After the Welfare State

After the Welfare State is a small little collection of essays from various authors that takes a look at some of the failings of the welfare state, its history, what came before and what can come after. I became interested in this book after I critiqued The Nanny State Made Me by Stuart Maconie. In there I offered some fundamental economic and moral reasons as to why Maconie's arguments fell flat. I wanted to begin a deeper dive into the history and impacts of the welfare state. This book is a little short and makes a good introduction.

History of the Welfare State

We must first differentiate between the welfare state and the socialist state. Very rudimentary, socialism involves non-private ownership of "the means of production", or rather, a doing away with the concept of private property in general. Removing private ownership of the means of production necessitates some kind of centralised planning of the economy as a whole. The welfare state has neither of these properties. In welfare states there is private ownership of property, and the state is not planning the economy. In fact, some of the welfare providing institutions may themselves be "privately" owned, although, as we will discuss, this is more of an on paper privatisation than a real privatisation.

The defining mark of a welfare state that differentiates it from the liberal state is the state taking a vested interest in the welfare of citizens. In a liberal state, the state only serves the role of acting as a "nightwatchman" – protecting citizens against violations of their fundamental rights – that is, freedom and property. Within this system of protected fundamental rights, citizens are allowed and free to secure their own welfare, as they wish and how they see fit. In the welfare state, it is the state that mandates the welfare of the citizens as it sees fit. There is some arbitrary list of things which count as welfare which changes from place to place and time to time, but in general the welfare state will act to secure things like education, housing, food, healthcare.

How did such ideas come to fruition? As a Machiavellian, I won't accept answers of the type "well this is just a good thing for the state to do". No, we need to dig and find out who it was who actually drove this into popularity. According to Tom G. Palmer who wrote the article about the history of the welfare state in After the Welfare State, it was Otto von Bismark.

Bismark was running a long war on the free-trade liberals in Germany at the time. They preferred peaceable non-state means of bringing about prosperity. They favoured peace within Germany and peace with its neighbours. The issue with this from the perspective of the state is it requires the state to seriously give up power. Citizens will not become dependent on the state, thus not supporting its expansion. Citizens become dubious of expansions of taxation or credit, and the state does not have the power for territorial expansion.

How did Bismark remedy this? First through a creation of a compulsory insurance scheme for accidents, health, old age, disabilities and so on. Bismark called his measures "state socialism" and stated "many of the measures which we have adopted to the great blessing of the country are Socialistic, and the State will have to accustom itself to a little more socialism yet". A. J. P. Taylor, a historian, stated that "Bismark wanted to make the workers feel more dependent on the state, and therefore on him".

This is a standard tactic of the state, as Rothbard notes in Anatomy of the State. In there he asks how the state preserves itself, since even a non-democratic state needs the support from a majority of citizens. Securing this support often looks like using the resources of the state, which themselves come from the citizens, to "purchase" support. In other words, the state convinces the citizens that they themselves could not exist without the state.

Ideological confusion is also a source of support for the welfare state. As states become smaller and more open to freedom, a reactionary backlash against it forms. This ideological confusion usually takes the form of accusations of "exploitation" against property owners who hire workers. This is despite the fact that the labour contract is voluntarily signed by both parties. There is also a tendency, I find, to ignore the reality of the human condition. Some labour must be expended in the passage of time to acquire resources that are themselves scarce, in order to continue a fundamental existence. All of this is to ignore that the non-artificial assignment of property rights is the only way to prevent and resolve conflict in a fair and just manner. At any rate, a dissatisfaction with reality often leads people to seek the establishment of a welfare state, to "protect" "exploited" individuals from "owners". In reality, as we will explore, what this usually looks like in practice, for all the good intentions (or not), is a system whereby wealth is moved from the poor into the hands of those who are good at manipulating this system.

Unsustainable Promises

Of all nations in the modern world, none is a more clear tale of massive political failure than Greece. Within the EU, there is the famous PIIGS bloc (Portugal, Italy, Ireland, Greece and Spain) who have all had shaky finances that risk the Eurozone as a whole. However, none of the PIIGS are quite as bad as Greece.

What makes the tale of Greece sadder is how it was a major success story for a number of years. From 1929 to 1980 the average rate of growth was 5.2%. In the same period, Japan's was only 4.9%. It's hard to think that at one time within living memory, Greece was economically outperforming Japan, but it is true (of course, all of this on a per capita basis, Japan as a whole always outperforms Greece merely by virtue of having some 10X the number of citizens). After all of this success, Greece was permitted to enter the EU. At the time, public debt was only a sustainable 28% of GDP, the deficit was a reasonable 3% of GDP and the unemployment rate was only around 2%.

Greece suffered at the hands of democracy though. In 1981 PASOK took power, a party with a dedication to statist welfare policies. Often in democracies, the opposition party do not oppose but copy. As it was here, the opposition party ditched their financial conservatism and became a statist welfare party too. From then on, both major political parties in Greece were essentially the same party: supporting a bloated welfare state.

But can this simple change alone bring about the Greece we all know? Not quite, it needed another deadly poison. This was cheap credit from Brussels. After joining the EU and then adopting the Euro, Greece was able to obtain massive amounts of credit very cheaply. It amassed a public debt of €350 billion, and this was in the early 2000s. Consider that now the GDP of Greece is still only €222 billion and you start to see the scale of the issue. What's the problem with all this cheap credit? Why can't people just "print money"? After all, in this period per capita income in Greece was on average $31,700 – the 25th highest in the world. Higher than 95% of the EU average even. Private spending was also 12% higher than the EU average, giving Greece the twenty-second highest human development index and quality of life indexes in the world. So what's the issue? Well, all of this is in fact illusory. As we all know with hindsight, this spending was all going into malinvestments. In other words, spending which was not and could never be profitable. You might know this as a "bubble", and they're always bound to burst. When they do burst, they burst painfully.

What else had happened to Greece? By 2010 public debt was an eye-watering 140% of GDP, the deficit was 15% of GDP and government spending was 53.1% of GDP. This is the most stark figure – Greece had effectively turfed out the private sector which is always the true generator of wealth and replaced it with the state. How do we know this? Consider the Doing Business rankings of the World Bank – Greece ranked 109 out of 183 for ease of doing business. Its highest ranking was ease of closing a business – 43 out of 183. Just consider what it means when closing a business is orders of magnitude easier than opening a business – ranking 140 out of 183 by the way. Greece also ranked 83rd in the world for Global Competitiveness by the World Economic Forum and the World Investment Report by the United Nations Conference on Trade and Development ranked Greece 119 out of 141 for foreign direct investment. This is a nation that has well and truly killed any entrepreneurial spirit.

Where did this money go? Well, it was spent on expanding "social rights". These are, in reality, not rights at all, but benefits provided by unsustainable spending. The Greek political system is now ruined by this, forevermore. Any politician who proposes a reform to this system will never win an election. The opposing side only needs to say "they want to take away your rights because they're the bad thing". In reality, of course, no Greek person has ever had any of these so-called "rights" but only promises that can not be fulfilled, at least not in good faith. On average, Greece spends €10,600 per person and only brings in €8,300 per person in revenue. A shortfall of €2,300 per person. At 10 million people give or take, this is an easy shortfall of some €23 billion.

Can Greece ever recover from this? It won't be easy, to say the least. Spending will need to be cut to reflect sustainable, natural rights, of which, there are almost none, by the way. Borrowing will need to cease. Paying back loans will need to happen, which will certainly come at great expense since nothing has been gained from having them. Malinvestments will need to be allowed to liquidate. This will be radically painful. However, the most important thing to do in a financial crisis is: not start a new one. More than anything, Greece will need to find the will to reform its own political system whereby massive spending is not considered a right. Is such a thing possible? The barriers to it are certainly high to say the least.

The 2008 Financial Crash

The 2008 financial crash is among the most misunderstood events in human history. Ask anyone and they will confidently tell you that it was "greedy bankers", and not be able to fill in any details as to how the greed of the bankers actually caused it. At any rate, no, just random greed of bankers did not cause the financial crash. It came from a systematic attempt by the American state to allow people to afford homes who otherwise really couldn't (these, by the way, are concrete examples of malinvestments).

The Federal Home Loan Mortgage Corporation (Freddie Mac) and The Federal National Mortgage Association (Fannie Mae) are two agencies which are "government-sponsored enterprises". Government-sponsored enterprises are defined as financial services created by the United States Congress with the intention of "enhancing the flow of credit to targeted sectors of the economy". This tells us something important about Freddie Mac and Fannie Mae: they are in essence owned and operated by the US government (which comes with all the baggage this entails, for example, insulation from market consequences). Secondly, they provide credit below market prices thus artificially raising the time preference of their "customers".

I bring up Fannie and Freddie since these will be the stars of the show that is the financial collapse of 2008. The story of Fannie and Freddie is such a check list of everything not to do in finance that it's hard to even know where to begin.

While Fannie and Freddie existed for some time, they really became dangerous around 2003. President Bush, with a re-election coming in 2004, needed ways to drum up big voter support. His plan was simple: pay for millions of Americans to get a home. So what if they didn't have a down-payment, or even a job. Everyone should have a home. Housing is a right. Of course, in reality, it isn't. Voting and laws can not change the fundamental fact that housing does not exist by virtue of the universe itself existing. Housing needs to be brought into existence by human action. To fully understand the action of President Bush here, we need to understand that he only needs to win the 2004 election. Any election beyond that is beyond him. He only needs to convince Americans he's the man who will "give them" the most stuff now and, in essence, purchase their vote. He doesn't need to be concerned with whether these policies are good in the long run – as long as they seem good for the duration of his term, all is well.

So, President Bush sets Freddie and Fannie goals of increased home ownership across America, and, particularly among low income individuals. They even start a scheme whereby one could purchase a home with a down-payment which itself was a loan. In other words, without putting down a single dollar of their own, all the while having terrible credit scores. If this makes you feel warm and fuzzy and fills you with egalitarian pride, just remember that contradictions do not exist in this universe. To put that bluntly, if you are willing to accept the lowering of the bar to own a home, you also necessarily need to accept the eventual financial crash – with all the pain and suffering and saddling of the world with public and private debt for generations to come.

So anyway, what action do Freddie and Fannie actually take? Well, this is essentially one big money printing scheme. While the whole flow of money is hard to track, the basic idea is like this: Fannie and Freddie purchase mortgages from private banks. This allows the banks themselves to provide the mortgages but offset the risk of the mortgages falling through onto Fannie and Freddie. This allows the private banks to lower the standards of who can get a mortgages. This makes sense, generally a private bank will need to find some standard at which lending becomes too risky to be profitable. If they have little or no risk, they can essentially lower this standard as much as they like.

The issue with this system is immediately obvious. It has the horrible effect of massively artificially stimulating demand in the housing market, thus raising the prices of houses. Since house prices are now higher, even more action on the part of Fannie and Freddie are needed so they can keep up with their home ownership goals. This is what we call a bubble.

Fannie and Freddie were also not themselves clean. They became embroiled in numerous accounting scandals. Freddie had stashed away $6.9 billion (which was not on their annual reports) and Fannie actually overstated their own profits so the bosses could still get bonuses. In other words, they were both cooking the books. In fairness to the Bush administration and Republicans, at this point, they became suspicious of Freddie and Fannie and wanted to tighten controls on the enterprises. This had two effects though: Fannie and Freddie needed to create a huge lobbying campaign and cosy up to congress Democrats. The lobbying campaign was beyond impressive and sinister. Well over $170 million was spent on political lobbying by the enterprises. If you lived in a state with a Fannie/Freddie critical politician, you could expect a phone call which went something like "Your congressman is trying to make mortgages more expensive. Ask him why he opposes the American dream of homeownership". Of course, the congressman would actually not be making mortgages more expensive but eliminating artificially low and dangerous credit costs. Of course, the recipients of such phone calls did not appreciate these subtleties, and the campaigns were broadly successful (for Fannie and Freddie). Relying more on support from congress Democrats meant Fannie and Freddie actually had to put the foot on the gas on spending, so to speak. Democrats actually wanted even higher rates of homeownership. Fannie and Freddie were now unstoppable. So was the crash.

Since so much cheap credit had been poured into the market, the number of people who were able to buy a house was dwindling. At this point, from a very shallow perspective, the directives by President Bush had worked – more Americans than ever owned a home. The problem is, in order to keep the whole show on the road, more mortgages always needed to be created. Thus, Fannie and Freddie needed to start purchasing more and more sub-prime and Alt-A mortgages. Sub-prime is a risky mortgage and an Alt-A is a little less risky but still more risky than a prime mortgage. However, in reality, many of these "Alt-A" mortgages were actually categorised as such since there had not even been a basic credit check of the property purchaser – they did not even know the income of those being given credit. In other words, all these loans are "junk loans". In 2003, junk loans were only 8% of US mortgages, by 2006 the figure was 22%. Between 2005 and 2007 40% of mortgages purchases by Fannie and Freddie were sub-prime or Alt-A.

By 2008, Fannie and Freddie had huge exposure to the housing market. The sum of liabilities and mortgages they had guaranteed and issued equalled the US national debt. In other words, these enterprises could, theoretically, be expected to make good on something equivalent to the US national debt at a moment's notice (it goes without saying they could never fulfil such a promise). To put that in perspective, for every $100 they had guaranteed or lent through securities, they only had $1.20 of equity. What this means in effect is they have given out massive amounts of cash that does not yet exist, with very little ways to actually back that. Finally, their combined mortgage portfolio was over $5 trillion (yes, trillion), while around $1 trillion of that was junk loans (yes, one fifth).

As the saying goes, all bubbles must burst, and with an eventual drop in house prices, that bubble did burst. To understand why a drop in house prices popped this bubble, we need to understand why mortgage backed securities were so popular with investors in the first place. If you purchase a mortgage-backed security as an investment, you essentially have two benefits. You get regular large interest payments (from the person who owns the home paying off their mortgage) and if they default you can acquire the house and settle the balance. With constantly rising house prices, the risks from lending to risky borrowers were low. After all, simply evicting them and securing the house would in itself be a profitable move. However, suddenly, now that house prices dropped, this was not the case. Fannie and Freddie now had people defaulting on mortgages all over but the acquired houses were no longer profitable. We must remember too that this fall in house prices was no accident, it was caused by Fannie and Freddie. It was Fannie and Freddie that initially started the artificial demand of houses which raised house prices. Eventually, they simply ran out of people who were looking for mortgages – this artificially stimulated demand vanished and so prices drop. In fact, it was even worse than this. Since so many risky loans were given, so many homes were in foreclosure at once the market was flooded with cheap foreclosure homes. House prices plummeted. Fannie and Freddie are now sitting between a rock and a very hard place. They are guaranteeing trillions in mortgages that are now starting to default, but repossession is no longer profitable. Meanwhile, they still need to make good on payments to investors in their mortgage-backed securities.

What happened next? Well, in short, where do you find a trillion dollars? Really, you don't. Fannie and Freddie fell through, and were saved by massive bail outs from the US central government, driving the government even deeper into debt. The rest, as they say, is history. I'm sure most readers are at least aware of some of what happened but the end result was over 2 million US job losses, millions of people losing their homes, and countless businesses both large and small going bankrupt. In fact, the largest bankruptcy in American history came from this – the Lehman Brothers. An investment bank with over $600 billion in assets and some 26,000 employees.

The big conclusion I think everyone needs to take away from this is that one can blame "bankers" as much as they like, but ultimately, without the availability of very cheap credit from the US government, none of this would have been possible.

What's Next?

What struck me the most about After the Welfare State was not just the reporting of the staggering figures of debt that the welfare state have generated, but also real solutions to this issue. One thing they talk about extensively is something I have never heard about – the existence and spread of "friendly societies" which provided mutual aid. These were societies, and there was a huge number of them. In the UK in 1910 (one year before the British government essentially shut down the benefits of the practice of friendly societies) there were 6.6 million members of 26,877 registered societies (and possibly many more in unregistered ones!). So, what were these societies? There were, in effect, self organising institutions, privately operated by members, to provide some kinds of benefits for some kind of fee. In other words, in exchange for some kind of annual membership fee, a man could actually get healthcare and insurance, along with the other social benefits, in essence, friendship. The best part of this system was financial sustainability.

These societies provided all manner of care – from healthcare, to life insurance, to funeral care, to pensions – any member (and their family) would receive massive benefits. One of the primary ways this was kept sustainable was through strong means testing – you were expected to work, to contribute, and would not receive any benefits if deemed undeserving. The incentives provided to not milk the system for everything it had was enormous. The system maintained itself because the operators of such societies understood that without such measures they would financially collapse. In contrast, government aid encourages people downward – to consume much more than they produce. One of the reasons government aid does this is because it is not designed to help people but rather purchase votes. Secondly, these societies did not have massive amounts of cheap credit available to them. Every penny they had to spend had to be directly raised from voluntary contributions from members. What this means pragmatically is very few malinvestments will be made, or at least, the time preference of the organisations will not be artificially higher than they otherwise would have been. Finally, they are sustainable due to locality. Local leaders of these societies would seek out, for example, young doctors who wanted to build a practice or older doctors who were semi-retired and wanted only part time work and negotiate very favourable prices. The book recounts how in some places in America societies were purchasing healthcare for members at the rate of $1 per capita per year. The US inflation calculator only goes back to 1913, but $1 from 1913 is worth around $30 today. Where can anyone these days get healthcare for $30 a year? (Note, I personally pay around £2353 in taxes per year which directly go to the NHS – not including the rest of my tax!).

The book strongly recommends a return to exactly this kind of system. Doing away with the wasteful and unsustainable welfare state and returning to voluntary and sustainable organisations. After all, it is simply a myth that before the NHS existed in Britain sick people simply died without healthcare. Actually, through such voluntary organisations (and also some charity work through the Church), people were generally very well taken care of.

After the Welfare State is an interesting read which provides some real food for thought. It provides some good analysis of the causes and effects of welfare states, their history, what they replaced, what's in store for us if we don't scrap them, and how we can avoid their disastrous effects. I only wish the book was more detailed – it felt short and surface level for such a huge analysis. I think the next place to go from here is a deeper dive into the friendly societies and the actual health conditions of people before the welfare state. Is it conceivable that with modern technology and modern levels of wealth, such societies could provide people with better healthcare than modern welfare states?