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Throughout the world, societies are

reexamining, reforming, and restructuring

their social welfare systems. New ways are
being sought to manage and finance these
systems, and new approaches are being
developed that alter the relative roles of
government, private business, and individ-
uals. Not surprisingly, this activity has
triggered spirited debate about the relative
merits of the various ways of structuring
social welfare systems in general and
social security programs in particular.
The current changes respond to a vari-
ety of forces. First, many societies are ad-
justing their institutions to reflect changes
in social philosophies about the relative
responsibilities of government and the
individual. These philosophical changes
are especially dramatic in China, the
former socialist countries of Eastern
Europe, and the former Soviet Union; but
The Advantages and Disadvantages they are also occurring in what has tradi-
of Different Social Welfare Strategies tionally been thought of as the capitalist
West. Second, some societies are strug-
by Lawrence H. Thompson* gling to adjust to the rising costs associated
with aging populations, a problem particu-
The following was delivered by the author to the High Level American larly acute in the OECD countries of Asia,
Meeting of Experts on The Challenges of Social Reform and New Adminis- Europe, and North America. Third, some
trative and Financial Management Techniques. The meeting, which took countries are adjusting their social institu-
tions to reflect new development strate-
place September 5-7, 1994, in Mar de1 Plata, Argentina, was sponsored
gies, a change particularly important in
by the International Social Security Association at the invitation of the
those countries in the Americas that seek
Argentine Secretariat for Social Security in collaboration with the ISSA economic growth through greater eco-
Member Organizations of that country. nomic integration. And, finally, in many
parts of the world, social welfare reform is
motivated by the need to adjust the costs of
* Deputy Commissioner of the Social Security Administration. The views welfare systems to economies that are no
expressed in this article are the authors own and do not necessarily reflect those longer growing as fast as they did in the
of the U.S. Government or the Social Security Administration. first three or four decades after World
War II.
Whatever their motivation, these
changes are being discussed and debated
widely. And the current discussions seem
in several ways to reflect a new level of
sophistication about the complexities of
social welfare policy. One example of this
is the recognition of the important relation-
ships between social welfare systems and
the economy in which they exist. The state
of its economy will often influence a soci-
etys willingness to support its social wel-
fare system. Healthier economies facilitate
more generous social welfare systems,
while economic difficulties frequently
lead, sooner or later, to retrenchments.
At the same time, the size and structure of

Social Security Bulletin l Vol. 57, No. 3 Fall 1994

l 3
social welfare systems can themselves decisions. But careful and objective variations) to structuring income support
influence the pace and rate of growth of analyses of the many implications of programs. I begin by describing briefly
economic activity. Social welfare sys- each possible social welfare option are each in turn.
tems that inadvertently discourage work also very important. That conclusion
activity --or encourage a shift from the emerged from a recent expert meeting
hosted by the International Labor Office Social Insurance
formal sector to the informal sector---can
reduce the aggregate amount of income (ILO) in Mexico City. The experts noted Social insurance is the largest single
available for distribution among societys that a key element of social security element in and the foundation for the
members. Similarly. a system which reform was: . ..careful and rigorous ex- social welfare system of most countries.
discourages domestic savings can have ploration of all of the options-in a par- It grew out of voluntary insurance
the effect of slowing economic growth, ticular countrys context--considering arrangements of the medieval European
while. given the proper environment, one [such objectives as] administrative efii- craft guilds, was institutionalized by
that increases domestic savings could ciency, cost containment, breadth of European governments in the late 19th
enhance economic growth. coverage. and transparency .. . and early 20th centuries, and soon spread
Another indication of the increased My purpose in developing this paper from there to the Americas. Since social
sophistication of current debates is the is to contribute to the rational debate and insurance is the foundation of so many
realization that social welfare policies are discourse referred to in the IL0 commu- social welfare systems, it seems the rea-
developed to achieve a variety of differ- nique by developing further some of the sonable starting place for this discussion.
ent and often competing social objec- thoughts 1 have just outlined. In particu- Although details vary from one coun-
tives. These social objectives include the lar. 1 wish to suggest a framework for try to another, social insurance programs
effective protection of the population thinking about the various goals, objec- throughout the world share certain char-
from various economic risks, the promo- tives, and structures and to offer some acteristics. The interaction of these char-
tion of increased economic activity. the suggestions about the relative advantages acteristics gives social insurance a unique
redistribution of economic resources, the and disadvantages of different ap- set of attributes, and the differences
facilitation of the smooth operation of a proaches to achieving the various goals. between social insurance and other social
free labor market, and the efficient opera- 1 seek to further the dialogue about welfare approaches can be traced prima-
tion of social institutions. No single these topics by producing a document rily to differences in the mix of these
policy will be best able to achieve all of that will provoke others to think and characteristics. Some expert commenta-
these various objectives, so the choices react. Some may suggest the addition of tors cite seven characteristics as essential
actually made will necessarily reflect important social objectives that they elements of social insurance.
decisions, either implicit or explicit. believe I have overlooked. Others may
about the relative importance of the vari- suggest additional ways in w-hich particu- 1. Compulsory participation. Most
ous ob.jectives. lar social and economic structures may people participating in social insurance
Since assessments of the relative im- help achieve a given social objective. All programs do so as a result of a legal
portance of competing social objectives such suggestions and elaborations will requirement. In some programs, a small
will vary from country to country and help us to increase our understanding of minority may be allowed to choose
from time to time, social welfare policies these important issues. whether to participate.
appropriate in one time and place need Finally, in order to simplify (some-
not necessarily be appropriate in another. what) an already complicated discussion, 2. Government sponsorship (and
Moreover, the degree to which a particu- my analysis focuses almost exclusiveiq regulation). Governments create and
lar approach to the social welfare system on programs that supply cash benefits; supervise social insurance programs, but
does, in fBct, advance a particular objec- indeed the implicit focus is almost do not necessarily manage them. The
tive will also vary from place to place exclusively on pension programs. Much programs may actually be operated
and from time to time, Put simply, the of the discussion contained here would entirely by private sector institutions
policy that is most effective in achieving be appropriate for other major social (for example, the German health and
a given objective in Argentina may not welfare programs, such as those con- pension systems); by a combination of
achieve that objective in the United cerned with acute health care services. public agencies and private contractors
States, and the people of the United But health programs also introduce (the model used for Medicare. the health
States tnay wish to pursue a particular other issues that go beyond the scope of insurance program for the aged in the
objective with their social welfare system this paper, such as provider reactions to United States); or directly by a public
that is not as important to the people of different institutional arrangements. sector agency (the model used by Anglo-
Argentina. No particular structure is the Saxon countries for operating their public
most appropriate one at all times and in pension programs). Where the private
The Competing Approaches
all societies. sector runs these programs, however,
Philosophical considerations will Most advanced societies rely on some operations are tightly supervised by the
always he important to social welfare combination of six approaches (or close public sector.

4 Social Securit! Bulletin Vol. 57. No. 3

l l Fall 1994
3. Contributory finance. Most- social insurance schemes also subsidize Other characteristics combine to give
sometimes virtually all-of the resources benefits for nonworking members of the social insurance some of its key attri-
needed to run the program are raised families of workers, students, members butes. For example, advocates of the
through explicit contributions collected of the armed forces, homemakers caring social insurance approach argue that it
from the employer or from both the for children, and others whose activities delivers benefits in a way that promotes a
employer and the employee. A workers are deemed to be socially beneficial. sense of individual worth and dignity
contribution is usually a fixed percentage among recipients. They argue that this
of his or her wage or income.3 7. Separate accounting and explicit result flows from the fact that social
long-range financing plan. Social insur- insurance is financed by explicit contri-
4. Eligibility derived from contribu- ance contributions are usually earmarked butions (characteristic 3) and that entitle-
tions. Eligibility for benefits under social to pay the social insurance benefits. ment to benefits derives from the pay-
insurance programs rests, in part, on Governments typically keep separate ment of these contributions (charac-
current or previous contributions by the accounts that permit comparisons of teristic 4). The underlying philosophy of
individual and/or the individuals program receipts and program benefits, the program, then, is that beneficiaries
employer. though they may also present financial have earned the right to receive their
information that integrates the social benefits by paying in their contributions.
5. Benefits prescribed in law. Uni-
insurance programs with the other gov- The linkage between contributions and
form sets of entitling events and sched-
ernment operations. Governments also benefits can also serve as an incentive for
ules of benefits are developed, an-
typically develop an explicit plan show- compliance with social security taxes,
nounced, and applied to all participants.
ing that projected revenues are sufficient although the strength of this incentive
Administrators of the program have little
to finance projected expenditures for will obviously depend on how closely
discretion in determining who should get
several years into the future (or, if rev- benefit amounts are linked to prior
benefits or how much they should get.
enues are not sufficient, explaining how contributions.
6. Benefits not directly related to the government proposes to balance Some advocates of the social insur-
contributions. Social insurance programs projected receipts and scheduled ance approach also argue that it intro-
usually redistribute toward lower-wage benefits). duces fiscal discipline into the political
workers or toward persons engaged in Some of these characteristics are nec- process. Beneficiaries of social welfare
activities deemed to be socially desirable. essarily linked. For example, if a social programs (whether pensioners or health
Perhaps the most dramatic redistribution insurance program is to provide adequate care providers) naturally favor raising the
occurs in health insurance and flat pen- support to lower-income households, it level of benefits paid under the program.
sion benefit programs, in which higher- must redistribute from higher-income Because of the combination of contribu-
wage workers contribute more than participants to lower-income participants tory finance (characteristic 3) and the
lower-wage workers but everyone re- (characteristic 6). But a program that separate accounting of program receipts
ceives the same benefits. In most public redistributes explicitly and significantly and benefits (characteristic 7), however,
pension programs, benefits are scaled to must also be compulsory (characteristic program expansions are likely to require
previous earnings. Even then, the lower- 1) or else higher-income people will an increase in contribution rates. Thus,
wage worker tends to get back propor- choose not to participate. And a program they argue, wage earners-who will have
tionately more than the higher-wage that is compulsory must be sponsored by to pay higher contributions to finance
worker, sometimes much more. Many the government (characteristic 2). program expansions-have an incentive

Characteristics of competing social welfare approaches

- ----
Employee ! Voluntary tax
- --L
Participation compulsory ... .............. .... ....... Yes Yes Yes No N/A N/A
Government sponsors ...... .. ............. ............. ~ Yes No No No Yes Yes
Contributory finance .. ........... ............. ... ...... Yes Yes Yes Yes No No
Eligibility based on contributions ...... ... ...... Yes Yes Yes Yes No No
Benefits specified in law .... .. ........... .. .......... Yes No, but No, but No Yes, but Yes
Benefits related to contributions .. .............. . No Yes Yes Yes No No
Separateaccounting.. .......... . .... . .. Yes Yes Yes Yes No No
Reserve financing required ..,...................... i No No, but Yes No, but No No

NA = not applicable.

Social Security Bulletin Vol. 57, No. 3 Fall 1994

l l 5
to support restraints on the growth in several countries and have been used Means- Tested Programs
social insurance benefits.4 more recently in other countries as a Means-tested programs, often referred
means of providing pensions. Employee to as social assistance, pay benefits to
8. Reserve financing not required.
mandates share many of the attributes of those who first demonstrate limited eco-
Reserve financing is a final attribute
employer mandates: programs are spon- nomic resources. In such programs,
worth noting because it is not neces-
sored and regulated by the government, entitlement has nothing to do with wheth-
sary-and, in fact, is relatively rare-in
eligibility for benefits is linked closely to er claimants have had prior earnings or
social insurance, whereas it is more com-
the payment of contributions, and bene- have ever paid taxes. A major advantage
mon in some of the alternative institu-
fits are financed to a significant degree of means-tested programs is that in con-
tional arrangements. Financial reserves
from contributions. Perhaps two differ- trast to social insurance, or employer and
are frequently required in private sector ences between employer and employee employee mandates, they do not link
pension plans in order to help assure that mandates are worth noting. First, eligibility for benefits to prior economic
pension promises are met. Social insur- employee-mandated pensions must be behavior. As a result, benefits can be
ance can be financed on a pay-as-you-go advance funded; as far as I know, there is tailored to current individual circum-
basis only because it is backed ultimately no other way to organize them. Also, in stances and assistance can be concen-
by the taxing power of the State. principle, a substantial amount of redis- trated on those with the fewest resources,
tribution could be built into an employee who need them the most. Means-tested
Employer Mandates mandate program through the use of programs are financed from government
Another approach to providing social targeted, government subsidies.6 Design- general revenues so that program costs
welfare benefits involves government ing an employer mandate program with a are not separately identified (except by
mandates that all employers (or all large substantial amount of redistribution analysts who pore over budget docu-
employers) provide or finance specific would be more difficult. ments).
social welfare benefits to their employ-
ees. Employer mandates and social Voluntary Arrangements Universal Programs
insurance share many characteristics. (Tax Expenditures)
Some programs provide social welfare
In both cases: (1) the social welfare pro- Governments often encourage benefits to all legal residents. These
gram results from explicit government employers to provide (and/or individuals universal programs share several charac-
sponsorship (though, in this case, not to make) private arrangements which teristics with social insurance: benefits
government operation), (2) eligibility either replace or supplement public sector are prescribed in law and participation is
for benefits is connected to employment, social welfare programs. The encour- compulsory (to the extent that participa-
(3) participation is compulsory, (4) bene- agement usually takes the form of a tax tion is a meaningful concept for these
fits are financed primarily from employer expenditure-an arrangement whereby programs). They differ in other impor-
(and, occasionally, employee) contribu- someones (usually the individuals) tax tant ways. Financing for universal pro-
tions, and (5) benefits are financed liability is lower than it otherwise would grams usually comes from general reve-
according to an explicit plan. Also, be as a result of the undertaking of the nues; eligibility is tied to residence rather
employer mandates invariably involve activity. Government encouragement than previous earnings or contributions;
specification in law of either a minimum of private arrangements is probably and financing for the program is not
level of contribution or a minimum bene- most common in the area of retirement planned for separately from the planning
fit package, although employers are usu- savings, but is also associated with for other types of government expendi-
ally free to offer a better package than the some health care benefits in many tures. Since there is no separate financ-
minimum.5 places. ing arrangement, there is no possibility of
The two approaches differ in at least Although voluntary programs are by advance funding through accumulation of
two important ways. First, programs definition not compulsory, their shape is reserves.
resulting from employer mandates are frequently influenced by government
less likely to redistribute; they focus because programs qualifying for the Combinations and Hybrids
almost exclusively on individual equity at special tax treatment must meet certain Although presented bet e as separate
the expense of social solidarity. Second, minimum conditions. As with the em- and distinct, the differences among these
employer-sponsored pension plans are ployer and employee mandates, these approaches sometimes become blurred in
more frequently (though not universally) programs rarely redistribute explicitly. actual practice. Societies often construct
advance funded. That is, financial Voluntary programs targeted at individ- social welfare systems that rely on a
reserves are accumulated in advance to uals do not have to be connected in any combination of the approaches; for in-
pay claims. way to particular employment patterns or stance, public pensions in Canada are
situations, although they can only be provided through the combination of a
Employee Mandates effective with individuals who have a flat rate, universal program and an
Employee mandates have long been a reasonable income from which to make earnings-related social insurance pro-
part of the health insurance systems of the voluntary contributions. gram. Occasionally, a new approach is

6 Social Security Bulletin Vol. 57, No. 3 Fall 1994

l l
developed by combining features of two l Distributing equitably the costs and turn to the interaction of the two. In
or more of the traditional approaches; for benefits of the system; in particular, particular, the following discussioncom-
instance, medical insurance for the aged assuring that those with more limited paresthe strengthsand weaknessesof the
in the United States is provided through a economic resources are protected different approachesand explores how
program that shares many of the attri- adequately. effective each is likely to be in achieving
butes of universal programs (at least for l Efficient operation of social welfare the different social objectives.
those age 65 and over), but which, tech- institutions so that, to the extent Individual dignity-One objective is
nically, is voluntary and involves the possible, the resources devoted to simply to organize the system in a way
payment of a partial premium. Finally, them go to the improvement of bene- that treats each member of society with
hybrids also arise as different ways ficiary welfare rather than adminis- dignity and respect. As noted earlier,
evolve to administer these programs; for trative overhead. social insurancepromotes individual
instance, at the option of employers, the respect and dignity through the philoso-
My second cluster involves attributes
earnings-related pensions in the United phy that those who make contributions
that can help promote a healthy economic
Kingdom are either operated by the State have earnedthe right to the benefits.
environment. It recognizes that an effec-
in the form of social insurance or by Other employer-provided benefits, as
tive social welfare system can rest only
employers in the form of an employer well asvoluntary and employee-
on the foundation of a healthy economy.
mandate program. And, under certain mandatedapproachesshould be equally
It includes:
circumstances, employees may contract effective in promoting this objective. In
out directly. Encouraging individual thrift and not
contrast, those who receive means-tested
discouraging, unintentionally, indi-
benefits are often stigmatized.
vidual work effort8
Social Objectives Universal programsshould be just as
Fostering responsible government
effective at promoting individual respect
I shall focus on attributes that can be fiscal policies by discouraging the and dignity as are the employment-based
clustered around two broad social objec- tendency to overpromise social wel- programs, as long asthey remain univer-
tives for the purposes of this discussion, fare benefits and assuring that pri- sally available. Some fear, however, that
recognizing that other categorizations vate saving is available to finance universal programs are politically unsta-
would be equally valid. capital formation. ble-that they will be vulnerable to the
The first involves attributes related to Facilitating the smooth operation of
introduction of means-testingas a way of
providing effective social protection to markets, especially labor markets, dealing with somefuture budget crisis.
the population. The social protection particularly by constructing institu- Those who value highly the objective
cluster includes: tions that minimize the social costs of assuringthe dignity of recipients and
of economic change. fear that universal programsmay eventu-
l Treating people with dignity and ally be means-testedusually advocate
respect. Interaction of one of the employment-basedap-
l Assuring the most complete cover- Approaches and Objectives proaches,social insurance,or either em-
age possible for the system. A social Having sketched the alternative insti- ployer or employee mandates. They see
welfare system cannot provide effec- tutional approaches for constructing the explicit contributions associatedwith
tive protection to people that it does social welfare systems and the alternative social insuranceasbuilding a political
not cover. social objectives for such systems, I now bulwark against future means-testing:

Comparative ratings of competing social welfare approaches

I Social 1 -Employer] -~-Goyee Tax; Means-tested 1 Universal
Item insurance 1 mandates] maud~a~penditures! programs ~ programs

Dignity.. ................................................................... A A A A F B+
Coverage ................................................................. B C C F N/A A
Costs and benefits scaled to ability to pay .............. C F F F A C
Administrative costs.. .............................................. B D D D F A
Encourage individual thrift.. ................................... D B A A F D
Fiscal discipline.. ..................................................... A F A F C C
Facilitate labor market adjustment.. ......................... A F A F A A
Budget cost.. ........................................................... D A A A B F

N/A = not applicable.

Social Security Bulletin l Vol. 57, No. 3 * Fall 1994 7

those who have been paying the contribu- revenue bases of the two programs differ. built into the program.O Whether an
tions will resist program changes that Social insurance contributions tend to be entire birth cohort can receive a higher
would deprive them of the benefits that proportional to wage income, except return under private arrangements de-
they feel they have earned. among the highest earners. Furthermore, pends on the relationship between the
Developments in the Canadian public earnings tend to be a larger fraction of rate of growth of productivity and of
pension system raise concerns about the total income for households in the middle population, on the one hand, and the real
stability of universal programs (and sug- of the income distribution and a smaller interest rate on the other. Whatever the
gest that social insurance is somewhat fraction for households at the lowest and relationship may be, the gap between the
more stable), but they fall short of con- highest income levels. As a result, wage- two is not likely to be large and consis-
firming the worst-case scenario just out- related financing is more regressive than tently in one direction or the other for
lined. Canadian public pensions consist personal income taxes; but is not neces- long periods.
of two separate programs: (1) a universal sarily more so than corporate taxes or Means-tested programs assure a
flat pension financed from general reve- sales, excise, and value-added taxes. A greater redistribution because other trans-
nues, supplemented by (2) an eamings- universal program financed by higher fer programs are less effective at target-
related pension paid under a contributory personal income taxes would probably be ing benefits to those who are most in
social insurance program. In 1988, in more progressive than social insurance; need. Paradoxically, their more effective
response to budget difficulties, Canada one financed by increases in value-added targeting does not mean that means-
amended its personal income tax law to taxes may well be less progressive. tested benefits are necessarily more
claw back at least part of the universal In general, social insurance ap- effective in serving low-income benefi-
pension payment from the higher-income proaches will be more redistributive than ciaries. These beneficiaries are less apt
elderly and to tax it away entirely from private sector arrangements, whether to apply for benefits that carry the stigma
those whose incomes are above a certain these arrangements are mandated or associated with the means test than they
higher level. Canada does not claw voluntary. In health insurance, the would be for benefits paid through a
back social insurance benefits9 greater progressivity derives largely from universal or social insurance system.
Coverage.-Social welfare programs the difference between wage-related Administrative cost.-Administrative
cannot be effective if they do not reach contributions and individual premiums. expenses increase the total cost of the
the population in need. Broad coverage In pensions, it tends to derive from the social welfare system without increasing
is achieved easily under universal pro- provisions that afford lower wage work- benefits the system can pay, and can vary
grams for which, by definition, everyone ers proportionately higher benefits under dramatically from one system to another.
is eligible. Broad coverage is more diffi- social insurance programs. In principle, Major administrative cost elements
cult under both social insurance and some greater redistribution can be built include the cost of revenue generation,
employer mandates because eligibility into private sector programs through the money management, benefit eligibility
requires attachment to employment. use of targeted government subsidies. determination, and ongoing benefit
Some people simply do not have suffi- This would appear to be more feasible for administration.
cient attachment to gain eligibility; others employee mandates and voluntary indi- Of the alternatives discussed here,
are employed in informal and casual vidual programs where a subsidy can be universal programs probably have poten-
labor markets, in which many employers based directly on the household income tially the lowest administrative cost.
do not comply with the law. Employee of the intended recipient than it is for Revenues are raised as a part of general
mandates are likely to be even harder to employer-based programs where the tax collection procedures, there are no
enforce than are employer mandates and subsidy cannot be targeted to apply only money management costs, and eligibility
voluntary programs are likely to have an to particular participants. usually depends on meeting a few, rela-
even lower rate of participation. Finally, People with relatively less taste for tively easily verifiable conditions. The
means-tested programs may fail to reach redistribution will be more likely to favor administrative costs of social insurance
a substantial fraction of the population private sector approaches, and those who are also potentially quite modest since
they are intended to serve, in part be- favor private sector approaches may do eligibility tends to be based on informa-
cause not all of the target population so precisely because they prefer less tion that can be collected and maintainer
knows the program is available and in redistribution. At least in the United relatively easily. On the other hand,
part because some of them are discour- States, higher-income workers occasion- means-tested programs can be relatively
aged by the hassle of applying for bene- ally argue that they should not be re- expensive to operate because of the neec
fits or the stigma associated with accept- quired to participate in Social Security to collect and verify extensive financial
ing them. since they could get a higher return on information in order to assure that indi-
Distribution of benefits and costs.- the amount they must contribute to the viduals are (and remain) eligible for
The distribution of benefits and costs program if allowed to invest it privately. benefits.12
under a system of social insurance is They are probably correct. But the lower Generalizations are more difficult
likely to differ from that under a univer- return they receive under Social Security about the relative administrative costs o
sal program only to the extent that the is mainly the result of the redistribution public and private sector programs.

Social Security Bulletin l Vol. 57, No. 3 l Fall 1994

Public sector programs usually enjoy ings. On balance, their results do not costs. As discussed earlier, the possibil-
potentially greater economies of scale in support the fear that such a system will ity of an increase in social insurance con-
their operations and avoid a substantial seriously erode savings and capital for- tribution rates to balance revenues and
amount of the sales expenses of private mation. On the other hand, studies in the expenditures helps to create a political
sector firms. At any given time and United States also suggest that funded constituency for restraining benefits. The
place, however, inefficiencies inherent in pension plans do have a positive effect on linkage between current contribution
many public sector enterprises-such as savings. National savings may increase rates and future benefit level is even
facilities or excess staff resulting from by 30 to 40 percent of any increase in the more obvious under employee madates.16
political pressures-may more than offset aggregate amount of assets being held in In contrast, under other approaches,
the potential advantages enjoyed by the pension and other retirement accounts.5 the cost of social welfare programs is
public sector, especially if the private Taken together, these two results suggest frequently less visible. Cost increases in
sector firms are exposed to effective that, in the absence of offsetting changes programs financed out of general revenue
competition. I3 Within the private sector, in government fiscal operations, shifting generate pressures on politicians to de-
one would expect that employer- from a pay-as-you-go social security vise ways to finance the additions to the
sponsored approaches would involve system to an advance-funded pension total budget. But, they do not translate
fewer administrative expenses than system would have a positive effect on directly into tax increases that voters
would employee-sponsored approaches national savings. will realize are directly linked to devel-
since the former should more frequently Fiscal discipline.-Another objective opments in social welfare programs.
be associated with larger institutions that is to counter the natural tendency for Fiscal discipline can be preserved if
are better able to capture economies of political decision makers to overpromise. appropriate budget procedures can be
scale and that would have lower costs of Granting benefit increases is popular, but adopted and enforced. But, these proce-
sales per individual served. entails the assumption of future liabili- dures operate on total spending, and do
Work and savings incentives.-For ties. If these liabilities become too large, not prevent runaway costs in a social
several decades economists have ex- their costs can eventually have undesir- welfare program from crowding out
plored the effects on individual behavior able economic and social consequences, expenditures on other governmental
of various elements of the social welfare such as: activities.
system. I4 In general, their analyses sug- Similarly, sooner or later, increases in
l An increase in evasion of legislated
gest that work effort would be somewhat social welfare costs imposed on employ-
responsibilities or the growth of the
higher in the absence of the payment of ers will show up as smaller increases in
informal sector, either of which
cash benefits. The magnitudes are not wages. In this way, workers will ulti-
makes the social welfare program
overwhelming, however, and the studies mately pay for the social welfare benefits
less effective at protecting citizens;
do not address such crucial issues as that their employers are required to pro-
whether, on balance, social welfare is l A reduction in international competi- vide. But, the linkage is far less direct
increased by allowing the elderly to work tiveness of domestic businesses, and far less obvious to workers. Thus,
less. These studies do suggest that re- which will eventually undercut living workers cannot be counted on to form an
strictions on the amount that can be standards and reduce social welfare; effective constituency for restraining the
earned while still receiving retirement l Inflationary pressures, as govem- costs of employer mandates.
benefits will further reduce work effort ments seek to support a greater level Politicians are not the only members
among the elderly, at least somewhat. In of expenditures than can be financed of society prone to over promising. The
general, studies have not attempted to through current tax receipts, which same phenomenon can affect private
analyze differences in the impact that will eventually interfere with eco- sector institutions. Left to themselves,
different approaches to constructing the nomic growth; or employers may promise their workers
social welfare system might have. l Reducing benefits for current benefi- that smaller wage increases today will
Studies of the effect of taxation on ciaries-who might have arranged allow for improved pensions in the future
work effort have, in general, also shown their economic affairs differently had and then never actually set aside the
only weak linkages. Higher tax rates they known that promises were not resources necessary to assure payment of
may have as much of an impact on com- going to be kept. (Benefit reductions the pensions. Similarly, competition for
pliance as on actual work effort. In prin- can occur either directly through business may cause investment compa-
ciple, tax payments that are linked to legislated reductions or indirectly nies to undertake risky investments in the
future benefit increases might introduce through inadequate adjustments for hope that they can produce a better return
less of a work disincentive, but the effect, inflation.) than their competitors. In either case, the
if any, appears to be slight. State may eventually find that it is re-
A number of economists have exam- Of the various approaches, social quired to fulfill inadvisable promises
ined the impact that the pay-as- insurance and employee mandates are made by private sector institutions. The
you-go social security system in the unique in mobilizing countervailing irony, then, is that where the State wishes
United States has had on individual sav- political pressures to constrain program to rely on private sector institutions, it

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may be forced to regulate these institu- used as a mechanism for increasing broadened to include questions about the
tions closely to assure that they respect national saving, use of mandated private wise use of administrative resources and
the fiscal discipline of the market place. sector programs would have a somewhat the impact that these systems are having
The status of the national govem- higher probability of actually producing on the wider economy.
ments budget can also influence both the the desired economic result. The growth in the set of options avail-
structure of social welfare institutions Facilitating market adjustments.- able for constructing these systems, along
and the economic effect of social welfare Though economic growth benefits soci- with the broadening of objectives some
policies, For one thing, political choices ety as a whole, frequently, growth dis- think these systems ought to serve, has
may be influenced by a desire to mini- rupts the lives of particular people and led to debates that are often vocal but not
mize the costs that appear in the budget. institutions. Less productive firms and always productive. The premise of this
A major disadvantage of universal pro- industries must be allowed to shrink to paper is that such debates will be much
grams is that they involve substantial make room for more productive firms more productive if their participants
budget outlays. Measured by budget and industries. Such changes cause jobs agree that there is no one correct way to
outlays, social insurance programs are to move from one firm to another and, organize a social welfare system. The
almost as expensive as universal pro- perhaps, from one geographic area to various alternative approaches have dif-
grams; presumably, they will be equally another. Minimizing the impact of such ferent strengths and weaknesses. Most
expensive if coverage were as extensive. economic shifts on the social welfare of options are well suited to achieving one
One potential advantage that social insur- the population is worthwhile in itself, and or more particular social goals, but are
ance has, however, is that by construc- it will increase the political acceptability not particularly well suited to achieving
tion, it brings its own revenue stream of the economic growth and change pro- another.
with it. This doesnt change the total cess. We should not be surprised if social
amount that government must raise or welfare systems continue to become both
The approaches to constructing the
will spend, but it may make raising reve- more diverse and more complex. Since
social welfare system most vulnerable to
nues easier. An advantage of means- societies seek to achieve a variety of
disruption as a result of economic growth
tested programs is that they require far social objectives simultaneously, we
and change are those tied closely to par-
less of public resources. should not be surprised to find them
ticular employers-either the employer
The great attraction of employer and turning increasingly to mixtures that
mandate or the voluntary, employer-
employee mandates is that their cost does utilize some combination of the various
based systems. The other approaches
not appear directly in the government approaches outlined here, rather than
break the link between social welfare
budget (though the cost of employer relying primarily on one approach. And,
benefits and any one particular employer,
mandates may be reflected indirectly in since different societies attach different
thereby helping to insulate the system
lower business tax collections). Even importance to different goals, at any
from the disruption of change.
when they must be supplemented by gap- given time we should expect to find dif-
filler programs, mandated programs are ferent structural arrangements favored at
likely to appear cheaper. different places. And, finally, since
Concluding Comments
Another important impact of govem- social goals change over time, we can
ment budget policy involves the linkage, Public social welfare systems have expect that the particular mixture of
if any, between retirement savings and become more complex and varied over approaches employed in any one place
national savings. History gives many the years. The earliest systems focused will also evolve and change over time.
examples of social insurance programs in on what we now think of as means-tested In this paper I have suggested a frame-
which large surplus balances were di- assistance programs. Govemment- work for discussing the various options.
verted to other government uses, either sponsored social insurance emerged I have also suggested some of the advan-
directly through politically motivated about a century ago. Although voluntary tages and disadvantages of using each of
investments or indirectly through govem- employer-provided social welfare ben- the approaches to achieve each of the
ment borrowing of the social insurance efits predate social insurance, the idea of possible social objectives. In some cases,
surplus to cover deficits elsewhere in the relying systematically on employer man- my comments have been supported by
budget. In either event, government dates is a later development. And em- empirical evidence; in other cases, they
actions serve to offset the increased sav- ployee mandates are even more recent. have been more speculative. In all cases,
ings and capital formation that would For many years, social welfare debates they are more apt to reflect experience in
otherwise have been supported by retire- were dominated by the set of concerns Western Europe and North America than
ment program surpluses. It may be that associated with providing effective pro- elsewhere. 1 trust that others will be able
governments are somewhat more likely tection, particularly coverage and cost to modify or elaborate on my analysis
to spend reserves in public sector pro- distribution. More recently, as the social based on their own studies and their own
grams than they are those in private sec- welfare systems have grown to account countrys experiences, and that in doing
tor programs. If this is the case, and if for substantial portions of government so, they will help us all to understand
retirement program surpluses are to be budgets, social welfare debates have better these important issues.

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l l
Notes nomic Literature, Vol. 3, No. 2, June 1992, Lessons from the United States. (GAOiHRD-
pp. 741-803. Barr develops the following 91-90, June 1991) Washington, DC: U.S.
I If we were speaking about social welfare objectives of the welfare state: macro eff- Government Printing Office, 199 I, p. 3 1,
policy more broadly, we would also have to ciency, micro efficiency, economic incen- I4 For example, Henry J. .4aron, Economic
consider a seventh approach, direct provision tives, poverty relief, protection of accustomed
of social welfare services by the government. Effects of Social Security, Washington, DC:
living standards, income smoothing, vertical The Brookings Institution, 1982; and Michael
This is a common strategy for delivering equity, horizontal equity, dignity, social V. Leonesio, Social Security and Older
health services, but not relevant to a discus- solidarity, intelligibility, and absence of Workers, Social Security Bulletin, Vol. 56,
sion of pensions. abuse. No. 2 (Summer) 1993, pp. 47-57.
2 This list is adapted from the definition of Since the major social purpose of retire- Presumably, the rest of the increase in
social insurance developed by the Committee ment programs is to allow people to retire, pension assets is either offset by larger liabili-
on Social Insurance Terminology of the these programs will necessarily produce some ties elsewhere in the economy or replaces
Commission on Insurance Terminology of the reduction in work effort relative to the situa- asset accumulation @at would have occurred
American Risk and Insurance Association. tion that would exist in their absence; if they in the absence of private pensions. For exam-
This group also specifies that social insurance did not produce any reduction in work effort, ple, Alicia H. Munnell, The Economics of
coverage must extend beyond government they would have failed. Other things equal, Private Pensions, Washington, DC: The
employees. See Robert J. Myers, Social however, one would want them to not dis- Brookings Institution, 1982.
Security, 3d ed., Bryn Mawr, PA: McCahan courage work effort prior to retirement or to
Foundation, 1985, pp. 995-996. prevent those who decide to retire from sup- One can see the importance of this effect
plementing their retirement incomes, should in recent reforms in German health care
i In some countries, such as the United
financing. Germany uses contributory social
States, social insurance contributions are they desire to do so.
insurance to help finance personal health care
indistinguishable from taxes since they are 9 Nor does the claw back policy apply to services, and in recent years, has enacted a
specified in law and collected by the taxing Canadian health insurance, which also fol- series of reforms that have reduced physician
authority. The connection between taxes and lows the model of a universal program. incomes and pharmaceutical company reve-
contributions is not quite so close in some
See U.S. General Accounting Office, nues. These reforms could be achieved even
other countries. For example, each German
Social Security: Analysis of a Proposal though important interest groups were being
sickness fund (technically, a private sector
to Privatize Trust Fund Reserves, forced to absorb economic losses because
institution) establishes its own contribution
Washington, DC: U.S. Government Printing they were advertised as necessary to keep
rate and collects all social insurance contribu-
Office, 1991. worker contribution rates from rising. In
tions from its members. Also, voluntary
See Henry J. Aaron, The Social Insur- other words, the political influence of those
supplemental contributions are allowed under
ance Paradox, Canadian Journal of Eco- paying the contributions offset the political
several countries pension programs.
influence of those benefiting from the pro-
nomics and Political Science, Vol. 32, No. 3,
4 Social insurance developments around gram. The same effect was illustrated in the
August 1966, pp. 371-374.
the world suggest that this is an argument United States in 1983, when the Congress
more applicable in some political and social I2 Experience in the United States illus- adopted limited taxation of Social Security
systems than in others. Whereas these trates the relative magnitudes. The annual benefits and a higher retirement age as part of
arrangements appear to have helped assure administrative costs for the U.S. Old-Age and a package to restore fiscal balance to that
fiscal discipline in Germany or the United Survivors social insurance program average program. Neither proposal would have been
States, different institutional arrangements about 0.8 percent of annual benefit payments. adopted had not the alternative been another
may be required in other countries to prevent By comparison, the administrative costs of the increase in the Social Security contribution
over promising. parallel means-tested program for the aged rate.
and disabled operated by the same agency
( Social insurance also tends to offer a
averages about 7.6 percent of benefit pay-
uniform package of benefits, with employers
having the option to provide separate, supple-
mental programs. I3 North American health insurance illus-
trates the potential size of the gap between
h As a practical matter, this may be more
private and public sector institutions (and
important for health insurance than pensions.
among public sector institutions employing
A good case can be made for subsidizing
different approaches). The Canadian national
health insurance costs for those with low
health insurance system follows the universal
current period income. It is less clear whether
model and experiences administrative costs of
one would want to subsidize pension contri-
just under 1 percent of total outlays. The U.S.
butions for those with low current period
national health insurance for the aged follows
income. Presumably in pension programs
the social insurance model and employs more
redistribution is more appropriately based on
complicated provider payment mechanisms;
lifetime income rather than current period
its administrative costs run about 2 percent of
outlays. U.S. private health insurance compa-
For example, see Nicolas Barr, Eco- nies administrative costs average 10 to 12
nomic Theory and the Welfare State: A Sur- percent of outlays. See U.S. General Ac-
vey and Interpretation, Journal ofEco- counting Office, Canadian Health Insurance..

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