Sam Hammond on Welfare Reform and Social Insurance

The China shock is rethinking our attitude towards globalization, what should the government’s response be?

Sam Hammond is a poverty and welfare policy analyst for the Niskanen Center and has recently published a new paper titled, “The Free-Market Welfare State: Preserving Dynamism in a Volatile World.” He joins the Macro Musings podcast to discuss the paper along with some of his other research. Sam and David also discuss the repercussions of the China shock, how to reform America’s welfare system, and the design characteristics that would define an ideal social insurance state.

Read the full episode transcript:

Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected]

David Beckworth: Welcome to the show, Sam.

Sam Hammond: Thanks for having me David. First time, long time.

Beckworth: I know. You're one of the few faithful listeners who I can confirm that has listened to all 105 episodes so far, which makes you uniquely qualified to answer this question. What has been your favorite episodes thus far?

Hammond: Well, I'm biased, but-

Beckworth: Not including your bosses or your colleagues, which we know you love them.

Hammond: Well, then I can also say Nick Rowe, who is former professor. Cardiff Garcia who has the second best podcast on economics.

Beckworth: Nice. Second best. I like that.

Hammond: The multiple George Selgin podcasts are all interesting. Will Luther's. I like the economic historians.

Beckworth: Yeah. Those were fun. Good. You've been a longtime listener. You know the show. You vouched for it. I know you've told me several times you religiously-

Hammond: I'm an evangelist.

Beckworth: You're an evangelist and you religiously listen to it which is great. You know the question I'm about to ask you is, how did you get into your area of work? How did you become an economic policy wonk on the topics of poverty and welfare analysis?

Hammond: It goes back to, so I was fortunate enough to have a high school that had an economics class. In that program we had to review a book or do a book report. The book I picked up was called Filthy Lucre: Economics for People Who Hate Capitalism by Joseph Heath, who's actually a philosopher, not an economist. He's a very econ-literate philosopher I would say. It introduced these fallacies of the left and the right, and really got my mind spinning on the power of economic reasoning, economic ways of thinking.

Hammond: I went back and one of his earlier books was called The Efficient Society: Why Canada is as Close to Utopia as it Gets. It discusses largely the differences in the values that ... Comparing and contrasting America and Canada, what makes us different. I'm Canadian. One thing is in America we institute a liberty norm. You can think of the Constitution as being inspired by that. Canada, Joseph Heath argued, was more of an efficiency society, meaning a Pareto efficiency, win-win, positive sum outcomes.

Hammond: A lot of his examples traced to the development of Canada's social insurance system, including our Medicare system. That has been a big inspiration for me. I ended up with the recession, like a lot of people, becoming fascinated by finance and macro, reading a lot of the macro blogs. Nick Rowe, Worthwhile Canadian Initiative, Scott Sumner obviously. Initially when I was deciding where to go for grad school, didn't really do much thinking in terms of rankings or anything like that. I was like, "Where are the bloggers at?"

Beckworth: There you go. That's why university departments should be blogging.

Hammond: I think that's really underappreciated probably by faculty and department heads is how much of a marketing tool just being out there in the blog, econ blogs is for grad students.

Beckworth: Based on that, you decided to go to a grad school where Nick Rowe worked, at Carleton.

Hammond: At Carleton. Little did I know that he only taught undergrad, so we didn't really interact.

Beckworth: Come on Nick Rowe, you can do better.

Hammond: Nick Rowe is great. I think he's an exemplar of how economists and philosophers embody similar things. Because a lot of the way he writes is working it through toy models, thought experiments. I really like that style of thinking, and had the pleasure of sitting in through some of his lectures where he develops some of his toy models. He's a fascinating guy.

Beckworth: He definitely sharpened my thinking on monetary theory over the past decade, through the recession and the recovery. He's definitely been one of my favorites as well. That led you into policy work, so you went to Carleton and you got your graduate degree. You moved into the policy world. You're now at the Niskanen Center. I've had two of your colleagues on before, Karl Smith and your boss, Brink Lindsey. They've mentioned this before, but for our listeners again, explain what the Niskanen Center does and what your role is there.

Hammond: The Niskanen Center was founded as a refuge for libertarians who wanted to branch out from orthodoxy. Our founder, Jerry Taylor, his heresy was to think that climate change was a big deal. My heresy is obviously to think that a welfare state can be efficient and complement markets. I ended up going there from the Mercatus Center where I did tech policy. There's actually a bit of a gap there, like how did I go from tech to poverty. Actually, I feel like I'm doing some of the same policy work.

Hammond: As we'll get into, I'm very concerned about maximizing long-run growth potential of the economy, and don't want to do anything that comes at the expense of that. When I argue for different welfare reforms, in the back of my mind I'm arguing against someone who's a economic growth, productivity growth über alles type. That's why I lead in with the issue of dynamism.

Beckworth: Your new paper is titled The Free Market Welfare State. Very provocative, interesting paper. I'm sure you're getting lots of interesting feedback on it. I want to begin with a discussion you mentioned early on, this point of dynamism that Joseph Schumpeter had talked about, creative destruction. Tell us about his interesting insight about capitalism bringing about its own demise. What was he arguing?

Hammond: Well, I think Schumpeter's big point is that capitalism's a very unnatural phenomena. It's not like some visions of laissez faire where this is just the natural state of the world. Actually, industrialization was a total departure from millennia of human history.

Beckworth: We're the exception to human history.

Hammond: Absolutely. Schumpeter noticed that capitalism had this awesome power of creative destruction, including institutions. He has another quote in Capitalism, Socialism and Democracy where he says something like, "Capitalism destroyed the feudal system that came before it, and eventually it'll destroy itself." His reasoning there was that the amazing productive powers of capitalism produce enormous changes in society, and that can be very disruptive.

Hammond: He predicted that the disruptions within a capitalist economy would lead people to eventually backlash against it, and institute various forms of protectionism.

Beckworth: I'm thinking historically the US case we had, for example, the transition from an agrarian, agricultural-based economy to an industrial one. There was a huge uproar. The agrarian revolt. There was painful transitions whenever the economy undergoes these structural changes. More recently, you noted in a paper, there's been the effect of globalization, in particular the China shock which right now you could argue President Trump in some ways crudely responding to that. Talk about this China shock and how it has been painful and has created some repercussions for capitalism in America.

Hammond: Obviously the China shock, the term comes from David Autor's work, who I think has done a lot for me personally, but I think more broadly the economics profession to update how we think about international trade and its impact, especially for a developed economy. In the China Shock, in his big paper he outlines a set of consensus statements of what the profession thought in, say, circa 2000.

Hammond: The thinking was international trade doesn't greatly harm the sectors that it's competing against in developed economies. Workers are easily reallocated to new productive ends. Trade is a win-win. That was certainly my thinking historically, especially coming from a more free trade, libertarian background. I think the China shock belies that. His research has shown that essentially the import competition of China stemming from its ascension to the World Trade Organization led to anywhere between one and two million jobs lost.

Hammond: That could be fine. Obviously we just had a jobs report, jobs are being destroyed and created all the time. What made the China shock different was how concentrated they were in particular regions of the country, and that geographical boundedness obviously had some major implications for labor reallocation. Subsequent research that I point out in the paper has connected the China shock with changing political attitudes.

Hammond: One thing that I think free traders in general underrate is how purely economic phenomena can have lasting effects, even if they're temporary because we have a political system that is responsive to them. Depending on how that political system responds, temporary shocks can have lasting political, economic consequences. Some of the subsequent research, there's one paper called From Tiananmen to Outsourcing that shows how congressional attitudes to China have reached a low point, lower than just after the Tiananmen Square massacre, and how attitudes in Congress have shifted from human rights in China to issues of trade, intellectual property.

Hammond: How with district-level data, congressional districts that were most exposed to trade with China have polarized dramatically. It's not simply that they've gone to a reactionary right wing direction, but also Democratic districts have gone more left populist in their own way. This has a pretty robust correlation with the decisive voters in the last election. Whether or not I'm being political here in saying this, but in terms of a if/then statement, if you are a free trader, then this should make you straighten up in your seat a little bit.

Beckworth: The rise of Bernie Sanders on the far left and Trump and his populism on the right are a byproduct of this shock, this China shock. That's what this data shows, right?

Hammond: I think largely. I would also point to Dani Rodrik's paper, The Economics of Populism. I think it's probably the best overview of all the different lines of evidence here. One of the things he points out is that there is this interaction between cultural and economics. It's a perennial debate that is Trump a cultural phenomena, or a economic phenomena, and really it's both. It's hard to deny that it's both.

Hammond: Economic anxieties can get translated into cultural anxieties too. I think the weight of the evidence shows that the China shock had a big impact in the rise of a more polarized and populist politics.

Beckworth: It was also interesting you noted in your paper that the folks most adversely effected by the shock, they turned to disability insurance rather than unemployment benefits or the trade adjustment money.

Hammond: Assistance.

Beckworth: Assistance they could get. I remember David Autor talking about this, that they effectively treated disability insurance as unemployment benefits. Is there any more background on why that happened, why they turned to disability rather than traditional unemployment?

Hammond: Well, there's been a long-term erosion in unemployment benefits overall. Also, this varies by state, but states have done various things to restrict access to unemployment insurance. Some states have even moved forward with drug testing unemployment insurance beneficiaries and stuff like that. That's one factor. Another factor is simply that we lack a robust income supports system in this country. Some people will point to the generosity of social security, disability, but really in a international context, disability insurance in America is hard to get and not the most generous by any means.

Hammond: What separates us is the abject lack of an alternative. There's a path of least resistance. Moreover, partly because social security is so means tested and, I would say, cynically regulated, it's also very hard to get out of. Because once you're in, you're not supposed to be looking for work or to take work.

Beckworth: Because you have a disability.

Hammond: Yeah. Exactly. One of the points I make is not only do we need more income supports, but we could learn from the United Kingdom that has, I think, in 2012 reformed their core disability program. It's called the Personal Independence Payment. The thing they did was to make disability universal and unconditional. If you're assessed for disability insurance, you'd be assessed just like anyone would. You're set on a fixed term. Let's say short-term disability, you're assessed for two years. You get your disability payment, but there's no strictures restricting you from looking for work if magically you improve or some job comes along.

Hammond: I think that actually in some ways would reduce, what you could say, the supply side structural harms from disability insurance, while actually in some ways embracing universality, which I think is a good example of how my policy recommendations can cut across some traditional ideological commitments.

Beckworth: You use this example of China as a way to illustrate the fact that the US social insurance system is not very strong. In fact, you have a chart comparing it to the rest of the world, the rest of other advanced economies. Your argument is that we have a relatively weak social insurance system in the US, but the fact is we're getting more and more integrated into a global economy. We're more and more susceptible to economic shocks. We'll get to this later, but you argue this isn't a very sustainable arrangement that we're at. Something's going to give and something has given when someone like Donald Trump or Bernie Sanders is going to rise to power.

Beckworth: If we're going to go down this path, we might as well address it head on before it takes an ugly turn. Now, you frame this interestingly in two ways, because people like me, I'm very free market, flashes of libertarianism running through me occasionally, though some might question that. There's a part of us that worries about the heavy hand of the interventionist state, the central planner, the redistributionist, the zero sum game where you take from Peter to give to Paul.

Beckworth: You make a distinction between an interventionist state like that, that's zero sum. Maybe some could argue negative sum, but at least zero sum. There's the interventionist state and then there's what you call the social insurance state. With a social insurance state, you're making this argument it's very distinct and different than this bad image of the interventionist state in that it creates certain ex-ante, beforehand. It's a different beast altogether because it allows entrepreneurs then to flourish.

Beckworth: If you want to take risk, start a business. If you have a sufficient and well-designed social insurance system, you're more likely to go out and try that. Why don't you talk a little bit about these two different systems.

Hammond: It's a point that I first learned from reading FA Hayek who is a free marketeer extraordinaire. He drew a distinction between central planning and a comprehensive system of social insurance. One of the points he made in The Road to Serfdom, I think buried in a footnote, is that, he was writing in the 1940s, that in many ways Britain is more socialistic than Sweden, because at the time Britain had nationalized industries and stuff like that. Whereas Sweden had in many ways combined universal social insurance with a very capitalistic economy. I'm not a historian of Sweden, but early in their economic history they privatized their forests.

Beckworth: Interesting.

Hammond: Pretty radically capitalistic in that sense. The distinction was that they had these universal systems of social insurance where Bo Rothstein, who's a sociologist of welfare states, says that their motto was, "It's the people's insurance." What this distinguishes, it distinguishes not just the classical free market view of social welfare, but it also pushes back against more left-leaning egalitarian views of social welfare state, which actually in some ways are in concord with the right wing view.

Hammond: If you're an egalitarian, you agree that it's robbing Peter to pay Paul. You're for that. Whereas if it's social insurance, then it's not any different, per se, than private insurance in the sense that you have certain ex-ante benefits from having certainty about in this case your income and your standard of living. In many ways I can connect it to your preoccupation, like nominal income targeting. That is bringing a certain level of stability and certainty to the macro economy. In some ways income supports are just almost is income targeting at the micro level.

Beckworth: It's the micro version of it. You're right. I think your point is a good one in that you're saying this social insurance system actually promotes freedom, where the interventionist state actually eats away at freedom. Examples of the interventionist state that we don't like that erodes freedom, would be occupational licensing, non-compete clauses, zoning restrictions, things that actually reduce economic freedom, inhibit your ability to pursue happiness and life and all those good things.

Beckworth: What you're arguing is just like we have car insurance where we pool all our risk together and therefore I'm not nervous to go drive my car to work or drive my car and do what I want to do with it, you're arguing the same thing for our income. A universal system where you pool it. I guess what was surprising reading this is that Hayek, this Austrian economist. Most people if they know Hayek, they think of him as this hardcore libertarian. He recognized this distinction.

Beckworth: Now, you in your paper take it and say ... He was talking about Sweden and UK in the 1940s, but you compare it, you bring it up to date. What two countries do you compare in modern times to make that analogy?

Hammond: Part of the point of the socialist or the social insurance state, an interventionist state is when there are economic anxieties, when there are economic shocks, they can be in the democratic context be translated in one of two ways. Maybe three or four or five ways, but I'm bundling them two ways. One way is to increase demand for safety nets. Another way is to actually address the issues that are causing the economic anxiety in the first place.

Hammond: Emmanuel Macron recently put this as the choice we face between social protection and protectionism. In the context of modern, a modern day example is if you look at modern day Venezuela, it's often described as a social democratic country. It's the same term we use for the nordic countries, social democracy. They're totally different distinct systems. I think that Venezuela would love to have big safety nets too, but they've totally killed the goose that lays the golden egg. They have nothing left to redistribute because the approach they take is decidedly anti-capitalist, is price setting, price controls, soaking the rich to the extent that there is taxation.

Hammond: It's not this insurance-based model, which I think in some ways is not just consistent with the market but in a way completes the market. There's a gap in the market that social insurance can fill. I associate the Venezuelan case with a form of left-wing populism. We might think of Trump as being a right-wing populist, but this can come in different flavors.

Beckworth: Now, you also mentioned that Sweden and Denmark both persistently score high on economic freedom indexes put out by conservative think tanks like The Heritage Foundation. They're doing something that's very unique and different, in contrast to what we think of a typical socialistic, interventionist-

Hammond: Some people will say that's just an accident, whereas I'm saying there's method to the madness. Why do they rank consistently high? We mentioned trade. The nordic countries are some of the most open to trade in the world. I think Denmark, their export sector is 50% of GDP, thereabouts.

Beckworth: The smaller you are, by definition, almost the more you have to depend on trade.

Hammond: Part of the failure for the United States to have effective adjustment policies, let's say, is the fact that we were for most of the 20th century a third of the global economy. I think even today if you remove NAFTA countries, merchandise exports are 3% of GDP or something like that. In terms of exports in goods. We have this image of ourselves as being this free trading country, but almost just by dint of geography we're actually quite closed. I think that's actually part of the reason why we've been complacent relative to those other countries.

Beckworth: The smaller you are, the more you depend on trade. The US is large. We haven't as a percent of our economy engaged in as much trade as, say, Denmark. Denmark, in other words, is very susceptible to trade shocks. If exchange rates move, if trading partner goes somewhere else, it can really hit home hard. They've had to wrestle with this in a more serious way than we've had to wrestle with it. What they've turned to, you argue, is this universal social insurance approach.

Hammond: Specifically they have a model that's sometimes called flexicurity or flexible security. Their innovation is, I think it goes by a motto, "Your job's not protected but your employment is." They're separating employment from the job, and they have very high replacement rates for wages for lost employment, like upwards of 90% of your wages are replaced. The condition, the reciprocity of that system is that within three months if you're not finding a new job, they're ramping up the active labor market policies, retraining you, giving you subsidies to make you more desirable for employers.

Hammond: As a result, they have this incredibly dynamic labor market. Something like one in five Danes switch jobs every year, which is unheard of job mobility.

Beckworth: In the US, we have the opposite problem. One of the things we've discussed on previous shows, how labor mobility's actually declining in the US. Over there it sounds very dynamic.

Hammond: The other side of the coin is that they have very few statutory labor laws.

Beckworth: Very flexible labor markets there.

Hammond: They have collective bargaining agreements. That's how most of this is regulated, but they still have at-will employment.

Beckworth: You can fire and hire someone very easily. You want to keep the labor market flexible, fluid, responsive to changes in the markets.

Hammond: I just want to put this out there at the top is that I'm not saying the US can be like Denmark. There are many, let's say, let's call it invariant factors that we can't just replicate a different country. We could have a system with American characteristics, that's maybe moving within the Anglo tradition.

Beckworth: Toward that direction.

Hammond: That direction. Right.

Beckworth: You come up with a list of design principles or characteristics that would define this social insurance state, that would promote economic freedom and capitalism. I'm going to list them off real quick, four of them, and then we'll work our way through them in more detail. The first one is it would enable entrepreneurial risk taking. The second one is easing adjustment and search costs. Third one is benefit portability or detaching social benefits from your job with the market you're in. Then finally, making the economy more robust to immigration.

Beckworth: Let's start with the first one, a well-designed social insurance state would make entrepreneurial risk taking more easy. It would enable it. Tell us about that idea.

Hammond: This paper is setting out a kind of research and reform agenda, a way of thinking about things, not necessarily putting forward any specific policy. Of those four principles, the first one, entrepreneurship and risk taking. A free market welfare state should be one that enables people to take risks without fearing catastrophic outcomes if they fail. In any dynamic market, failure is always an option, because we don't want to keep failed businesses alive just for the sake of people's social security.

Hammond: In this case I cite the work of Gareth Olds who's now assistant professor at Harvard Business School. At the time, I think it's his dissertation work at Brown looked at the relationship between entrepreneurship and the safety net and the connection to food stamps. If you search for food stamp entrepreneurs, you can find one of his papers. What he finds is that there was this big enrollment increase in food stamps in the 2000s.

Hammond: Looking at the geographical variation in that, he shows that it led to a 20% increase in new business formation for eligible population. The most interesting thing there is that it wasn't necessarily people who had enrolled in food stamps. It was just people who had become newly eligible, suggesting that this is insuring against entrepreneurial risk taking. This, I point out, is an accident. Food stamps, SNAP is a nutrition program. It's meant to supplement the groceries of low income households. It's not meant to be this income support, but, in fact, because grocery spending is fungible, it functions in this way and has the characteristics of this.

Hammond: Part of the point I make in the paper is how would we construct this if we took the complementarity between markets and social insurance as our starting point, and used that as a way to think about the design of that program? How would we go about enhancing the ability to take risks, rather than just stumbling into it?

Beckworth: You say you wouldn't cut food stamps, but you'd simplify enrollment and convert it into more cash benefits. In other words, this is a quasi-income support program. You said it's fungible. It makes it easy to people, smoother consumption, or to spend on what they need to spend it on.

Hammond: Since publishing this paper I had one person reach out to me saying that they're starting a startup company, and they were nodding along to the paper because they're having cash flow issues. Let's put it that way.

Beckworth: SNAP would be useful for them. I guess you're not a big fan, then, of President Trump's recent proposal to turn the SNAP program into deliver packages to your house.

Hammond: I don't know how alive that proposal is.

Beckworth: It would take it away from the spirit of what it is now though. It would make it-

Hammond: Right. In some ways it is like a communist commissar for food. They wanted to replace SNAP benefits, which right now you get SNAP on a card, EBT card, sort of like a debit card. It's redeemable at eligible grocery stores. They wanted to reduce "abuse" of the system because people were spending the money on unhealthy foods. Really when you look at the stats it's no different than any other population. To make it more in line with the mandate of a nutritional program, one proposal was that they start sending beneficiaries a subscription box service essentially, filled with-

Beckworth: Blue Apron.

Hammond: Yeah. Sort of like Blue Apron. I called it gray apron, because it's kind of sad.

Beckworth: Communist apron.

Hammond: There would be canned beans. I don't know. Beans are pretty healthy.

Beckworth: It did strike me as strange. It's taking choice away and also forcing, the very thing we criticize, big government into making decisions for these households that are very diverse, very different.

Hammond: I think it also stems naturally from a view of this program as just a have to have not program, as supplying some basic needs. Whereas if you start thinking of it in terms of insurance and risk taking and this ex-ante risk pooling arrangement, then you think about the program differently. You are less worried about how people spend the money, because in many cases maybe they want the flexibility to roll that money into a venture.

Beckworth: I had this discussion with someone recently about the abuse of the food stamp program. I looked up the stats, and it is very small, as I recall. It isn't a huge waste. There's not a lot of waste going on in the program.

Hammond: You got to be careful how you think about what counts as abuse. Under the law as it stands, selling your food stamp benefit, selling more than $100 of it is a felony with a maximum penalty of five years in prison. That's abuse, but some people have phone bills.

Beckworth: It might be a legitimate use of the funds, but legally it's not. That's the first one, so the first one is if you have a robust social insurance state, it's going to allow you to be more entrepreneurial, take risks because you feel relatively safe, as this business reached out and told you firsthand. Your second point is it also helps with search and adjustment costs. Walk us through that argument.

Hammond: This is an argument that we touched on with the China shock issue. There's a great book called Failure to Adjust by Edward Alden, that goes a deep dive in how we got to the current state we're in, and the lack of adjustment policy in the United States, that I would highly recommend. Essentially most open economies that we've already mentioned have robust systems for helping labor reallocate in the face of adjustment costs, because equilibrium is not just this automatic thing, like in our new classical models where there's a trade shock and people automatically ... Human beings are not widgets and we're not financial capital. We can't just be-

Beckworth: Quickly move to the newest job.

Hammond: Unfortunately the Cayman Islands is a long flight away from me. It's not a click of a mouse. These adjustment costs are serious and they're a big part of a modern economy. This goes back to the fact that capitalism is a very unnatural state of affairs. The development of unemployment insurance itself stemmed from industrialization. As I point out in the paper, if you look at the history of unemployment insurance, there was really no function for it in agrarian economies prior to the Industrial Revolution because in an agricultural economy we're all working the farm. To the extent that we have social insurance, it's the family or tight knit communities.

Hammond: We're all subject to the seasonality of agriculture. There could be a blight but that's a shock that affects everybody, so it's very hard to pool those risks. With the Industrial Revolution you have this enormous increase in specialization and trade. As a result you have idiosyncratic risks to your employment, where you are a podcaster and I am a policy person, and there's people outside who are working in services, and there's people down the road who are regulating banks. We're all doing different things.

Hammond: Depending on how the patterns of trade shift, you could have a shock whereas I would have a boon. There's new opportunities for pooling risk, and that was reflected in the development of unemployment insurance.

Beckworth: The idea, again, is that with the Industrial Revolution we get incredibly labor specialized which is great on one hand and it makes us more productive. You specialize in what you do. You get better at it. You learn it. Productivity grows. We're better as a whole, richer as a whole. At the same time, we're also more susceptible to shocks. It's more likely you could lose your job to innovation, productivity, competition. We're more susceptible to shocks with the Industrial Revolution. Idiosyncratic shocks that are unique to me.

Beckworth: That creates this need for some kind of way to cushion the blow. One of the arguments was, and you alluded to this before. One of maybe the critiques of your paper would be, "Well, why don't we rely on private charity, churches, your family structure?" As you mentioned, that was in the past something that was used. With increasing labor specialization and the transition from farming to industrial output, that social safety net broke down, didn't it? What's the story there? Why don't we see private charities doing more? Is government crowding it out? What's happening?

Hammond: Well, there's a few different accounts here. I've done some early work on social capital and its role in local social insurance. The actual story, I think, is actually complicated. I've an essay, if you search for separation anxiety and my name, you can find an essay I wrote on this. The development of commercial insurance in the 1800s was in my view the key thing that disrupted mutual aid societies. In essence, mutual aid societies, they used to be called flat rate societies, because everyone paid the same flat rate.

Hammond: If you were out there chain smoking tonight and I was an example of health, we'd pay the same flat rate to be a member. What that implied is that we weren't pricing risk, in essence. The development of commercial insurance coincides with the development of actuarial tables, the first life tables for life insurance, the development of early statistics, the Gaussian curve and stuff like that. That's all being discovered. There was this massive boom in commercial insurance in the 1800s in the UK and across Europe as nascent insurance companies realized these supernormal profits that could be had by accurately pricing risk.

Hammond: You saw the death spiral of mutual aid societies being brought about by skimming off the low risk people and leaving the high risk people, so to speak. Not only that, but because there are economies of scale, there were winning commercial insurance agencies that became nationwide.

Beckworth: The mutual aid societies, those were the early forms of private charity.

Hammond: Right.

Beckworth: Fraternal societies.

Hammond: Fraternal. There are definitely benefits to having, let's say, insurance administered at a low level, subsidiarity. I have a different piece, Don't Abolish the Welfare State, Decentralize It, which looks at the relationship with social capital and the welfare state. One of the interesting things about big welfare states like Sweden is that they have very high rates of social capital. Bo Rothstein is, again, the go-to person on this. Part of the reason for that is they have a very decentralized system of administration. A lot of it is administered at the municipal and county level.

Hammond: There are different ways of preserving the social capital of a community that are congruent with a more universal system. Maybe a faceless bureaucrat sending you a check is not the best in that sense.

Beckworth: You mentioned the 1800s. We go move forward, we have the Great Depression. Daniel Hungerman's done some research on this question, did government crowd out private charities. Maybe you could summarize his research on that.

Hammond: Hungerman has a study looking at the New Deal programs of the Great Depression and how they impacted our religious affiliation. I think he looks at church charitable giving. My main commentary on that is there is a crowd out effect. If you think of it in terms of an elasticity for government spending and charity, yes, there was a substantial reduction in church philanthropy, but it was 90 to 1 for increased government spending.

Hammond: In essence, you couldn't have modern day mutual aid societies replace the roles that the state has taken on, not by a long shot. There's another book called It Takes a Nation that makes this point, playing off the "it takes a village." In fact, modern social insurance systems really do take a nation. They take this, both to get optimal risk pooling, and because the dollar amounts are just staggeringly higher than what was ever provided in the past by mutual aid societies and churches.

Beckworth: Let me summarize your point here, is that what worked in the past probably can't work presently. These private charities may have functioned in the past but may not work presently because of the size of the problem, the complexity of the problem as well.

Hammond: And the fact that we now price risk.

Beckworth: And we price risk. Back then we didn't price risk.

Hammond: This is why my essay on this is called Separation Anxiety, because there's this jargon in economics between a pooling and a separating equilibrium. You can think of mutual aid societies with the flat rate that they paid as being the pooling equilibrium. They weren't looking for signals of risk type. With the development of commercial insurance, we started to actually price risk appropriately, "appropriately." Those pooling arrangements unraveled. In some ways, universal welfare states are basically reinforcing a pooling equilibrium in insurance at the nation state level.

Beckworth: Just, again, it'd be almost impossible, for example, for churches to fill in what governments are doing in terms of social insurance.

Hammond: In terms of spending, right. To the extent that we can decentralize administration or harness civil society as a window to especially case management and stuff like that, I think that's totally realistic.

Beckworth: Well, let's move to your third characteristic or way you would design this social insurance state. That is benefit portability. Talk about that.

Hammond: Benefit portability is just the notion that we think of firms as optimal units for production, not social insurance. If a nation state is the optimal risk pool, maybe Amazon will one day have an optimal risk pool, because it will be a big enough company. The example I use is our weird health care system in America that for really complex, convoluted historical circumstances provides most people, about half of people's health care through their employer.

Hammond: That, very well established, creates job lock. You're less likely to switch jobs if you're worried in the interim that you lose your health insurance. It also distorts firm distribution, because bigger firms have an easier time with compliance for various health care regulations. They also have bigger internal risk pools. The issue of benefit portability, again, goes to that Danish motto of "we want to protect your income or your employment, but not your job, per se."

Hammond: We want a system that provides economic security without propping up failing businesses, without propping up failing industries. Because we ultimately want that stuff to liquidate and be replaced by the new industry, and for people to be retrained and to be brought back into those industries. That's just, I think, one of the more important design principles. Actually one of the reasons why I point towards more universal public option style policy prescriptions is that they tend to be ...

Hammond: There have been proposals to make complex legislative carve outs that you could have some kind of saving account that followed you from employer to employer. I would rather just do something simple and look at direct provision of insurance.

Beckworth: You mentioned for health care, and that's a long conversation. Maybe we don't want to get into it right now. One simple suggestion is universal catastrophic insurance, maybe an expansion of Medicaid. That'd be just for catastrophic health problems.

Hammond: This is a proposal that goes back to the 70s. Back then it was called maximum liability insurance, and it was a Nixon proposal actually. Martin Feldstein, who later became chief economic advisor to Reagan, endorsed it.

Beckworth: You said Milton Friedman also.

Hammond: Milton Friedman in the-

Beckworth: Which was pretty surprising to read.

Hammond: If you sat some economists in a room to design the ideal program, you would. The issue, going back to this point about insurance, is, I don't know the exact statistic, but something like 5% of sick people drive half the costs. There are these catastrophic outcomes that can just bankrupt a person. You couldn't possibly self-insure through savings because part of the issue is that the expected value is not the standard deviation.

Hammond: An elegant solution is to provide a universal catastrophic program that would essentially give everyone automatically enrolled in a high deductible plan that would cover catastrophic costs for health care. Then that would also, I think, fix a lot of the private market, because you could purchase supplemental insurance and you wouldn't have insurance companies being as worried about preexisting conditions and all that stuff. Because they'd be focused on smaller bore costs.

Beckworth: The last characteristic is migration robustness. Tell us about that one.

Hammond: Well, this goes to the argument that social welfare and immigration have a tension. I didn't want to come into this paper denying that that tension existed. Because I think it is a real tension. The point I would like to make is that it really depends on how you design these programs. If you had unconditional flat benefits that anyone was immediately eligible for when they entered the country, that would be a problem.

Hammond: As a matter of fact though, most of our biggest social insurance programs like Medicare and social security are what economists call contributory. You pay into the system. Even if it's not fully funded, you still have the sense that I'm eligible for what I've paid into through my payroll or through other fees. Work by Martin Roos has found that depending on the ratio of contributory versus non-contributory benefits, you can do a lot to modulate the net fiscal impact of immigration on a country.

Hammond: Then there are obviously other ways to do this too, through time limits on new immigrants before they're eligible for benefits. I would point to Switzerland which has a pretty robust social safety net and also very high rates of foreign born. They've done a lot of innovative things on making those two things compatible.

Beckworth: You have a quote from the namesake of your institution, who says, "Build a wall around the welfare state, not the country."

Hammond: That's Bill Niskanen's famous line. I would just modify that and say that there are ways of making the wall porous around the edges through contributory benefits. Obviously the benefits of an unemployment insurance system to the extent that we've talked about search and adjustment costs apply equally to non-citizens. Unemployment is another example of a benefit that we have to pay into first before we become eligible to receive.

Beckworth: These are some interesting ideas, and I can see the appeal to them. I can also see people maybe having knee-jerk responses to them. I won't mention any names, but just prior to this recording we ran into a colleague here in Mercatus who wasn't too excited about this paper. I guess part of this is your political mood affiliation and how you frame this and how you package it, the marketing of this. I think it's easy for us to, again, think, when you make this proposal, Sam, to think the interventionist state model versus the social insurance state model.

Beckworth: You have in the paper a table that has these different buckets, different categories to help us put the proper framework on what we're thinking about here. Talk us through that. What is the proper way to think about this idea?

Hammond: As a graduate of George Mason University, I'm very influenced by public choice economics. Part of my argument is that small government free marketeers have not absorbed the public choice critique of themselves, that there are certain limits to how small of a government you can have that is simply compatible with a democracy. There are examples of governments that have both deregulated markets and very small social transfers, but they tend to be authoritarian city states. They tend not to be big.

Beckworth: Like Singapore.

Hammond: Like Singapore or Hong Kong, or even Chile to some extent. This goes to my distinction between social transfers or insurance and what you could think of as central planning or interventionism. I have a two by two that draws the distinction between if you're pro market and pro transfer, or anti market or anti transfer and the vice versa. I point out that our traditional ideological spectrum, the big government, small government spectrum running from your right-wing libertarians to your left-wing social democrats doesn't actually align with the regimes that we see in the world.

Hammond: There aren't these pure libertarian countries or these pure social democracies. Instead you have interesting mixes of capitalist economies with large transfers and what you could think of as more reactionary economies with small transfers but high amounts of regulation and protectionism. The United States when you plot this on a graph, and I have a graph there that plots social transfers against regulation, the US is sitting by itself in the quadrant.

Hammond: I'm arguing that that's somewhat unstable, that we have a dynamic where we are relatively unregulated but have low income supports, and that we're starting to see the outcome there through that economic anxiety that that generates being translated into populist candidates, and also protectionist regulations, both the macro level and through third or fourth best policies like occupational licensing.

Beckworth: I want to restate what you said but use the term economic freedom. You use less regulation, but let me put it in a flavor that some listeners might like. Economic freedom.

Hammond: Yay.

Beckworth: We love economic freedom. We do, liberty, freedom to choose, start a business, move where you want to move. What you find, and it's a pretty striking graph, so I recommend our listeners go to this paper, look at this figure three which will be posted on the SoundCloud page for the podcast. It shows this really strong positive link between income transfers and economic freedom. Maybe more simply, a strong link between a robust social insurance and economic freedom.

Beckworth: That by itself is interesting, but what's also interesting is the US is way off the trend here. There's a fitted line, shows a strong relationship and the US is an outlier. Your argument is, and it seems plausible on one hand, that we're at a point and a condition that can't persist. We're beginning to see it already emerge, the fraying of the edges, through the interest in the Bernie Sanders, Donald Trumps of the world.

Beckworth: Let me just take the other side. Well, we've been here several hundred years. Why can't we persist in this equilibrium? Is it just that we finally are getting to the point where we're seeing the tensions really emerge, the contradictions emerge from the arrangements we have?

Hammond: Well, it's not just that. We talked earlier about how historically the US has been a de facto closed economy. China coming online has made us not the large economy in the international models that we used to be. That's one big factor, globalization. I point also at trade, or at technology. I'm a big believer that technology has had a secular slowdown. We've been relatively stagnant for the last, say, 40 years. We're not having the same big disruptions that we used to, like people living through the Industrial Revolution experienced.

Hammond: If you think that that might happen again, you think there might be some kind of fourth industrial revolution or IT revolution, artificial intelligence, robotics, you have to start thinking about the social upheaval that will ... History doesn't repeat, but it rhymes. If this happens again, how is that upheaval going to be translated in the United States? Will it be into an interventionist mode, or into a social insurance mode? That's the things I point at as being worrying.

Hammond: In the jargon of economics, my chart, I think, represents a saddle path. Countries that deviate from that saddle path, they can do it, but there are forces that draw them back. The countries that get drawn down to the reactionary equilibrium where you have low economic freedom but also low transfers, we have stories about how that happens and we have stories about how countries like Sweden get buy-in for high levels of economic freedom through social insurance.

Beckworth: Your model, in short, is predicting the US is going to converge to one of two points over time. One point being authoritarian, low economic freedom, or more economic freedom but with a bigger, more robust social insurance system. We should be smart and help guide that, pick that path before the path is picked for us.

Hammond: It requires us overcoming aspects of our traditional ideological equilibrium. This, I think, ties back again with what makes the Niskanen Center unique, is we're willing to deviate from that spectrum, and go on the off diagonal.

Beckworth: In the minutes we have remaining, I wanted to ask you about a couple of observations you made at the close of your paper. Number one is Wagner's Law. You mentioned Wagner's Law, and you also mentioned that Tyler Cowen who is my boss and the head of the Mercatus Center, Tyler Cowen brings up the paradox of libertarianism. Why don't we close by fleshing out what those two things mean and how it ties into your paper?

Hammond: Wagner's Law, it's a stylized fact really, it's not really necessarily a law. We just don't have any examples that counter it. The law is that as countries get wealthier, their governments get bigger. It's just something we observe. We don't have the economy of the 1900s with no income tax and small tariffs and very small federal government. Countries around the world that have gotten wealthy all look similar to the extent that they have bigger governments.

Hammond: This ties in with Tyler's essay, Paradox of Libertarianism, where he says, to some degree libertarianism is in a bit of a intellectual ... I think the quote is, "The intellectual crisis of libertarianism today is that they don't accept the package deal of modernity." The package deal is that economic freedom requires big government. Not just as a incidental fact, but as something that, as I argue, has a causal relationship with economic freedom.

Hammond: This goes, again, to the public choice critique. The public choice critique has to be turned on ourselves a little bit, and suggests that the political economy of welfare states means that they're probably not going away, but if they go away that we'll have something worse. Overall, there's been this, you could say, the anti-entitlement orientation of conservatives within America. The thing is, to the extent that spending can substitute for more interventionist approaches, if you take a hard line against entitlement spending, you're going to start looking for off-budget alternatives, things that don't appear to cost anything because the costs are borne by society.

Beckworth: Takeaway is we're going to be moving in one of two directions in the future. Let's pick the direction carefully now. Let's have some forethought in it, and let's hopefully make the choice to move toward economic freedom. The package that comes with that is a robust social insurance system.

Hammond: Right. We don't have to reinvent the wheel, but we can absorb the fact that there is complementarity between markets and social insurance, and do something novel to the extent that we build that into our design, that we design these programs with the complementarity in mind. We don't have to become like Denmark. We could become something totally new.

Beckworth: Well, on that happy note, our time is up. Our guest today has been Sam Hammond. Sam, thanks for coming on the show.

Hammond: Thank you very much.

About Macro Musings

Hosted by Senior Research Fellow David Beckworth, the Macro Musings podcast pulls back the curtain on the important macroeconomic issues of the past, present, and future.