The Real Beneficiaries of the Welfare State

The great social-democratic dream of a comprehensive welfare state—promoted by the centre-Left and centre-Right alike—is turning into a worldwide disaster. Suspicions are spreading that socialised welfare has reached a tipping point, with few genuine remedies in sight. Budget deficits and mounting public debts show that many welfare states are going broke; in Western Europe and the USA, they imperil monetary stability. Public-sector unions and powerful lobbies of recipients of tax-funded largesse are demonstrating against cuts to “their” programs. Those dependent on government pensions despair over their shrinking purchase power. High unemployment seems entrenched. The uneasy feeling spreads that the West has lost its system of robust institutions and is therefore outdone by the competition in emerging nations, where material security is everyone’s individual responsibility or that of the family. This creates indignation, unrest and a foreboding that the future might be less secure.

The welfare state is based on the mistaken notion that inequality is injustice. To some extent, unequal wealth is the result of age. People at the threshold of retirement have more assets than young protesters who have never had a job. Differences in incomes are also necessary to create material incentives to perform services for others. Egalitarianism only promotes laziness and risk aversion, ensuring that everyone remains equally poor. The question has to be asked whether we prefer a society with fairly equal incomes and wealth, which realises slow economic growth and sluggish job creation, or one where there are rich and poor, but average incomes keep rising and job opportunities are plentiful. The bien pensants should focus on the life opportunities and the income growth of the poorest 10 per cent of the population, rather than pandering to envy.

When one looks a little more closely at income and wealth differences, one soon discovers that, in dynamic economies, there is a lot of mobility up and down the pyramid. Moreover, popular feelings about the rich differ greatly whether one considers people who acquired their wealth by innovation and enterprise, and those who owe their socio-economic position to political patronage. “Occupy Wall Street” protesters are not concerned with Steve Jobs, but with the directors of government-licensed, tax-supported banks and the owners of protected industries. The inequalities that the demonstrators resent derive from government interventions and the political protection of certain people against having to legitimate their wealth time and again by competing in free markets. 

The consequences of proliferating redistribution 

Promoters of the welfare state should by now realise that redistribution policies have not worked. Children still live in poverty. There are still rich and poor, because the welfare state in Australia and other Western democracies is engaged in churning, giving to and taking from the same people. A new example is the carbon dioxide tax, burdening households and industries with artificially high electricity bills, but compensating most with subsidies and vouchers that absolve selected producers from bearing the costs. The visible hand often favours well-organised, noisy groups, while the deserving poor lose out. Citizens perceive this, often in imprecise ways, and angrily conclude that the whole political and economic game has become unjust. Acts of civic disobedience multiply.

Much has been written about the consequences of cradle-to-grave welfare, how it ingrains a stifling helplessness and a passive claims mentality. The politicisation of daily life, which goes with it, diverts individual effort and life planning from learning and being productive into scheming, complaining and lobbying. It destroys self-responsibility and dignity, promotes group egotism, discourages citizen engagement and smothers traditional charity.

A more fundamental, often overlooked, consequence of the welfare state is that it has perverted the very character of government. Modern economic growth took off 200 to 300 years ago under protective government—elected or unelected rulers protected citizens from external threats (defence) and secured their private property against thieves, fraudsters and violent threats (rule of law). Taxation was limited, subjected to the consent of the people’s elected representatives and made equitable by formal rules. But the essential primary government function of protecting life, liberty and property has been white-anted by more and more confiscation to bankroll socialised welfare. To the extent that the state takes property rights away to give to others, it contravenes its protective function. Incomes and wealth are not only redistributed in the clumsy way of raising taxes to pay out subsidies, but—given growing taxpayer resistance—increasingly by regulations, which take individual property rights away, but favour preferred clients of the state.

In the Australian context, the explosive and intrusive growth of legislation and regulation handed down by federal, state and council busybodies is testimony to the progress of such dirigiste redistribution. Thus, young families are not permitted to buy a cheap second-hand car in Japan and bring it here, and owners of Australian businesses can often not freely sell to the highest bidder, if that bidder happens to be a foreigner. Landowners still have the right to pay property taxes, but often find that they are no longer allowed to cut down the trees they own or collect the water that falls on their land. Their property rights to develop what is rightfully theirs are diminished by thousands of prohibitive rules, which partially disown them. Owners of skills are hindered in marketing their skill freely because some distant authority defines what is supposed to be permissible “fair work”.

Most of these rules have nothing to do with protecting others from undue side effects of rightful property uses. Nowadays, property owners often have to prove their innocence (to obtain some licence), overturning the time-honoured principle that everyone is innocent till proven guilty under the laws of the land. The density of redistributive rules just hampers innovation and entrepreneurial creativity. The cumulative interventionism has infantilised younger generations and taught them to shirk responsibility. Many of these interventions are inequitable and unjust.

Electoral democracies of the West European and Australian type have been perverted by the regular election-year auctions of handouts to politically decisive groups. Many spending promises cannot be met by taxes, yet are nevertheless made. This has driven up public expenditures and taxes to levels that our forebears could never have imagined. Government agents now take as much as half of all spending decisions, leaving private citizens less and less economic freedom to choose. In Europe, this has led to spreading cynicism, taxpayer resistance, recourse to black markets and fraud. And in the United States it is a prime driver of the anti-statist “Tea Party” movement. Where citizens were once proud to let others know what they contributed to the shared task of government by way of taxes, they now brag about tax avoidance and otherwise wasteful schemes to avoid social-security contributions.

Cynicism about government is widespread. In those many democracies in which citizens enjoy the freedom to vote (or not to), falling participation rates send out potent signals that something is amiss. Students of history are aware of what can happen to democracy when parliaments become the arena for the ruthless group egotism of organised lobbies and unjust redistribution ploys and when administrators betray the citizens. Many then turn to radical, totalitarian leaders—of the communist, nationalist or environmentalist varieties—while the bulk of citizens stand passively by. The Weimar Republic in Germany, as well as Italy and Spain in the 1920s and 1930s, offer frightening examples of what can happen when the bulk of citizens no longer have a stake in a stable, robust democracy. Don’t say it can never happen in Anglo-Saxon democracies. 

The principal–agent problem in politics

While these insights are familiar to most astute observers, one dimension of the welfare state has frequently escaped critical comment and public attention: Who are the real beneficiaries and the real bosses of the welfare state? Who is really in control of education, disability support, health and old-age care? Who really decides to restrict our freedom to use the many property rights that rightful ownership used to confer? And are the over-regulated, over-taxed citizens the only victims? In the literature, these questions are discussed under the heading of “principal–agent problems”.

The term was made popular in the 1930s by Marxist critics of capitalism, who pointed to a systemic flaw in joint-stock companies. The shareowners—the principals—were normally poorly informed about the complex details of operations, whereas their agents—the company managers—were close to the action, enjoying a knowledge monopoly. Nor did the principals—at least the smaller shareowners—have as strong an incentive to seek material advantage as the managers do. The result of this asymmetry in knowledge and motivation was that the agent-managers shirked entrepreneurial risk-taking in favour of the comfortable life, voted themselves high salaries and enjoyed on-the-job consumption that the owners did not know about. The real bosses, the critics said, were the managing agents; the share-owning principals were losing control of their capital. Agent opportunism was therefore becoming the Achilles heel of capitalism. We have since found out that legal institutions and competitive markets for shares and managers have assisted in containing this problem. Capitalism and the joint-stock company have kept flourishing.

The principal–agent problem is real and acute in the complex present-day business of government. The citizen is simply not able to understand what is going on in, say, hospital management, pharmaceutical provision, education funding or the protection of the country from terrorists. Besides, it is rational for citizens to remain ignorant because individuals have no hope of influencing government business. The assumption is that periodically elected representatives do the citizens’ bidding and ensure that effective use is made of scarce resources. This assumption is increasingly unrealistic.

The tenured managers of welfare and other public activities are the insiders, who can and—more often than not—will bamboozle inquisitive parliamentarians with complicated technical and organisational information. They frequently behave like the bosses they are and treat the citizens and their representatives with barely disguised contempt. The bureaucrat-managers are able to vote themselves high salaries and superannuation schemes. They organise high on-the-job consumption: seminars in pleasant places, staff meetings, office parties, access to credit cards, implementation of convoluted administrative processes that protect everyone from risk and responsibility, commissioning expert reports that help them shirk risks, buying computer models based on assumed knowledge that in reality no one can ever have, and so on.

Sometimes, bureaucratic infighting can also be interpreted as on-the-job consumption. If the work routines are boring, inter-office rivalries not only offer an interesting diversion, but also appeal to tribal instincts and strengthen team spirit. That energies and time are diverted from the supposed primary purpose of the organisation rarely matters, as there are no clear-cut performance criteria and few penalties. Although there are many hard-working, honest bureaucrats, the prevailing workplace culture in mature welfare states has frequently become corruptive, lax and self-indulgent.

Whereas the harsh profit-loss signal in competitive private industries forces managers to oppose excessive salary demands and workers fear for their job security, public-sector managers find it too troublesome to resist promotions and salary increases, and workers normally enjoy job security. In private business, risk-taking is encouraged by commensurate profit expectations. In the public welfare sector, there are no profit rewards, so entrepreneurial risks are shirked. The incentives that public-sector managers face are asymmetric: if a risky project works out, there is normally no reward; if a risky decision goes wrong, they will be reprimanded or demoted. Instead of solving problems, managers therefore shift or transform them into other problems. Public-sector managers often also over-staff operations, which gives them a chance to rise in the hierarchy and be paid for supervising more employees. The more legislators set up frameworks that enable detailed administrative decisions, the bigger the chance for all sorts of agent opportunism.

The agents of government business are no more or no less self-seeking than the rest of us. Becoming a bureaucrat does not turn an ambitious knave into a knight in shining armour, whatever the rhetoric about civil “service” might imply. There are many well-meaning people in the ranks of the bureaucracy, but the system of administrative incentives and rewards promotes power broking and careerism. Different from the managers of capitalist firms, the bosses of administrative empires enjoy secure tenure and rarely face the discipline of competition. There may be bench-marking, but who enforces failures to perform? The public health service, for example, is a monopoly, whereas the managers of mining or building companies have to show tangible results, so opportunistic management and risk avoidance soon become evident. Whereas markets work by direct give and take and with the clear signals of black and red ink, give and take in the public sector is collective and indirect, so that there is always the incentive to shirk on the giving and make excessive claims when taking. The temptations for graft and kickbacks are great, so traditional standards of probity frequently go out the window. In complex administrative systems, it is hard to prevent a gradual deterioration in the standards of transparency and honesty.

Genuine cost controls are few. To return to the example of public-sector health services, the costs keep rising, the patient queues become longer and complaints are cold-shouldered. Rapid technical innovation normally reduces costs (think of computers, electronic entertainment or air travel), yet massive research and innovation in medicine and pharmaceutical production have not had that same beneficial consequence in the government health sector. Instead, bureaucracies in all Western welfare states have grown fast and procedures have become more cumbersome and costly. Changing matters in tax-funded health or education monopolies, military bureaucracies or national parks services is a huge task for young political entrepreneurs, but one that will be rewarded with voter allegiance. 

The view that the individual pursuit of happiness is egotistic and that salvation is best left to well-meaning civil servants and copious government finance is systematically propagated in government schools, government-owned media and through political advertising and media manipulation. Bureaucratic elites often try to entrench and widen their influence by fostering lobby organisations that demand more socialised welfare and more regulation in particular areas. The term “non-government organisation” that is often applied to these single-issue groups is a misnomer. Bureaucrats cultivate them by information, government grants and preferential access. The original notion that civil society expresses the autonomous needs and demands of the citizens in a dialogue with political elites is frequently subverted. “Civil society organisations” are often captured by the bureaucrat bosses and made to do their bidding because they are on their payroll. Another bureaucratic technique of guarding their patch is to create citizen-advisory bodies, but to select compliant persons as community representatives.

In an earlier era, a critical, independent press used to comment on the pursuits and shortcomings of bureaucracies, but now the number of public-relations staffers (spin doctors) far exceeds the number of genuine journalists, who are all too often reduced to editing media releases. If they do not co-operate, they soon discover how hard their work becomes. Public discourse is therefore biased in favour of bigger and bigger government. When did we last listen to AM or PM on ABC Radio without hearing a plea for more government spending or an interventionist manipulation of markets?

Modern bureaucracies tend to defend their positions with an avidity and guile reminiscent of the power plays of feudal lords. In European history, rivalry between governments for mobile expert craftsmen, investors and merchants and the gradual evolution of democratic controls broke the power of the parasitic feudal lords and strengthened the freedom of the individual—a key factor in the emergence of modernity, better living standards, more security and the possibility for all to pursue their chosen brand of happiness. With the phenomenal growth of the redistributive state, these achievements are now again imperilled.

Public-sector unions fortify the welfare bureaucrats’ power positions. In most mature economies, Australia included, union membership in private enterprise has been dwindling. The union stronghold is now the public sector, including the health and education unions. They command resources that can buy them political influence and patronage, and they are able to stifle reforms. A vice-president of the US arm of News Corporation recently decried the way public sector unions in the USA “are thwarting economic growth, strangling the middle class, and generally hijacking the democratic process to serve their own ends rather than the public”. In Australia, one hears very few such outspoken analyses of how the public-sector union tail wags the national dog. Yet, in reality, officials that sit across the table from public-sector union representatives when salaries and workplace conditions are negotiated are often union members, too. Many have a keen motive to avoid confrontations. Why should they stand up for the taxpayers’ interest, when yielding to union demands makes their life so much easier? The taxpayers will have to pay anyway. The result is that welfare-sector workers often enjoy higher pay or cushier workplace conditions than their counterparts in comparable private organisations—just compare the extra-curricular work hours of teachers in private and public schools. In the process, the usual pattern of budgeting is turned on its head: whereas private households tailor their spending to their budgets, public-sector bosses fix spending and then demand budget finance to meet possible shortfalls.

One consequence of the rise of the welfare bureaucracy is that the frontline staff, who deliver education, aged care, disability or health services, have also become victims of the new class of bosses. Regulations frequently deprive them of exercising professional judgment; paperwork entraps them; needless formalities and procedures increase their workloads and distract them from the real work in their chosen profession. They become demotivated and demoralised—“We only work here!” Sullen serfdom then spreads; loyal, intelligent engagement is lost and productivity wilts. These developments are doubly regrettable, because so many services need to be tailor-made and delivered with personal empathy and engagement.

Elected politicians form another class of victims of the rise of the bureaucrat principal-boss. The still widespread assumption that your elected representative on council, in state or federal parliament can improve matters is of course still carefully cultivated by politicians, but it is often no more than an illusion. How many political parties in Western democracies have been elected on the basis of ambitious reform programs, only to falter because the real bosses of government business soon capture the parliamentarians? The problem is aggravated if former bureaucrats enter politics and, instead of critically scrutinising administrative actions, act on the belief that administrative action is the only way to solve welfare problems. All too often, the people’s elected representative realises that the union representatives, whose demands he or she should scrutinise, will at the next election provide the campaign funds and the volunteers. As a result, the roles of agents and principals are turned upside down. Moreover, men and women of the people, when elected, are often not up to arguing with top bureaucrats, who tend to be ambitious, intelligent and know that they are there permanently, whereas inquisitive ministers or MPs come and go. Yes, Minister!

Only when the electorate and the politicians fully acknowledge the acute principal–agent problem and we shed all naive illusions about public welfare delivery, can we hope for improvement. In Australia, where belief in do-gooding government is deeply entrenched and where the more scandalous opportunism of arrogant bureaucrat elites, which one can witness in overseas welfare states, has still been kept somewhat at bay, we are far indeed from any such sea change in thinking about governance. 

Restoring control to the principals

Because of the many intractable knowledge problems, there is no panacea for the pervasive principal–agent problem in government and socialised welfare. The best general prescription for restoring genuine democracy and a robust, free economy is to privatise wherever possible, to foster competition and to devolve activities to lower levels of government (subsidiarity). There is much international evidence that this not only saves the welfare state from itself, but also reignites a can-do attitude among citizens. The resurgent self-confidence of Australians after the reforms between 1980 and 2000 offer some pointers.

Another example worth studying is Sweden, once the archetypical welfare state. In the 1980s, public debts amounted to 76 per cent of the national product, as the government was funding ever more elaborate welfare programs. By 2010, government debt had been pegged back to 36 per cent of GDP, welfare benefits had been pruned and health and education thoroughly reorganised. The previously ailing school system was replaced by a system of school vouchers that enable parents to shop around for the best-performing schools. Parents appreciate being again in control, with schools having to compete for clientele. Ailing economic growth picked up, from a measly annual average between 1975 and 1998 of 1.2 per cent in real per-capita incomes, to real per-capita growth in 2010 and 2011 averaging 4.4 per cent. These reforms, which were supported by both main political parties and were carried through without major turmoil, had become necessary because welfarism and the substantial inflow of welfare-seeking migrants had destroyed the old Protestant ethic and because many citizens saw the dangers to freedom of an overbearing, intrusive bureaucracy.

The understanding that the power grab of the bureaucratic agents has disempowered the people and their elected representatives and that this endangers economic growth, financial stability, job creation and democracy is the essential first step to escaping the slide into serfdom. In Australia, we are still very far from such an understanding. In rethinking big government, one has to realise that there is a wide spectrum of possible institutional arrangements to give people access to goods and services that fall between the extremes of central mega monopolies and small, private for-profit competitors. Economics Nobel Prize winner Elinor Ostrom has demonstrated the creative and effective way in which clubs and other community organisations can create value in assisting economically weak groups. We now witness a revival of the co-operative community movement, because big bureaucracies have failed and because co-operatives that are close to local communities can draw on much better information. A plethora of administrative arrangements should therefore be implemented to re-empower the citizens and to undo the centrally run, top-down model of tax-funded welfare provision.

Much encouraging evidence is now available around the world on how this can be done. One example is the great success of private “shantytown schools” in poor countries. Typically in many Third World countries, such as Indonesia, families set up some members as teachers in government schools by buying them their jobs. The teachers, who then “own” a secure job, recoup the investment by extracting bribes for good marks and taking up second jobs. Absenteeism of teachers is normal; educational attainment is atrocious. Such blatant practices were abandoned in the West when military commissions were no longer sold, but nepotism and political patronage still prevail in surprising places.

Against this background, in many poor countries small fee-paying schools have been a great success. Poor parents withdraw their children from government-run schools, even though they often find it hard to pay the fees (although they are low). Paying the teachers and avoiding education bureaucracies make this worthwhile, as the level of student achievement in these shantytown schools shows. I was dining with Kenyan friends in a Nairobi restaurant on the night when the results of competitive tertiary scholarships were announced on television. Everyone in the restaurant stopped eating and applauded the high share of success by the graduates of shantytown schools, even though none of the affluent diners’ children would have attended such a school.

One way by which the citizen-principals and communities can again take control of education services from bureaucracies and teacher unions is the concept of charter schools. Local clubs, business groups or entrepreneurs hire a school principal and a body of teachers and set up a school that teaches programs attractive to the local community. The organisers of the schools conclude a charter with the education department that secures them a level of public funding in exchange for their promise to adhere to a core syllabus and the fundamental program that the organisers are promising in their charter. Quality standards are checked periodically by an inspectorate.

The charter school concept can be easily combined with the device of education vouchers. Because egalitarian starting opportunities are deemed desirable, parents of school-age children may be given tax-funded vouchers. Schools then receive no direct funding, but have to compete for these vouchers by offering the quality and content that the customers want. Instead of a politicised national curriculum, a rich variety of educational offerings are developed and teams of teachers become enterprising innovators. Schools that fail to compete or do not offer discipline go out of business. The concept of education vouchers has been around for a long time. It has now been tested successfully in many places. In Sweden, for example, parents have been receiving vouchers since the 1990s, which they can use to pay the school of their choice for their children. As of 2010, more than 15 per cent of elementary and more than half of all high-school pupils attended non-government charter schools, which are exposing traditional public schools to quality competition. Standardised tests of academic attainment in Sweden have greatly improved. 

A similar approach can be taken to solving some of the problems that citizens in all welfare states have with the bureaucracies that run public hospitals and other health care services. In Spain and the United Kingdom, local groups have had considerable success with founding and running local hospitals as “trust hospitals” (or “charter hospitals”). Instead of decisions being made by remote, anonymous, self-seeking bureaucrats, day-to-day management and overall strategy are in the hands of boards made up of engaged members of the local community, often men and women who donate their time and other resources. Doctors and nurses working in trust hospitals interact directly with the professional hospital managers and local boards. These trust hospitals are funded by taxes (and private donations) in exchange for offering public access and adhering to agreed standards of hygiene and clinical care. Since the board and the manager are close to the local community, knowledge problems are greatly reduced. As responsible hospital managers work on-site, tensions and conflicts with doctors and nurses are normally sorted out there—a huge improvement on the notorious ill-will between frontline doctors and nurses and distant bureaucrat bosses that is observable in so many public hospital systems. The directors and managers of local charter hospitals have incentives to shop around for the best offers of food, laundry, repair services and the like, whereas distant health bureaucrats all too often take politically- or union-motivated decisions, or even corruption-tainted ones.

The concept of charter hospitals can be combined at least partially with the concept of vouchers and payment for services rendered. Patients, who for example need an operation, can obtain a voucher to cover the costs of the operation, once a doctor has certified that such surgery is indeed required. They may then shop around. Information about quality of service, waiting times and other relevant dimensions is demanded and provided. As always competition—here between different voucher-seeking hospitals—generates valuable information. And if patients do not have the expertise to assess such information, advisers will soon appear to meet that demand. Of course, many hospital admissions arrive as emergencies, where prior doctor assessment and shopping around with vouchers are not possible. In these cases, trust hospitals can be funded according to the volume and types of services they provide.

While the concept of community-based trust hospitals may appear novel, it would be no more than a reinvention of the past in many parts of Australia. In the nineteenth and early twentieth centuries, most hospitals were founded and run by their local communities. One can find inspiring examples of small, community-run, but government-funded hospitals in rural Victoria. We are not talking here about exclusive private hospitals, but hospitals that offered access to all. Doctors and nurses were highly regarded. Matters changed in one state after the other, however, when local hospital boards were replaced by “expert” bureaucracies and the entire health system was centrally planned. Since then costs have snowballed, and wrangles over finance and complaints of poor service have turned the post of health minister into a political poison pill.

The abuses and failures of public hospital systems are regularly documented in costly government inquiries, reforms are announced—and the ailments and cost overruns of the hospital system continue. Australian state hospital systems bear an uncanny resemblance to the endless treadmill of fruitless reform throughout the history of the Soviet economy.

The Soviet command economy showed what happens when empowered bureaucrats become the true bosses and turn the populace into poorly treated, disheartened clients. It was an extreme example of the pain that undiagnosed principal–agent and knowledge problems can cause. Indeed, these were the ultimate causes of the downfall of the Soviet system. Western welfare states are drifting in the same direction. Reform after reform is studied and announced, but the cost burdens, poor quality standards and growing citizen cynicism persist.

If state ownership and central planning of welfare services are not abandoned, Western democracies seem condemned to facing similar traumas. The freedom and prosperity of future generations, indeed the continued blossoming of Western civilisation, depend on whether we manage to push back the government of the people by the bureaucrats, for the bureaucrats.