies of interventionism for being senseless, self-defeating [and] absurd [...]9, ultimately posing as mere steps in the transformation of capitalism into socialism10. As radical as these assertions sound, they are in line with the general thought of men like John Stuart Mill or Adam Smith who were also enthusiastic defenders of maximal freedom in economic activity. In The Constitution of Liberty Hayek urges critics to take a closer look at the message that was actually being conveyed through these statements. The classical liberals as well as Hayeks contemporaries did not refute government action on principle, but rather the interference of government against the rule of law and the infringement of the basic rights of members of society through the state. Therefore, conformity to the rule of law poses as one criterion for adequate government policies. A character that is non-infringing on the private sphere of individuals is a second provision. And as long as proposed measures fulfil these most basic requirements they cannot be refuted as acts of interference, but must be tested for expediency. Considering this clarification of the non-interventionist imperative [t]he range and variety of government that is, [...], reconcilable with a free system is thus considerable.11 In his book Hayek rules: It is the character rather than the volume of government activity that is important12. The broad scope of possible state activities offers a number of policies that are indeed expedient, but at least as many are of detrimental nature. In the mind of the author, the basic mean to distinguish one from the other is represented in the rule of law. This superiority of the legal framework is based on the liberty it preserves for the individual in the liberal society. In that respect, the legal certainty and the possibility for planning and adapting individual actions are but two important points provided for under the rule of law. It is to be kept in mind, though, that the criterion of conformity to law is a necessity but not a sufficiency for the approval of policy measures. Activities that prove in
8 9

Hayek (1939; p.5) Mises (1927; p.85) and Hayek (1939; p. 17) 10 Mises (1980) 11 Hayek (1960, 2006; p. 202) 12 Hayek (1960, 2006; p. 194)

accordance to the moral law might still turn out to be inefficient when tested for expediency. On the other hand there will be efficient policies that will not be deemed realizable under a rule of law. The vigorous admonition that liberals express in this context is simply that in order to preserve the freedom of all in liberal society government is to refrain from enacting policies that are not in accordance to general rule of law and which are therefore considered to be of arbitrary nature. In this sense, even a majority supporting an unlawful activity to be carried out by the state cannot be considered enough to legitimize the pursuit of such. A practice like that carries the danger of opening the floodgates for further arbitrary desires of an oppressive majority. As a last consequence the recurrent contempt for the rule of law would effectively abolish it as the superior safeguard on individual freedom, and with it the very foundation of a liberal order. Three Categories of State Action In essence, it is of great necessity to distinguish clearly favourable policies from detrimental or merely inexpedient ones. The basic logic with which Hayek differentiates among possible government activities has been laid out on the fundament of moral law. Using this rationale the multitude of government activities can be separated into three distinct categories ranging from operations that are essential for a working market economy and tasks that are on principle compatible with the free economy, to acts of interference that effectively cripple the market forces. (1) First and foremost, there is the category of pure service activities in where coercion does not enter [...]13 although the coercive measure of taxation may be used in order to finance the provision of such. This category is limited to non-rival and non-excludable goods, which naturally would not be supplied by the private sector. However, the practicability still has to be tested in order to avoid measures that do not balance costs and benefits to society as a whole. Common examples of this class include the establishment and support of a reliable monetary system, the introduction of standard weights and measures, the processing and provision of information for citizens and [...] the support, if not also the organization, of some kind of education.14 These activities pursued by the state constitute the most basic ones he is to fulfil in his non-coercive role. They are deemed essential to the workings of the free economy and their provision through the state can therefore not be relinquished. Other types of material service belong also to this rubric including the building and upkeep of infrastructure, health services and sanitary provisions as well as a lot of the amenities, which municipalities offer their residents. These provisions are especially

13 14

Hayek (1960, 2006; p. 195) Hayek (1960, 2006; p. 195)

characterised by their invaluableness not in terms of costs but rather in terms of benefit to society. Hayek further qualifies the description of this type of activiti es; hence government may at any moment be best qualified to take the lead in such fields, [...]15. However, from this general suitability one cannot infer that the organ of the state has and remains to have exclusive responsibility of pursuing such activities. The danger in Hayeks eyes [...] is not state enterprise as such but state monopoly16. Productivity and efficiency in this sector, just as in any private sector, can be increased through the government assuming the role of a financer while leaving the realisation of the particular project to private and competitive agencies. Other state enterprises may also just be opened to general competition from private agents, though in this case special advantages, e.g. subsidies, have to apply to both public and private providers. (2) A second category of governmental operations is concerned with administrative tasks, e.g. the establishment of so-called factory-legislation, frameworks for the improvement of work environments, governing production techniques as well as health and safety standards. Building regulations may also be included in this category. 17 Before such regulation can be ordered they remain to be tested on whether they are deemed reasonable in terms of overall costs and benefits. For purposes of efficiency these sets of rules are to be kept as general as possible in order to allow for a reasonable degree of discretionary power on behalf of the government. However, [...] this need not be discretion unlimited by general rules [...] as the safeguard of judicial review remains in place to guarantee that single measure are in adherence to the moral law. (3) The third and last rubric of state action encompasses all governmental measures that are not realisable under the rule of law [...] because they cannot be achieved by merely enforcing general rules but, of necessity, involve arbitrary discrimination between persons.18 Such policies involve the state taking on the role of a planning agency, deciding and controlling the means of production, the persons to carry out this production or the terms of sale. In coherence with this, Hayek especially stresses the incompatibility of price and quantity controls with the free market economy as arbitrarily determined prices throw supply and demand off balance, while the signalling effect of prices on production is also rendered inoperative. Moreover, [...] this kind of controls [...] must in their very nature be discretionary and arbitrary and [...] must be altogether excluded in a free system [...]19.

15 16

Hayek (1960, 2006; p. 196) Hayek (1960, 2006; p. 196) 17 Hayek (1960, 2006; p. 307, et seq.) 18 Hayek (1960, 2006; p. 199) 19 Hayek (1960, 2006; p. 200)

2.3. The Welfare State under the Constitution of Liberty From this general classification of the governmental productive efforts one can now determine the legitimate role of the welfare state in the liberal society. According to F. A. Hayek these state activities are to constitute part of the first class of productive efforts (1) as they are not just feasible in a liberal order, but rather essential to the workings of the free economy. The services provided for through the welfare state are to contribute to the endeavour of planning for freedom as they should aim at fostering the viability of the market by eliminating avoidable uncertainty that individuals may be facing in the competitive order. For Hayek himself the institution of these social provisions is unquestionable in the modern industrialised societies, if [...] only in the interest of those who require protection against acts of desperation on the part of the needy.20 Just like the realm of general public policy the welfare state, too, can take on a variety of different operations to foster an efficient market structure. Though, the author remains unambiguous on the condition of these activities being carried out without the use of coercion volume and diversity of possible measures are not restricted by any particular criterion. As long as proposed policies prove in accordance to the rule of law and stand the test for expediency there are no explicit limits to the means and methods that can be employed to increase individuals welfare in the competitive market economy. Moreover, as the liberal society allows for perpetual technical improvement and continuous enhancement of the overall wealth the current state of affairs concerning social policy should not be considered the end of the flagpole.21 Since more freedom in economic and social affairs allows for greater gains from trade individuals will be inclined to socialise part of the increase in general welfare to continually extend the socially beneficial welfare state in order to evade further uncertainties involved in market exchanges. The Problematic of Social Justice Taking into consideration the very nature of this dynamic, it strikes the author as peculiar that many members of the contemporary society want to do away with the safeguards on the freedom that drive this constant progress. The reason can be found in a relic of the socialist era biasing public policy, namely that of distributive social justice. However, the liberal government, which is restricted in its use of coercion, does not command the powers to determine the material position of particular people or enforce any kind of distributive or social justice.22 In essence, such justness can only be achieved through surrendering parts
20 21

Hayek (1960, 2006; p. 249) Hayek (1960, 2006; p. 202) 22 Hayek (1960, 2006; p. 203)

of the individual private sphere and therefore individual freedom to the state. A sharp contradiction exists, as Hayek offers to explain, [...] between the ideal of freedom and the desire to correct the distribution of incomes [...]23 for the purpose of increasing justice. The justice to arrive at would be legitimised only through the decisions of government which in turn raises the question of what is easier to bear: the injustice of a natural distribution of wealth or the injustice arbitrarily imposed by a discretionary government? Due to the fact that many advocates of distributive justice are not aware of the principal incompatibility of their aims with the rule of law circumvention of the same have become a habit. Following from these premises the repeated neglect of the rule of law in modern societies can be reconstructed, though not reasonably understood. Hayek determines that [...] the traditional limitations upon the powers of the state have been rendered inoperative, by the workings of the socialist utopia, leaving the governmental body in a state of power that needs to be restricted in order for the liberal society to thrive. Writing a great many of his books,24 F. A. Hayek especially attended to the errors and the imminence of the socialist order considering both the hot and the cold socialism.25 In examining the socialist tendencies in the contemporary politics of the welfare state the advocate of the Austrian School clearly saw a great deal of danger arising [...] not so much [from] the aims as [from] the methods of government action.26 The Constitution of Liberty incorporates this criticism as well. And, although Hayek shows himself convinced of the fact that [...] socialism has been generally abandoned as a goal to be deliberately striven for [...], he is at the same time quite worried that [...] we shall not still establish it, albeit unintentionally.27 Hayek continues to emphasize the importance of the methods employed as opposed to a mere judgement of the ends these serve, since the pure desirability of a distinct aim is often confused to justify all possible measures to reach that aim. Methods, which are based on the exertion of governments coercive strength to secure the state a monopolist position of some kind, pose in fact a threat to freedom and the liberal social order. It is in this conception that the economist and social philosopher outlines a number of tasks that are to be assumed by the liberal government in the pursuit of a comprehensive welfare state. The Social Security Apparatus According to Hayek, the system of social security has been thrown off balance due to the creation of a detrimental incentive structure in the pursuit of distributive justice. It is as
23 24

Hayek (1960, 2006; p. 203) The Road to Serfdom (1944), Freedom and the Economic Order(1948), Law, Legislation and Liberty (1973-79), The Fatal Conceit (1988), 25 Hayek (1960, 2006; p. 224), i.e. the passionate pursuit of the socialist ideology as opposed to the more objective aspiration for distributive justice and social security 26 Hayek (1960, 2006; p.225) 27 Hayek (1960, 2006; p. 224)

a means of socializing income [...], that the welfare state has for many become the substitute for old-fashioned socialism28, as the author puts it in his publication of The Constitution of Liberty. In its original purpose it was intended as a comprehensive system of social insurance in order for the individual to make provisions for the case of retirement, sickness or unemployment. In accordance to Hayek, his insurance structure has largely been turned into a mere system of transfer payments out of the pockets of the productive population into the pockets of citizens, which are unable to maintain themselves. Furthermore there has been a shift from providing a minimal alimentation to securing an adequate standard of life. This just distribution is provided partly without verifying the actual indigence of the beneficiary. However, the author argues that this procedure is irreconcilable with a liberal state since it assumes discretionary use of the governments coercive powers to determine the just position of everybody29. Again the arbitrary powers exerted by the body of the state prove not in line with the moral law, posing a threat to society as a whole. As a resolution for the continued existence of the liberal order, Hayek proposes a compulsory insurance structure providing for the needs in old age, during sickness, unemployment, etc. Compulsion in this case is only justifiable as it protects from the even greater coercion exercised by individuals who do not provide for themselves and who will in effect become a liability to the public. In coherence with this, the author advises the state to finance and assist the development of appropriate institutional structures, though desisting from continuous supervision.30 It is important to refrain from a national monopolisation of the social security structures as a healthy degree of competition in these fields allows for the constant production of [...] new answers to current needs, answers which no advance planning can contemplate.31 A first target of examination is posed by the provisions for the unemployed. As Hayek apprehends, the nature of these provisions will very likely be [...] one of the most important factors determining the extent of unemployment.32 From the basic liberal notion of equal treatment for all under the rule of law the provisions for the unemployed have to target both, the victims of sudden changes in the demand for labour as well as workers that face foreseeable seasonal fluctuations in their trade, in the same manner. In Hayeks perception these cases of unemployment can only be coped with if the workers themselves display a healthy mobility while wages are to remain reasonably flexible. In contrast, a system which guarantees unemployment payments at a certain percentage of the former wage effectively reduces both the flexibility of general wages as well as the mobility among workers. From this reasoning Hayek advocates a genuine insurance structure [...] in which the different risks
28 29

Hayek (1960, 2006; p. 251) Hayek (1960, 2006; p. 252) 30 Hayek (1960, 2006; p. 249) 31 Hayek (1960, 2006; p. 254) 32 Hayek (1960, 2006; p. 261)

of various trades are reflected in the premiums paid.33 The risk of unemployment in a particular trade is then pooled among all workers in that occupation. Resulting from this, the labour supply in these fields will tend to regulate itself as opposed to the situation in which general redistribution schemes allow for the subsidization of employment beyond the economically desirable point. Generally, for the case of unemployment, social security is to include a minimal and uniform provision for all individuals unable to support themselves. This assistance is to be bound by proof of actual neediness, since claims do not result from contributory payments and consequent entitlement to such a provision. The further provision for an above-minimum standard of life should be individually provided for with the help of competitive agencies and unemployment insurances. Hayek even suggests that the labour unions could contribute a fare share in organising such assistance for their members.34 A further effort of the welfare state consists in the provision of medical treatment for the obvious reason that health care is part of securing the general livelihood of each citizen. In Hayeks mind, the nationalization of health care carries not only the risk of mere monopolisation, but also the danger of uncontrollable invasions of the patients private sphere as doctors in effect become servants of the state. Just as inconceivable proves the idea of a health care apparatus free-of-charge as there exists no reasonable standard of which medical treatments can and should be provided for every single member of society. Such standard could [...] at most, be the bad average standard of service that can be provided equally for all.35 Hayek, in turn, strengthens the case for a system based on insurance. Utilising such competitive structure enables each agent to secure for himself additional care and treatment, if he deems the added expense worthwhile. The author therefore advises to review the nationalisation of health care, because a competitive health insurance market, in which the state may still partake as a competitor among many, is likely to serve the individual better. The pension system constitutes one of the most important branches of the social security net. Next to the established provisions for old-age, this category also includes payments made to otherwise disabled or unemployable people, and all kinds of dependents provisions. In Hayeks eyes the serious issues arise from the states effort to provide adequate old-age benefits as opposed to a fair minimum. Generally, such provisions are not paid from the accumulated capital based on prior inpayments of the beneficiary. To the contrary, these pensions constitute mere transfer payments from the currently productive to the unproductive, since individuals gain a claim irrespective of prior contribution or actual neediness. This constitutes the absolute relinquishment of the insurance character of this assistance turning the complete welfare state into [...] a play ball for vote-catching
33 34

Hayek (1960, 2006; p. 262) Hayek (1960, 2006; p. 262) 35 Hayek (1960, 2006; p. 260)

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demagogues36, as the author puts it. However, in case of the contemporary pension system Hayek does not see an immediate point of vantage for reform. In his view, the established system has actually managed to put a [...] strait jacket on evolution [...]37 since current benefactors generate their own claims in paying off the claims of current retirees. In this sense, Hayek remains definitive in honouring the claims that are in existence even if these arise from institutions that are not in accordance to the liberal fundaments. In conclusion, the author deems the liberal society capable of providing a minimum assistance to all individuals in need. This general level of welfare is, nevertheless, to be bound to proof of actual neediness. Any provision beyond the subsistence level has to be secured independently through the help of competitive insurance structures or private investment. Education & Research in a Society of Progress The issue of education represents a further important feature of the welfare state in the free society. As Hayek puts a great emphasis on the role of knowledge in the constant progress of the liberal state he also recognizes governments obligation to finance a compulsory standard of education for its citizens. This however does not mean that the state should also run the particular institutions that provide for schooling and research. In Hayeks mind the educational system put into place is not to be state-dominated although [...] government should prescribe some of the content of this education.38 In an attempt to formulate a concrete policy proposal he points to Professor Milton Friedman who advocates the financing of school vouchers from government coffers allowing parents to send their children to a school of choice within a private and competitive education system.39 The principle of academic freedom does not stop short of research and higher education within universities. Though, centrally financed institutions of higher education managed to remain largely independent from governmental influence in their research endeavours the author proposes that a [...] multiplicity of private endowments [...]40 would be more beneficial in financing scientific progress. Hayek further expresses the idea of subsidizing higher education in areas where additional training will not necessarily result in higher earnings for the beneficiary (i.e. medicine, engineering, law, etc.). On the opposite side the economist challenges people who partake in vocational training that is likely to increase their prospective earnings to view their expenses as investment. Therefore such education should rather be offered financing on credit instead of public subsidies.

36 37

Hayek (1960, 2006; p. 257) Hayek (1960, 2006; p. 264) 38 Hayek (1960, 2006; p. 328) 39 Friedman (1955) 40 Hayek (1960, 2006; p. 339)

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III. James M. Buchanans Political Economy 3.1. Social Contract Theory and the Role of the State Within In his book The Limits of Liberty: Between Anarchy and Leviathan, the American economist James M. Buchanan elaborates on the bases of freedom in the liberal society. In conformity with Friedrich A. von Hayek, the author upholds the value of freedom as a basic premise for social cooperation, which in turn serves every single agent to achieve his individual objectives most efficiently.41 Buchanan identifies a process of social contracting to be of huge necessity for designing the fundament of cooperation among people. Social contracting which the author describes to be a process of negotiating, that includes all of societys members, is applied at two stages according to Buchanan: (1) The constitutional stage, at which the initial assignment of individual property rights takes place and (2) the post constitutional stage characterized as commencement of the negotiations aimed at reaching agreement on the joint consumption of services and goods by the societal community. Buchanan models the preconstitutional setting to mirror the natural state as proposed by Thomas Hobbes in his Leviathan. This anarchic state of humanity is characterised by the absence of any kind of law. Given the scarcity of resources and the inequality in mens production capabilities and consumption habits, disputes among the inhabitants become inevitable in the state of anarchy. Predatory as well as protective behaviour will become the norm amongst all individuals in this setting. Nevertheless, both thievish and protective activities are always borne by the production function as these activities consume both time and energy, which cannot be used for the production of consumable goods. As equilibrium arises from the individual adjustment to this war of all against all 42 humanity arrives at the preconstitutional stage of social contracting. Merging into the constitutional phase of Buchanans contract theory a first law is employed: A comprehensive agreement on disarmament will arise as individuals come to realise that the effort spent on stealing and securing goods from competitors could well be expended to increase overall production, thereby leaving everyone better off.43 Furthermore, a second agreement will be put in place guaranteeing certain rights to every individual. A delimitation of individual rights is of greatest importance for the stability of the constitutional order as some individuals may be inclined to fall back into their old predatory behaviour being faced with pareto-inferior outcomes under direct production.44 This initial social
41 42

Buchanan (1975; Ch. 1, par. 7.1.1) Hobbes (1651; Ch. 13, sect. 14) 43 Buchanan (1975; Ch. 4, par. 7.4.16) 44 Buchanan (1975; Ch. 4, par. 7.4.17)

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contract derives its legitimacy from the unanimous consent of all individuals, which can only be warranted if the proposed setting is advantageous to all. Therefore, an initial redistribution of goods and resources has to take place leaving all individuals with endowments paretosuperior to the natural equilibrium and the distribution under direct production.45 Subsequent to the constitutional contract the private exchange of goods and services through markets is established. Although, individuals come to fulfil a great deal of their needs and objectives through such interchange a further aim for collective action becomes apparent: the trade in jointly consumable, i.e. public, goods.
46

Due to the problematic of free riding,

Buchanan does not expect such collective effort to arise naturally. Coherently, he advocates a postconstitutional social contract comprising all members of society for the purpose of collective decision-making.47 In reaching collective decisions Buchanan explicitly resorts to the standard of unanimity as a guarantor for efficiency of the chosen measures. However, recognizing the importance of transaction costs in such an extensive decision process the author acknowledges that less-than-unanimity or even simple majority rule may have to suffice to warrant overall institutional efficiency. In coherence with distinguishing two separate stages of social contracting Buchanan also identifies two distinct tasks of the state in each setting. At the constitutional stage citizens employ the state to act as a mere enforcing agent reassuring and administering the property rights agreed upon. In this function the state is not actually producing justice but rather objectively judging the compliance of individuals to the existent framework of rules. In this, Buchanan depicts government as an automat programmed to correlate legal sanctions to particular violations of the law. To clarify: the body of the protective state does not fulfil any legislative function. Instead government is entrusted with the straightforward enforcement and realisation of the social contract.48 In contrast, the state inherent in the postconstitutional setting has the command over legislative provisions. This task can be labelled productive in the sense that government is facilitating collective action so as to achieve greatest well-being of society. In coordinating individual objectives and creating satisfactory trade-offs through compensation the productive section of government engages in a complex adjustment process, unlike the clear-cut role as an umpire in the constitutional phase. In coherence, the outcomes of the states productive efforts must not be judged as right or wrong. Nevertheless, every governmental policy on behalf of its citizens constitutes a legal contract to be enforced by the protective body of the state.

45 46

Buchanan (1975: Ch. 4, par. 7.4.25) Buchanan (1975; Ch. 3, par. 7.3.1) 47 Buchanan (1975; Ch. 3, par. 7.3.12) 48 Buchanan (1975; Ch. 4, par. 7.4.40)

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3.2.

The Logical Fundament of Social Policy in the Constitutional Order James M. Buchanan bases his conception of social policy on his comprehensive study

of collective action within a contractually designed liberal order. This theory of public goods provision is concerned with the tasks of the productive state in the postconstitutional setting apart from the protective function assumed in the constitutional phase of social contracting. The states task of reinforcing the individual rights and property rights of its citizens in the constitutional phase is important not merely based on the protective function that is enacted. Securing the most basic rules and thereby individuals positions in society also allows for much more complicated exchanges than the pure market exchange of private goods. The government in its protective function builds the foundation for collective action in the pursuit of providing goods publicly, which cannot or will not be provided through the market. The productive state, in turn, is entrusted with the task of increasing the communitys overall well-being through the furtherance of collective action in the case of goods [...] characterized by extreme jointness efficiencies and by extreme non-excludability []49, i.e. public goods. As has been said, such provision is based on collective action letting different policy options become evident, which aim to compromise conflicting needs and compensate for disregarding one need in the face of another. In general, these processes do not only involve two options of public action to take, but as individuals needs and value schemes differ greatly so do the courses of action available to government. The Economic Model of Politics Facing such a broad variety of possible policy measures one is to review each option for the incentive structure inherent, for the results anticipated and the methods employed for this purpose. In order to identify expedient and legitimate policy options Buchanan deems it necessary to conceptualize the relationship existing between the body of the state and its citizens. In the pursuit of this he utilizes three essential elements, namely: the methodological individualism, the model of homo economicus and his theory of politics-as-exchange. In his explanation of politics Buchanan advances the economic theory of politics, which is methodologically individualistic: Ultimately each member of a society is affected by the outcome of choices within politics and enacted policy essentially represents the aggregate of individuals choices in accordance to their preferences. Hence, explaining the process of how these individual value schemes are translated into policy measures needs to be based on an evaluation of the individual choice behaviour. The methodological individualism allows for the analysis of this choice behaviour under varying frameworks of rules. Therefore, this

49

Buchanan (1975; par. 7.6.19)

14

method can help to develop predictions concerning the outcomes of different institutional settings in the area of politics as well as markets.50 Analysing the results of politics on the basis of individual behaviour must then focus on what motivates citizens to join the collectivity in the pursuit of public goods provision. Here, Buchanan advances a fundamental idea from general market economics. The concept of homo economicus assumes individuals to be acting wholly self-interested in order to maximize their individual utility. This notion is widely accepted for simple market exchanges where individuals seek to maximize their net wealth within a two-party exchange based on their preferences quantified in utility functions. In politics, however, net wealth, as implicated by a certain course of action, is not just restricted to one single individual that is being observed, but rather to a whole community of collective actors presumed to be possibly affected by the choice outcome. From this basic incongruence of market and politics exchanges stems the reluctance of social scientists to approve of the application of homo economicus in collective action settings. Nevertheless, Buchanan is certain that the ideal of homo economicus is equally applicable to the realm of collective action, since [t]he minimal critical assumption for the explanatory power of the economic theory of politics is only that identifiable economic self-interest is a positively valued good to the individual who chooses.51 This self-interest is in no way contradictory to altruistic behaviour that may be exerted in the political arena. The model of complex exchange advanced by Buchanan includes such behaviour as internal to the individuals subjective decision making process meaning that the facilitation of the well-being of others can be seen as the self-interested pursuit of an altruistic actor.52 The author further clarifies that perceived disparity in the actual outcomes of market and political exchange does not infer from differences in the motives of individual actors but rather from the basic differences in the institutional structures within which choices are made. From the theoretical assumptions of methodological individualism and homo economicus, Buchanan now models politics as an exchange institution resembling that of the market. This mere exchange conception is challenged by the classical ideal that individuals join in collective efforts to further some common goal or good. In the authors perception, however, the political process, similar to the process of market exchange, is not [...] motivationally functional.53 In this sense markets and politics do not work because individual actors intend to further an overall allocation, but rather because actors utilize them to fulfil their own desires in the best way possible. In conclusion Buchanan defines politics to be [...]

50 51

Buchanan (1986; p. 244 et seq.) Buchanan (1986; p. 245) 52 Buchanan (1985; par. 10.3.11) 53 Buchanan (1986; p. 246)

15

a structure of complex exchange, a structure within which persons seek to secure collectively their own privately defined objectives [...].54 It follows from this that collective action is based on the voluntary support of individual actors. Justice and Efficiency in Politics In coherence, one can say that [...] politics as such has no aim or objective. 55 It simply embodies the institutional processes that allow citizens of a community to express their individual preferences over different courses of collective action. As the provision of public goods is in this the result of mediating a broad range of individual values the outcome can never be stated as being true or false, right or wrong. Such a judgement of the result of collective action would presuppose an external standard, which society is to strive for. If knowledge of this supra-individual value existed and was known to society there would be no case for politics at all since everyone would these commonly known goals. But as such a standard is nonexistent there is no basis on which to judge the outcomes of collective action. He concludes, that [w]hat emerges from a process is what emerges and nothing more. 56 . Further qualifying his statement, Buchanan admits that observing particular outcomes as results of particular processes may ultimately lead to judging the process itself as unacceptable. Therefore, the ends of collective action cannot be judged, but they may still provide a feedback upon which a process expediency can be judged. Although evaluation may not be applicable to the ends of the process, nevertheless, the process itself may be evaluated, according to Buchanan. His idea is that the results of political measures can only be judged through the processes from which they come about. Therefore, the efficiency with which the political process translates the individual values and preferences into desired outcomes is put into focus. Unfortunately, efficiency in this context cannot be compared to the efficiency of decentralized trading in markets. The political analogue [...] advanced by the public choice scholar, [...] must be that feature common over all exchanges, which is agreement among the individuals who participate.57 The unanimity rule is the proposed measurement of efficiency in political processes constituting the ultimate aim of normative improvement. The requirement of complete unanimity among collectively choosing individuals constitutes a very restrictive rule in the improvement process. This reasoning is in part true considering that an ever extending range of governmental policy would have to fulfil this criterion before being put into action. Besides, the transaction costs involved in the endeavour
54 55

Buchanan (1986; p. 246) Buchanan (1985; par. 10.3.42) 56 Buchanan (1985; par. 10.3.42) 57 Buchanan (1986; p. 247)

16

of approving all measures on the basis of unanimity would be detrimental to the overall efficiency this unanimity is to secure. Hence, Buchanan goes one step further and incorporates his economic theory of politics in the social contract theory of the liberal social order. Attaining Unanimity in Politics In the pursuit of interlacing these two theories the public choice advocate aims at mitigating the restrictive character of the unanimity rule as such. Therefore, he proposes to translocate the requirement of consentaneousness from the postconstitutional to the constitutional stage of the social contract. Analogously to a game, the choice setting is shifted from determining strategies within rules to determining the basic set of rules within which one can develop strategies. The problem of choice within a given set of rules is that [...] interests of individuals and groups are well defined and readily identified.58 Based on the fact that, at this stage, individual actors can adequately estimate possible consequences of policies on their personal economic or social position, conflict among winners and losers of certain strategies will arise and undermine any intention for cooperation. Shifting the unanimity criterion to choices among rules or institutions, within which strategies can be implemented, which do not explicitly have to fulfil the unanimity rule, can solve this problem. According to Buchanan such an [...] in-period violation of the criterion does not imply the inefficiency of the rule so long as the latter is itself selected by a constitutional rule of unanimity. 59 Through deciding unanimously on rules and institutions on the constitutional level individual actors experience a loss of interest identity60. This inability to identify their particular interests is due to the generality and permanence for which constitutional rules are designed. Buchanan defined this particular situation as a veil of uncertainty, behind which [...] a person faced with constitutional choice remains uncertain as to what his position will be under separate choice options [...].61 Ultimately, an individual, which is uncertain of how to best further his own interest in the face of a variety of most general and long-term rules, will choose an arrangement of institutions that will generally appear fair to him. This fairness, in turn, is constituted by a pattern of results that is widely agreeable to the chooser no matter what his eventual position within the range of results may be. Under such circumstance the individual will also accept a possible in-period disregard of his own interests if he expects them to be better suited under a possible long-run arrangement.62 Due to the fact that every member of society faces the same uncertainty in the constitutional setting unanimous agreement on a general set of rules and institutions is much more likely to arise than when individuals are
58 59

Buchanan (1985; par. 10.2.32) Buchanan (1986; p. 248) 60 Buchanan (1985; par. 10.2.33) 61 Buchanan (1985; par. 10.2.37) 62 Buchanan (1986; p. 248)

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able to readily identify their interests in the face of rather specific policy measures at the postconstitutional stage. The Normative Content of the Economic Theory of Politics The economic theory of politics is essentially of justificatory nature, offering a basis for evaluating existent structures normatively. In coherence with the theoretical assumptions introduced before such evaluation must focus on the question whether [...] the observed rules that constrain the activity of ordinary politics [could] have emerged from agreement in the constitutional contract.63 If one can confirm this dependency of policy and rule of law, then the relationship established between citizen and state is legitimate. However, if the questioning of constituted rules leads to the detection of incongruence in the same relationship, the institutional setting should be subjected to normative criticism. Reform proposals, in turn, will have to fulfil the unanimity criterion in order to pass as more efficient than the institutions previously existent. In accordance to James M. Buchanan it is at this point when social scientists can enter the political discourse in order to advance policy measures that primarily aim at increasing the efficiency of collective action, rather than aiming at the achievement of particular ends. In this undertaking the political economist is to remain as free as possible of any kind of value judgement since he is not to impose his preference schemes on others. In fact the scientist as a policy advisor is to [...] assist individuals [...] in their continuing search for those rules of the game that will best serve their purposes, whatever these might be.64

3.3. The Reality of the Contemporary Welfare State Socialism is Gone but Leviathan Lives On Buchanan largely agrees with F.A. Hayek on the nature of modern days welfare state as he claims that Socialism is dead but Leviathan lives on65. It is true that Socialism as the wishful thinking of being able to plan and control the whole economy through centralized institutions has once and for all lost its appeal after the events of 1989. However, the public has largely failed to draw consistent conclusions from the decay of the socialist utopia, according to Buchanan. In his opinion, politics in the large may well have changed. Nevertheless, politics in the small remain the same as planners have merely switched from organizing the complete economy to spending their effort on piecemeal interventions in particular markets. Buchanan warns though that if the politicization does not work on a large
63 64

Buchanan (1986; p. 249) Buchanan (1986; p. 250) 65 Buchanan (2001d; p. 188)

18

scale it will not work when applied in the small either.66 However, the small scale interventionism continues, which Buchanan ascribes to the curious [...] elementary logic of collective action67, wherein single market interventions work through a concentration of the benefits, while the involved costs are dispersed throughout the whole collectivity.68 The beneficiaries of such policies naturally favour their implementation irrespective of whether the costs actually exceed the overall attainable benefits. To further their own interest individuals will invest in rent-seeking behaviour trying to realise the offered benefits or even attempting to modify the institutional structures directly. Meanwhile, the possible victims of such inexpedient measures incur losses as they stay politically ignorant due to the relatively small share of costs they are facing. 69 Legitimacy & Liberty Coherently, Buchanan speculates that efficiency may not actually pose as a sufficient criterion for the welfare state in desisting from further interventionist policies. The author, in turn, advances the argument of legitimacy as the main criterion to rule social policy, since every member of the liberal order shares in the moral right to partake in voluntary market exchanges unrestrained from political intervention. However, Buchanan cannot help, but acknowledge contemporary state of affairs in which [...] democratic procedures lend legitimacy to the actions of bureaucratic agents. 70 Looking at the contemporary social security system Buchanan determines it to be not legitimate and inefficient according to his economic theory of politics. Embodying the imposition of wealth and income transfers, these policies of the welfare state are unlikely to fulfil the proposed unanimity criterion due to their coercive nature. The individual entitlement to liberty, as freedom from state coercion, must pose as the ultimate argument in the revision of allegedly legitimate institutions of the western welfare state.71 In accordance to his economic theory of politics Buchanan cannot help, but judge the contemporary welfare state illegitimate. He bases this evaluation especially on the coercive nature of the welfare state imposing a rather arbitrary scheme of wealth and income transfers upon his citizens. He further suggests that these measures did not fulfil the unanimity criterion beneficial policies are to conform to. As mentioned before an institution that does not fulfil this requirement is inefficient and should in turn be subjected to normative criticism, which is why Buchanan offers a reform proposal aiming to achieve a pareto-superior set of rules.

66 67

Buchanan (2001d; p. 189) Buchanan (2001d; p. 191) 68 Buchanan (2001d; p. 190) 69 Buchanan (2001d; p. 259 et seq.) 70 Buchanan (2001d; p. 193) 71 Buchanan (2001d; p. 194)

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However, he insistently designates the status quo as the ultimate point of departure in such constitutional reform as [p]olicy options must remain within the realm of the feasible, and the interest of political agents must be recognized as the constraints on the possible.72 Dismantling the Welfare State From these premises, Buchanan proposes a reform of the pension system, representing the single most important measure of income redistribution in the modern welfare state. As argued above the coercion involved in taxation itself and in the arbitrary transfer of the tax yield poses an illegitimate state measure, which could not have been approved of by unanimous consent. Nevertheless, Buchanan insists that the institution of the pension system does constitute an enforceable contract between the state and its citizens and any reform must therefore warrant the claims involved in this contractual arrangement of the status quo. Hence, the proposed reform must meet the obligations that arise from the pension system in order to obtain the unanimous consent, of both the people benefitting from reformation and the people who currently maintain claims against the pension system. Furthermore, Buchanan asserts that the transfer system is not in actuarial balance meaning that the current claims amount to net liabilities in excess of the tax payments to be anticipated at any moment. 73 These aggregate liabilities constitute implicit public debt, which cannot simply be forfeited, but must be recognized as a national monetary obligation. Open default in an attempt to avoid the costs involved in reform does not constitute a reasonable course of action in this situation, since credibility and legitimacy losses on the part of the state would testify a damning indictment of modern democracy. Dismantling the welfare state, government cannot, therefore, violate the implicit contract with its citizens by cancelling its debts since it has to fulfil the existent claims in the course of any reformative measure. In order to do so net claims of each individual have to computed, i.e. the present value of anticipated tax payments has to be subtracted from the present value of positive claims in benefits. In the next step a particular date has to be specified starting from which all tax payments supporting the pension structure and all benefits arising in this system come to a sudden stop. From this date on the old-age provision scheme ceases to exist, yet the national debt remains as an obligation of the state: Persons with positive claims then have to be paid off in cash value, while agents with negative claims have to pay their remaining tax burden. As mentioned before the existent positive claims place a tremendous financial burden on the state, however, Buchanan advocates [...] that funds for meeting the individual claims within the system be raised by the explicit issue of general-purpose national debt [...]74. The
72 73

Buchanan (1987; p. 248) Buchanan (2001a; p. 452) 74 Buchanan (2001a; p. 453)

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interest charges that arise from this debt on perpetual basis will in turn have to be borne equally by all current and future taxpayers. Buchanan concludes that this proposition should in effect fulfil the requirement of unanimity, since the continuous increase in implicit national debt is being stopped while individuals do not have to face any additional tax burdens or inflationary government policies to offset the discontinuance of the pension schemes. In effect, the interest arising from the issuance of public debt will not pose as an additional burden to the current tax payers [...] since this group, even before any structural change, is bearing at least this cost of the system.75 In conclusion the reform may then achieve unanimous consent, due to the fact that current beneficiaries are left indifferent as they are compensated at the full amount of their claims, while current and future tax payers are made better off through a reduction in tax burden as compared to their previous obligations. Subsequent to the successful dismantling of the pension system Buchanan prognosticates an evident increase in economic productivity as the tax burdens on citizens and the benefit burdens on government are decreased. This production increase will further enable the community to carry the annual interest obligations forward so as to attain a [...] gradually decreasing weight relative to annual gross product in the economy.76 In anticipation of the abolishment of the transfer system Buchanan further elaborates on the possible establishment of a [...] fully funded, actuarially sound pension scheme with separated and identified individual accounts.77 In effect, the author is proposing a competitive insurance based structure offering individuals the choice of providing for themselves on a competitive market for pension insurance or with the help of state-organised insurance. However, both options require the individual to settle payments into a designated account from which his own retirement benefits will be financed. This genuine insurance structure is, by definition, to refrain from any redistributive efforts. Nonetheless, Buchanan does not completely rule out any kind of auxiliary redistributive payments in the liberal order provided that this is desired by the collectivity. In the proposal of this reform of the welfare state Buchanan has offered a way out of the strait jacket which had been put on social evolution, according to Hayeks interpretation. It is to be kept in mind though that this reform is aimed at the abolishment of the existing pension scheme while the author did not explicitly offer a new structure in substitution. Nevertheless, Buchanan clearly points out that the costs of continuing the accumulation of implicit national debt outweigh those incurred in the dismantling of a system proven inefficient in a market context and detrimental to individual freedom in society.

75 76

Buchanan (2001a; p. 454) Buchanan (2001a; p. 454) 77 Buchanan (2001a; p. 454)

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IV. Social Policy for the Market Rethinking the Welfare State 4.1. Contract Theory as the Fundament of Social Policy for the Market The Welfare State Theory and Reality According to the theoretical fundament, which both Hayek and Buchanan have laid out, social policy constitutes a governmental instrument to provide for those needs of the collectivity, which cannot be fulfilled through market processes due to the inoperativeness of the price mechanism. What both economists emphasize is the purpose of the welfare state activity to reduce unnecessary uncertainty, which individuals in a market economy find themselves exposed to. The general intention is an increase in individual freedom for citizens, who can in turn pursue their own goals and desires more efficiently. In essence, the social policy, which is prescribed by Hayek and Buchanan, aims at facilitating the market economy by offering a range of social provisions equally applicable to all societal members in order to enable them to partake in the risky ventures of the free market economy. Considering these premises their conception of state activity represents a social policy employed facilitate the market. In contrast, the structure of the welfare state, as known today, originated from the necessity to cope with the social injustices that came about during the industrialisation in the 18th century. Social policy came to be designed to correct the inhumane results of the successful market, basically protecting the individual from the ruthless forces of competition. In conclusion the welfare state originated as social policy against the market. This conception is still prevailing today and the fundamental reason for this can be found in the ongoing dualism between markets and social policy. It is generally conceived that social policy is not instrumental for the furtherance of the free market, but rather corrective of the outcomes generated by the efficient free economy. The introduction of the programme of social market economy further accentuated these misconceptions as social policy came to be identified as redistribution of income in the name of justice. As a result, the mere function of the market seems to consist, crassly put, in generating the resources that the social state can redistribute.78 The relation between the social factor and the economic one can therefore be characterised as confrontational, insofar as the pursuit of a freer economy is thought to be borne by a reduction in social security, while a broadened social security net is expected to go at the expense of economic efficiency. The indicated value antagonism also accounts for the deadlock in the ongoing debate about restructuring the welfare state. Neither the proponents of social security nor the advocates of the free market are willing to give in, as they perceive

78

Pies (2000; p. 120)

22

the competitiveness of the market as detrimental to individual security and social justice, and vice versa. This dualism of social policy versus free markets offers no point of vantage for a normative theory of the welfare state free of any value judgement. At this point the debate can only concern itself with reform proposals of quantitative nature a discussion that poses only a dead end due to its subjective character. The Analogy of Protective and Productive State Utilising and extending the constitutional approach of James M. Buchanan, the economists Karl Homann and Ingo Pies developed a theory based on the systematic interdependence of the protective and the productive state. In shedding light upon the logic of the transfers, which occur in the social market economy they aim to resolve the dualistic nature of the current social policy debate. On the basis of explaining in the constitutionalcontractualist tradition what is commonly conceived as mere redistribution the two researchers offer a possibility of rethinking the welfare state. As outlined in the previous section of this thesis the political economist Buchanan distinguishes a constitutional and a postconstitutional stage in his social contract theory. At the constitutional stage collective disarmament is enacted to warrant the members an individual private sphere based on mutual recognition of exclusive property rights. Markets can arise premised on the existence of the protective state entrusted with the preservation of these property rights and the enforcement of exchange contracts. The productive state, which is emerging in the postcontitutional setting, organises the collectivity in the provision of public goods, which cannot be provided through private exchanges. The term productive might appear somewhat misleading in this context as the social state is not simply producing goods and services to supply to society. Actually, government is providing insurance structures for individuals to join in an effort of pooling the risks they are facing in the market environment. Reducing the expected variance of market outcomes for each person through the trade of risks, these arrangements also offer the chance to undertake high risk investments in order to realise additional gains from trade. Furthermore, the collective effort in public goods provision can be reconstructed as a two party exchange in which the state supports the originating contracts through provisions made to each party of the contract. 79 In essence, both the protective and productive sector of government aim at enabling individuals to realise all possible gains from trade. From this, one can infer that neither the productive, nor the protective state constitute an end in itself but rather a means to realise gains from trade. 80 The
79

Becker and Murphy (1998; p. 9): Taxes on adults help finance efficient investments in children. In return, adults receive public pensions and medical payments when old. This compact tries to achieve [...] efficient levels of investment in children and support to elderly parents. 80 Homann and Pies (1998; p. 214 et seq.)

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welfare state must not be conceived as a substitute for the inoperative market mechanisms, but as a supplement to the market.81 The Complementarity of Protective and Productive State Now, according to Homann and Pies, the two functional branches of government do not merely share the common goal of establishing and enabling markets they are also logically intertwined. Their respective legitimisation rests upon each other. It is generally agreed that the establishment of the social state is premised on the existence of the protective state guaranteeing individuals the protection of their private sphere and property rights. Only through the undisputable constitutional protection of such can the individual citizen agree to social provisions being made under less than unanimity rule. An important correlation largely disregarded in this context is that consent to the employment of a protective state is in turn based on the premise of the productive state.82 This interdependence becomes evident in Buchanans construction of the initial constitutional contract where he asserts that [...] some redistribution of goods or endowments may have to take place before a sufficiently acceptable basis for property claims can be established.83 An initial redistribution is the basis on which all individuals can consent to the constitutional delineation of property rights. Conceptually, the individuals interested in the protection of their endowments through social contract in fact compensate others, not in disposal of any endowments to be secured, for agreeing to the contract anyway. Or, looking at it from a different point of view, their interest in protection of property can only be aroused through distributing an initial endowment to them. In the proper sense, these initial transfers represent the creation of a foundation on which all individuals can partake and profit from a contractual organisation of the collectivity.84 Ultimately, transfers are not an invention of the modern welfare state and they are also not to be conceived as unilateral exchanges. From the setting of the constitutional stage it can be inferred that these transfers actually represent bilateral exchanges as preconstitutional participation and agreement to the social contract is paid off in the form of postconstitutional transfers of gains from contractual cooperation.85 4.2. The Logical Evolution of the Social Order Based on the logical foundations which Homann and Pies build the welfare state on, the evolution of the liberal social order can be reconstructed theoretically. In the
81 82

Pies (2000; p. 125) Homann and Pies (1998; p. 215 et seq.) 83 Buchanan (1975, 1999; par. 7.4.26) 84 Pies (2000; p. 125) 85 Homann and Pies (1998; p. 223)

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constitutionalist-contractualist tradition of J. M. Buchanan, they resort to the differentiation of three particular stages of societal cooperation: (1) chaos, (2) taxis and (3) cosmos. (1) The first, chaos, basically resembles the notion of the natural state, which is characterised by complete absence of order or an underlying framework of rules. For the purpose of realising possible gains from trade individuals in the chaotic order will agree to subject themselves to a contract involving all citizens for the purpose of coordinating collective and individual efforts. The point in this undertaking is to delimit the individual sphere of action so to secure each person a private sphere in which he can act freely. To compensate for the constitutional restriction in range of action every individual is entitled to a share in the gains that arise from the coordinated efforts. (2) Now, in a first step from the natural state into the taxis the individual actors are expected to agree to a constitutional contract in which coordination is aimed at producing equality of results. Due to the fact that the constitutional contract requires complete unanimity every party can exercise its veto right to their benefit. In the transition from chaos to taxis this will result in an egalitarian distribution scheme, since everybody is well aware of their respective initial endowment. According to Homann and Pies, this equal distribution is unlikely to be persistent as net receivers will come to learn that by extracting a lower relative size of transfers from net benefactors they can actually influence the incentive structure applicable to the productive. As those become able to keep a greater relative share of their income for themselves they also become inclined to invest greater effort in securing a higher income. This in turn translates into a rise in absolute transfers for the net receivers. Remarkably, an acceptable and anticipated level of societal inequality thereby becomes a literal factor of production. Although in the taxis setting it is justice in outcomes that is initially aimed at members of the collectivity will soon come to find that a healthy degree of inequality is essential for the progress and welfare of society as a whole. (3) Realising that inequality makes markets work more efficiently, the members of society may, in a second transition, come to agree on an even greater degree of inequality and resulting insecurity for the purpose of increasing gains from trade. In the order of the cosmos an orientation towards procedural justice will take place meaning that it is not equality in results which is striven for, but rather equality within the rules and institutions employed. This approach leaves much of the resulting outcomes to factors that are beyond individual control. Hence, individuals are facing increased insecurity and inequality in such an order. This consented inequality in 25

return allows the society to achieve full productivity of its inherent markets and therefore aids the realisation of gains from trade in excess of those possible in chaos or even taxis. 86 The wider the range of freedom and inequality in such a society, the greater will be the resulting welfare of all people in it. However, this touches the important issue of understanding the circumstances under which individuals are actually willing to consent to an ever-growing inequality and insecurity affecting their existence. This question is crucial to the legitimisation of a cosmic order since it cannot simply be imposed on society, but has to be assented to unanimously. Homann and Pies offer three integral requirements to be fulfilled to achieve consensus87: (1) First of all, a framework to secure individual freedom and property rights must be existent incorporating public legal institutions as well as private, which provide for fundamental and general security in the ever-progressing cosmic order. (2) Secondly, in agreeing to the more complex system the individuals anticipate the sharing in on all additional profits that arise. Thus, for unanimity to be achieved, every actor in society must be warranted an income, a particular subsistence minimum enhanced through payments from various insurance arrangements. Ultimately, a transition from taxis to cosmos will only be approved, if it guarantees each individual a standard income above the one enjoyed in the order of the taxis. Even though this standard income has the character of an insurance payment, Homann and Pies also justify it as a sort of pecuniary compensation for tolerating the agreed order. This construction allows transfers to remain legitimate in their nature even if a person should be unable to or not intending to participate in the created free market; on the basis of the income he is assured. (3) In a third respect, it is essential to understand the arising markets as artificial structures that are highly dependent on a supporting framework designed by the state. The support of the livelihood of each member of society through social security payments is equally important as the financing of a basic education. Besides the commonly known compensatory function of these measures government also functions as an investor initiating the establishment of structures to cope with dilemmas of cooperation that arise due to the constant progress of society. Such initial regulation of markets does not rule out an eventual deregulation for the purpose of allowing more competition and thus greater efficiency in some such fields of government investment.
86 87

Homann and Pies (1998; p. 217 et seq.) Homann and Pies (1998; p. 219 et seq.)

26

In conclusion, social policy, which is to allow for a maximum of individual freedom and welfare within a free market economy, has to guarantee to all members of society a subsistence level income to allow them to actually take the risk of participating in the free market. On the other hand, the state is also well advised to undertake certain investments to enable for a successful partaking in the market by financing for example the general education of the population. In essence each individual should justly expect his needs to be served better in the cosmic setting as opposed to that of the taxis. Through compensatory payments and investment aids the state is to facilitate the transition from taxis to cosmos and therefore the establishment, enhancement and development of markets. This identifies the range within which a productive social policy is to prevail.

4.3. Rethinking Social Policy as Overcoming Dilemma Structures The programme of social policy for the market as proposed by Homann and Pies establishes an alternative interpretation of what is usually conceived as redistribution. Therein, unilateral transfers of income within the contemporary welfare state come to be more accurately construed as postconstitutional compensations for preconstitutional investments, as represented by the initial unanimous agreement to the more productive order. Through the constitutionalist reconstruction la Buchanan, the two economists manage to eliminate the alleged dualism between the market economy and the social question. From this point on the debate over the realm of the social state can break away from the restrictive value conflicts that used to characterise the discourse. Value antagonisms can now be avoided with the result that the discussion can turn from assessing allocative aspects to the examination and reformation of procedural aspects. The discussion of the ends and aims of market and social policy have become irrelevant, insofar as they have been found to share a common denominator: Facilitating the realisation of gains from trade. Through the identification of common interests Homann and Pies manage to achieve an orthogonal positioning, i.e. an efficient outcome in their theory of the welfare state.88 From this general legitimacy of the productive efforts of the state, Homann and Pies go on to elaborate on the normative content of the programme. The line of reasoning applied to the constitutional reconstruction of the social market economy persists throughout this normative theory. The reconstruction of collective action problems as social dilemmas can then provide the basis for analysing the underlying conflict structure in order to be able to rethink the problem in a way that can generate consensus among the parties involved.
88

Efficient in the sense Buchanan proposed, meaning that differing values become reconcilable and unanimous consent is therefore possible.

27

Social dilemmas basically represent situations in which rational agents harm each other as the intentional actions of each individual come to produce unintended results for the collectivity. The apparent dualism between market economy and the social state can be modelled in this way. The value trade-off that individuals in the welfare state debate are facing leads them to an either-or position. Integrating this into a social dilemma model, the general value antagonism can be resolved, by focussing on the common interest. In this an orthogonal positioning becomes possible yielding an improvement for both parties of the conflict.

Figure 1: Rethinking the welfare state as a social dilemma with the solution of orthogonal positioning89

The welfare state debate can then be realigned from discussing ends to discussing actual means of reform. Once it has been understood that social policy provides the incentives on the grounds of which individual agents make use of the functionality of the market, the relevance of understanding and designing these institutional structures becomes evident. From this perspective the discussion of possible reforms is to focus on matters of expediency. Hence, according to Pies, social policy measures have to fulfil the postulated exchange characteristic. This means that in the first place, welfare state measures have to incorporate a certain advantage to the benefactors in this setting, since their willingness to exchange is just as vital to the legitimisation of any such activity.
90

This is conform to Buchanans

89 90

In reference of Pies (2000; p. 130) Homann and Pies (1998; p. 227)

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understanding of efficient policy measures as he highlighted the necessity of unanimous consent to the rules rather than the judging of outcomes and their alleged efficiency.91 In the pursuit of generating possible reforms an understanding of human cooperation is indispensable, which is why social dilemmas are equally suitable to model the interaction problems of the status quo. The collective self-damage inherent in these structures brings the institutional setting into focus from which these unfavourable outcomes arise. The prevailing incentive structure is decisive of whether individual interests conflict with the interests of the collectivity or whether they can be aligned.92 The investigated dilemmas visualize both the conflicting and the shared interests of all agents, thereby effectively indicating the optimal position attainable from the current status-quo. In turn, one is to identify a pareto-superior set of rules allowing for the realisation of the additional gains from trade. The pareto-superior framework is by definition beneficial to all parties involved, so that proposed reforms will generally attain unanimous consent. From this reasoning one can infer that social policy measures are justifiable, if they allow for the resolution of a social dilemma. On the other hand, they are to be subjected to criticism, if they, in fact, give rise to such interaction problems.93 The modelling of collective-action problems as social dilemmas therefore incorporates both a normative value as well as a feasibility judgement. Based on this, the approach of Homann and Pies constitutes an advance from Buchanans economic theory of politics, wherein he had to resort to unanimous constitutional decisions under a veil of uncertainty to legitimise less-than-unanimity rule in the postconstitutional setting. The theory is aimed at a collective orthogonal positioning from the apparent value dualisms by appealing to the common interests among all parties involved.94

4.4. The Benefits of Cooperation The modelling of collective action problems as social dilemmas should not lead to a narrow-minded view on how to enable cooperative action, though. Despite, this approach contributing much to the understanding of how individually motivated behaviour can lead to outcomes detrimental for the collectivity, it has encouraged [...] a tendency to think [...] that the real problem with efficiency gains is just an incentive problem.95 According to Joseph Heath, a professor at the University of Toronto, it is not merely a question of getting the incentives straight. He remarks that there are a number of cooperative
91 92

Buchanan (1986; p. 247) Pies (2004; p. 8) 93 Pies (2000; p. 130) 94 Pies (2000; p. 130) 95 Heath (2006; p. 350)

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benefits inherent in structures that seem to pose as collective action dilemmas. On close examination, however, the institutions necessary to resolve a certain dilemma structure often eliminate a beneficial institutional arrangement in place to avert a quite different social dilemma. In the pursuit of clarifying the involved misconceptions Heath is very particular on the fact that the role of the welfare state has to be rethought. Concerning governments role as the pioneer in the establishment of vital institutional structures it is to say that the state does not only take on the role of an initial investor, who paves the way for the establishment of competitive markets. Hence, Heath is very agreeing that the welfare state embodies much more than an institution for the mere redistribution of income. According to the political philosopher [...] there is no reason to think of the states role [...] as residual.96 The criticism Heath voices, refers to the mechanisms of cooperative benefits, in his mind the five dimensions of economies of scale, gains from trade, risk-pooling, selfbinding and information transmission. Now, the benefit generally undisputed by the market economy is that of gains from trade. Figure 1 shows that the private sector is not only directed at the actualisation of these gains, but also commands other institutional forms that yield the benefits of risk-pooling or self-binding arrangements and support the transmission of information.

Figure 2: Private and Public Institutional Forms97

According to the Canadian philosopher, though, it is in turn the welfare state, which [...] has often taken a lead role98 in the facilitation of such important cooperative benefits as the risk-pooling involved in the insurance structures of the social security net, namely: the unemployment provision as well as public health insurance. Allowing for the realisation of
96 97

Heath (2006; p. 317) In reference of Heath (2006; p. 348) 98 Heath (2006; p. 348)

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various benefits of cooperation that are sometimes being disregarded in the market-based pursuit of additional gains from trade government is [...] not only the insurer of last resort, but also [...] enforces a wide range of seemingly paternalistic policies [...]. The obligatory pension provisions enforced by the state realise the benefits of a self-binding arrangement. Furthermore, Heath names the various kinds of social work that the welfare state provides for also constituting self-binding structures. Also, government represents an authentic source of information for all members of society, delivering weather forecast as well as certifying and enforcing [...] standards of veracity [...] in the private sector.99 In essence, the collective action structure inherent in the productive state does not only serve the preliminary purpose of enabling markets and competition, but sometimes the state is the genuine provider of various measures beneficial to the realisation of cooperative benefits. The welfare state as such may even preserve benefits of cooperative action, which are generally disregarded by the market forces in favour of realising gains from trade. In evaluating alleged cooperative action problems and the methods to resolve them it is therefore worth considering all types of benefits, which arise in these setting, material as well as immaterial. According to Heath, [t]he issue [...] is over which type of collective action problems we should resolve, at the expense of which others. 100

99

100

Heath (2006; p. 348) Heath (2006; p. 350)

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V. Conclusion The liberal doctrine strives to maximise the welfare of society as a whole in order to [...] secure to man a life free from fear and want. That is all101, as Ludwig von Mises once put it. In providing for the material needs liberalism allows for the continuous progression of society and the internal development of each individual within this order. Cooperation among all members of society is crucial in this undertaking and government, in turn, is the ultimate facilitator of social interaction. The apparatus of the state comes to fulfil a wide range of tasks within the liberal society. Whether it is the preservation of individual freedom on the basis of the assignment and enforcement of private property rights, or governments effort in elaborating a legislative framework within which individuals can interact freely according to their objectives and desires. The trade and interaction between individual agents on the competitive markets in the free economy allow for the efficient accomplishment of personal desires and needs. Therefore, the case for the welfare state rests ultimately on the facilitation of social cooperation and free market exchanges. Social policy, then, has to be though and applied as policy for the market rather than policy in correction of the results of the market. In particular, state activity is to aim at the basic enablement of all individuals to strive successfully towards the realisation of their personal goals and desires. Through a stateprovided system of general education the liberal order seeks to enable each and every member of society to partake in the market and thereby to contribute to progress. Furthermore, social provisions, e.g. health care provision and old age pensions, are established and supported by the state in order to eliminate a great deal of avoidable uncertainties individuals may be facing in the competitive market economy. Planning for Freedom constitutes the primary purpose of the welfare state, and in this government is to support each individual equally in his pursuit of efficient market interaction. Only through enabling each and everyone to face the risks of competing in the free economy can the liberal social order warrant its steady progress towards greatest welfare for all. The equal promotion of each individual, however, does not constitute the aim of factual equality of all. It is particularly the contemporary ambition of social justice or redistributive justice that misleads the welfare state in the policies it pursues. Due to the absence of an external i.e. objective standard on what constitutes such just distribution social policy cannot, but direct its activities toward reaching procedural justice. Therefore, the welfare state is to create rules which are general in their outlay and equally applicable to all members of society. Only from such institutional arrangements, that treat everyone fair and equal, can true justice of outcomes arise.

101

Mises (1985; p. 51)

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References

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Pies, Ingo (2000): Ordnungspolitik in der Demokratie: ein konomischer Ansatz diskursiver Politikberatung, Tbingen, Mohr Siebeck. Sinn, Hans-Werner (2003): Der Sozialstaat: Mchtigster Konkurrent der Wirtschaft, in: Ist Deutschland noch zu retten?, Mnchen, Econ Verlag, Ch. 4, p.155-213.

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Own Work Declaration I hereby declare that all information in this document has been obtained and presented in accordance with academic rules and ethical conduct; I have fully cited and referenced all material that is not original to this work. I further declare that this thesis is my own work and effort and that it has not been submitted anywhere for any award.

Fanny Paschek Zschillestr. 1 01558 Groenhain Germany Date of Birth: 10/11/1986 Matr.-No.: 206209986 Course: B.Sc. International Business Studies