Welfare is Mean-Spirited and Bad Economics

In his latest New York Times blog post, MIT professor and former chief IMF economist Simon Johnson fallaciously argues that those who oppose welfare are mean-spirited and bad at economics. After reading this post, you’ll see it is actually Johnson who is the bad economist.

The main problem with unemployment benefits, or government handouts, is that they de-capitalize the productive members of society and capitalize unproductive members. The productive members I have in mind here are the entrepreneurs. Those who are predict what goods consumers will demand in the future and produce them in the present.

When the government imposes taxes, it takes money away from people who would have otherwise saved and invested, or spent that money. When taxes are imposed, the amount of money available for individuals to save and invest decreases. Saving and investing play a vital role in the economy. They allow entrepreneurs to borrow the money and invest in the production of goods for future consumption. Decreasing the amount of money available to entrepreneurs directly decreases the productive capacity of the economy.

In this situation, the most creative and productive people in society are hindered from continuing to make valuable contributions to society. The result is the prevention of goods from ever being produced and jobs from being created. So instead of opening up new jobs for the unemployed and underemployed, the government policy of welfare just transfers the money directly from the producer to the poor. When you de-capitalize the producers you magnify this effect and depress entrepreneurial activity. The most creative and best preference satisfying people are taken from, which sounds pretty “mean-spirited” to me. The goods we buy – those that make our lives easier, more fulfilling, and more joyful – are brought to market by the organization and foresight of entrepreneurs. Everyone is a consumer and seeks the alleviation of our discomforts through purchasing goods. Because of this, suppressing entrepreneurial activity is harmful to the whole of society – not just the “wealthy capitalists.”

The incentives present in the market economy are also messed up by the welfare system. People are given a monetary incentive to not produce anything. When you give people an incentive not to produce, they produce less. This is really a very simple principle, one that guides nearly all production. People do what they are paid to do.

There are also social effects beyond this that exist from income redistribution through taxation. The first of these is that the forced redistribution will disrupt the natural “harmony of interests” produced by the voluntary interactions of a free market. What this refers to is that by interacting in a peaceful way there is a mutual benefit that accrues. This harmony is present even when people cooperate on the market begrudgingly. For example, many people picket their management or hate Wal-Mart but continue shopping there anyways. As long as neither party physically aggresses upon the other’s property, there will be a harmony of interests working towards both parties mutual advancement.

There are many more negative effects of the government unemployment insurance system. Some people on the government dole may stop looking for work but continue to get payments. The welfare also adversely affects people’s performance when they have a job because they know that if they get fired they have a guaranteed source of income.  Also, instead of the unemployed being forced to accept the most urgent need for their labor on the market, they can prolong their search for work. The result is labor being misallocated in the short run and leads to a squandering of capital.  Capital is squandered because if more people were hired it could be utilized at a more efficient level.

At this point you may be thinking to yourself, “Yeah, alright, so welfare isn’t a perfect solution to the problem of unemployment, but surely it’s the best cure we have, so let’s keep it rolling.” Well, fortunately there is an alternative, one vastly superior to the government run welfare system. I am talking about private charity.

There are specific reasons the negative effects of government welfare don’t occur with private charity. The main reason for this difference in private and public methods of helping the poor is that private charities always have strings attached. They have stipulations on the funds they give out. One such stipulation is that if you are going to get the relief you must be actively trying to find a job. In addition the private charity has an incentive to actually make sure the person they are helping is trying to find a job. If it is found out that they are squandering donor’s money, they will cease getting donations. Some charities may actually train unemployed people for a job.

In addition, the sense of dependency is reduced when they make it clear that the aid is temporary. Those funding the charity can withdraw their funds at any time and cut off the stream. Those paying into the government’s welfare scheme have no choice and cannot revoke their payments if the government is found wasteful and inefficient. Thus, private initiatives in the private sector eliminate problems that arise in the bureaucratic provision of these services. When people are allowed to not work and live comfortably it pushes out their entrepreneurial spirit and urgency to find a job. Furthermore, entire communities can be bound up in the system of subsidy. This produces more people who tend to be dependent on the state for their livelihood.

The kind-spirited and economically sound approach to the issue of unemployment insurance is most certainly to end it. Let private charities, churches, and families fill the need of supplying the unemployed with resources. They will perform this function far more efficiently than the government could ever dream of doing. The result will be better resource allocation and less unemployment.

Lastly, it is a terrible fallacy to call welfare, or unemployment benefits “insurance.” They are not insurance in the sense that you purchase car or fire insurance. In the case of car insurance, a provider uses information about your age, the car you drive, and how many traffic tickets you have gotten to calculate your level of risk. You are then charged a corresponding rate depending on how risky they deem you via a probability function. Based on past evidence of people and cars very similar to yours, they calculate the probability you will crash into somebody and require a payout. The government does not do this.

The government never assesses your riskiness of being laid off (analogous to crashing your car). Furthermore, with the so-called unemployment insurance the government provides, you are forced to pay regardless of whether you perceive even the slightest chance of being laid off. It is NOT insurance. The word “insurance” is just used in an attempt to paint a prettier picture of what is really going on.

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2 Responses to Welfare is Mean-Spirited and Bad Economics

  1. Jack Dublin February 14, 2012 at 8:49 pm #

    Johnson is clearly unfamiliar with even the most basic observations on human behavior. We are all prone to pavlovian responses. Reward a behavior (or, at least, remove any negative reaction) and it will continue. It is in our nature and therefore true in all marketplaces. Just look at the rise in young single mothers. We have removed shame and injected economic incentives.

    Liberal Progressives(along with the other socialits) create systems and then demand human nature to fall in line. This has a rather poor track record, regularly ending in, at least, social unrest.


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