Monday, August 18, 2008

Reforming the Benefits System

In many of my posts I have proposed some radical solutions to some of the structural problems of the UK. You may want to see my posts on education and healthcare. In many ways the following article may appear to be radical, but is only really radical because we have become so used to the current system. However, it is perhaps the most controversial of solutions proposed so far.

The first thing to establish is that the current system is unsustainable in the future that is currently unfolding. The UK can simply not support the 'luxury' of a system that lets people stay idle on benefits. This is to sidestep the debate over 'what kind of society we want to be', because we will simply be unable to afford the current system.

What is the scale of the current problem? I am not going to go into figures here, as the figures for unemployment and how they are calculated is highly contested. All I will say is that it is far, far higher than the headline figure. What I will do, however, is step away from economics (although it is about economic drivers) and enter some muddy and dangerous political waters.

Before starting, a principle has to be established. If you provide economic incentives, and these incentives are perverse, you will get perverse outcomes. The current system provides just such an incentive with perverse outcomes. The problem in question is that of children. Having children in large numbers is currently a way of ensuring that the state gives support. The simple fact is that, if a person has responsibility for children, then they will gain the full financial support of the state, always with a justification that children must not ever suffer. This is a powerful moral argument, and very difficult to deal with. It is a moral force.

As difficult as it may be, the issue must be dealt with. Under the present system there is a perverse incentive to have children as a way of guaranteeing state support. This creates the incentive to have children in order to guarantee security. It is a curious parallel with 'less developed' countries, where having children are also seen as offering security - though with the vital difference that in less developed countries the security is taken from the potential for the future labour of their children. The problem in the UK is that the support that is provided for children of unemployed people is a drain on the state, and therefore a drain on every productive individual and business. The system is one in which children are being born into poverty, and adults are being encouraged into this situation. The more support the state offers for the sake of the children, the more children there will be born into poverty. At some stage the cycle has to be broken leading to the impossible moral dilemma of having to accept that some children must suffer so that others do not. Is there a path through this dilemma?

One thing to consider is that, in order to generate the wealth to support such a system of benefits, the country must be very productive and efficient. However, in order to be productive and efficient, the country must have a sustainable competitive advantage, and that a part of that advantage is an efficient state, and productive workers. Both of these are negated (in part) by a system in which, year on year, the numbers of people claiming benefits slowly increases. Even if the current challenges to the economic success of the 'Rich World' had never taken place, at some point a system of ever more state support 'for the sake of the children' would become unsustainable. In the current situation of intense global competition, the illogic of the system is being exposed more quickly. This does not address the morality of the situation, but does address the fundamental reality. If the current system continues, it will hit a brick wall as there will simply be less money available to support such a system.

At this stage it would be easy to characterise this point of view as heartless. How can anyone propose anything that will see children suffering from poverty? However, this is to ignore the reality that sufficient wealth absolutely must be generated in an economy to sustain such a system, and yet this system is in part a reason why the economy will fail in that task. In sunnier economic times, it was just about possible (just) to have a compromise in which all this was possible, that the economy as a whole could support the unproductive part of the economy. However, times are no longer sunny, and it will therefore be unsustainable.

Here is the real dilemma. If the benefits system continued without the reform of the principle of protecting children, then it would be impossible to create any system where any childless individuals might be subject to bad circumstances without further encouraging people to have children to ensure their own security. Children would simply become an even more important passport to the benefits system. One way or another the principle of benefits to protect children can not survive. If anyone can resolve this dilemma, I would be very interested to hear their thoughts (assuming that you agree with the view that the UK must reform, based upon the idea that we have entered an intensely competitive world).

I will now move on from this subject, and as a reader you have to either accept the economic rationale behind what I have said, or condemn me as a heartless monster (I will at some later stage offer another such situation where I might be so characterised, but for the moment this is the extent of my 'monstrousness'). Also, if you read on, you will see that it is unlikely that many children would ever suffer in the system I propose, though inevitably some would.

Having said this, I believe that overall less children would be born into poverty in the first place under my proposals. With no incentives for living on benefits, less children would be brought up in the benefits system. Furthermore, the system proposed (and this may surprise you) offers more generous benefits in some respects.

Having started with such a controversial point, I will start off the argument for reform with a quote from my essay 'A Funny View of Wealth' as it covers one of the central problems in the current benefit system.
'As mentioned before, all things in the UK are not equal due to the minimum wage, but also because the UK employer needs to compete for labour with the UK benefits system (which is an indirect minimum wage that applies to anyone entitled to social welfare benefits). This system allows an individual to remain economically inactive, or to choose an option of accepting a low paid job for very little real remuneration despite a major increase in the expenditure of their labour. In such cases the value of the labour expended is far below the minimum wage as it needs to be calculated as the weekly pay minus the benefits, to give an actual wage for the work done. The rational person in this situation might reasonably ask whether the loss of their free time to work is worthwhile for what will often be little financial incentive as, in this situation, the UK worker is often working for extremely low wages.'
This situation becomes even more extreme where there is a family involved. Under such circumstance there is the possibility that overall the individual will be working for very little additional income relative to the benefits.

Even more perverse are the benefits provided to those who are in work, benefits to supplement their income. In this situation the government is subsidising the labour of low paying employers. Without raising the wage to a living wage, many people would not be able to support a family and therefore would not take the job (under the current system). This raises the question as to why the government is in the business of offering subsidies for low wages? Whilst a teenager working as a waiter may not need a subsidy, there are many who are subsidised in their employment by the government. How can this make sense? In practical terms, employers who are paying living wages are also indirectly paying the wages of workers of companies that do not pay enough to create a proper incentive for work.

It is all very twisted and convoluted, but I hope that you grasp the basic principle - that perverse incentives are acting upon the market.

So how can this odd system be reformed? No one wants to see people begging on the streets, or children 'going without'. However, in order to retain the levels of employment that avoid this, the economy as a whole needs to be productive and efficient, and that means that the state needs to leave more money in the hands of business and individuals. This is the opposite of the welfare state as we know it.

As for my post on education, there needs to be an element of compromise. A situation in which a person is thrown out of work can not lead them into immediate destitution. It could be argued that they should save for a 'rainy day', a libertarian argument. However, history shows us that those at the bottom of the system often struggle to save enough for such an eventuality. However much people might argue for self reliance, it will always have limits. Those who are poorly educated, and with only a small amount of disposable income will never make such choices. Even in countries with no benefits system, people still do not save if they are at the lower end of income.

The compromise proposed here is that each individual should be given a personal allowance for unemployment. From the moment that a person reaches working age, and has worked for one year, they get an allowance for their entire lifetime, an unemployment account. This allowance is there for them to draw down at any time in which they become unemployed and would be calculated at the annual earnings of the average wage according to predetermined age bands. The allowance would be based upon 365 days of unemployment total, and each day of unemployment would give the individual up to 1/365 of the annual average wage. If they chose to take a portion of that wage, then they would only be debited a proportional amount from their unemployment account.

However, once an individual returned to employment, they would then recommence 'recharging' their unemployment account at a rate of 10% of their salary, paid each month into their unemployment account until they reached the full 365 days level. For the astute, it will already be apparent that what in effect is happening is that the government is offering a subsidised and unsecured loan.

In addition to the loan, another element of the unemployment system would be a process in which the person who becomes unemployed would also be immediately have returned their last three months income taxation. This would be paid in three lump sums over the three months following being made unemployed, and would still be counted as having been paid, despite being returned, if they gain employment in the tax year. This is to aid with the additional expenses of job hunting, and to offer a minor breathing space for higher earners with potentially higher outgoings (notwithstanding that higher earners should be in a position to save, some recognition of their higher net contribution seems fair).

One of the obvious problems with such a system is that some people might use such a loan to have a long holiday, or otherwise misuse the system. In order for a person to be given the unemployment allowance, they would need a letter from their employer that stated clearly that the person was made unemployed, with the employer liable for repayment of the money in the event that they lied in saying they made the person unemployed.

What happens if a person deliberately gets fired so that they can take advantage of the system?

Employers will be given an opportunity to identify cases where they believe an individual deliberately sought to be fired. Such cases would be investigated, and if it was believed that the individual deliberately acted in a way to lose their job, then the benefits would be withheld. It would probably not take many cases before the risks in such an approach became apparent, with the effect of making this kind of behaviour unlikely.

So what happens to those who exceed their allowance of one year of benefits?

Quite simply, they will need to fall back on charity, friends and family. In the traditional usage of the word, they will be destitute.

What about a young person who is having trouble finding their first job?

I have already outlined the education system in my previous post. If a person is unable to find a job then they will have the option of continuing education, provided they can be funded for this. If they can not either find an educational opportunity or work, they will be destitute and reliant on charity, friends and family.

Why include those who earn enough to save?

I start from a principle that everyone who is part of the system should be subject to equal treatment. As more wealthy people will be providing a larger proportion of the subsidy that the loan represents, they should at least be able to benefit from the same system.

Isn't this very harsh?

I am not sure that it is. It still provides a safety net, but also encourages individuals not to claim benefits unless absolutely necessary. Whilst an individual is unemployed, they will be well looked after. However, the cost of such care will be minimised.

The advantages in such a system is that it returns to the original principles of welfare systems, that it offers a safety net, and a good safety net. Being unemployed will not lead to impoverishment unless it is over a very long period of time. Even in a situation of deep recession, a person could extend their benefits over a longer period through not drawing down their full allowance. In fact they will have an incentive to only draw down the minimum, as it will have to be repaid.

Furthermore, with the time limitation, and the requirement to recharge the account, there is always a strong incentive to get back to work as soon as possible. Only the truly feckless would lose out in such a system and hard working people would have a safety net that would not only protect them, but would also protect them well. It would also provide a strong incentive for those that can afford to save for 'rainy days' to do so.

Lastly, it would be a much cheaper system, as the money would nearly always (one way or another) be paid back, with the only cost being the interest for financing the system. In an extreme example, it might even be possible to charge interest on the unemployment benefits paid out, though I am not proposing that here. Unemployment is a miserable enough experience without loading the cost with interest (possibly a rare sentimental point of view).

As with all my solutions, I welcome challenging questions, as such questions might highlight weaknesses I have not seen.

Note: Regular readers will have noted that I have still not continued my discussion on government spending and the Comprehensive Spending Review. I do have a partially finished version in draft, but thought is was time to address another positive solution. I will (eventually) get back to the review.

Note 2 Added 19 August:

I have not mentioned sickness benefit in the above post, and this is a major omission for which I apologise. There are widespread reports of doctors being 'sympathetic' to unemployed people and putting them on sickness benefits. As such, these benefits would only be granted when a person has seen a doctor appointed by the benefits system. They would also be required to attend the doctor at regular intervals, dependent on their condition, to confirm that they are still too sick to work.

For some conditions, there would be a maximum period of time for them to be allowed to claim, such as depression or injuries such that a person can not undertake manual work. Whilst there are some conditions that genuinely preclude work (which should be treated sympathetically) there are many types of work that can be undertaken by people who have less serious conditions, such as back trouble, where the person can retrain and find new work.

For those that are in a position where their sickness is short term, the benefits should be identical to the unemployment benefits system. For those who have sickness that is likely to be long term (greater than three years), the level of payment will need to be lower. Whilst this may appear as a 'punishment' for illness, it is actually just a recognition of the likelihood that the money provided will be unlikely to be paid back. As such, the cost to the state will be much higher and, in real terms, the benefit received will be higher (as they will not just be benefiting from an interest free loan, but will be benefiting from real cash sums). In addition, in some cases, there may be a need for grants for equipment which will be a further cost for supporting the long term sick.

As for the amount of payments it is difficult to give a formula here, as it depends on what level of payment would be needed to provide an acceptable life in different economic circumstances, and the family situation of the individual (in this case, having children should matter). As a ballpark, up to 2/3 of the national average wage would probably be reasonable. In order to afford such costs, the eligibility for sickness benefits would have to be rigorous, but that is the point of having independent assessment and clear delineation of what sickness genuinely precludes working. In a system that only awards the benefits from those genuinely precluded from work, the level of benefit can be higher than at present and still cost less overall.

Note 3 Added 19 August:

Inevitably, one of the problems with the system outlined will be the transition. One year on from implementation there would be a rash of horror stories in which families fell into destitution. There is no real solution to this. It is one of the reasons why genuine reform is so difficult. There are many people living on benefits who probably simply would not believe that the state would abandon them to their own devices. For such people, there is no solution except destitution to make them realise that they do need to contribute, and not just take. As a result there will be some heartbreaking stories one year on, and this would lead to campaigns, headlines, and a media circus. As with many reforms, it would require courageous politicians to implement the reforms. That is a matter beyond the scope of this post.


  1. Hi Mark,

    A very interesting post which I find it hard to disagree with. But I do have one question: do you think that the UK's population is too high or too low?

    I understood that until a few years ago in the UK, the population was actually falling, but this was reversed by encouraging immigration from central Europe. The situation is supposedly similar across Europe.

    I can see that there would be a difference in the 'economic productivity' of children brought up by responsible, educated parents, and those of drug-addicted teenagers on run down estates, but most people seem to think that a falling population is a bad thing, economically.

    I imagine that in a country with no perceived absolute safety net, and no apparent state encouragement to have children, it would be the most educated and responsible 'middle class' who would forego having a family.

    Could it be that nature has been bypassed by the increasing availability of contraception, so we are in a relatively new situation for which many of the traditional economic theories might not apply?

    So do you think your scheme might suffer from a tendency to reduce the size of the 'middle class' population? Could it be modified slightly to offer incentives to have children, but only if the parents were demonstrably unlikely to become unemployed, or is that, again, tampering with 'the market'?

  2. Have you ever wondered why market fundamentalists are almost universally in favour of "open borders"? One answer is given by Milton Friedman, when he said that it is impossible to have both open borders and a welfare state. In what follows I will talk about the "welfare state" as encompassing child support, unemployment benefits and health care together, for reasons which I hope will be made clear.

    The Chinese health care system is probably the most brutal I have ever come across anywhere in the world, and would make M.Friedman proud. Basically there is **no** guaranteed access to medical care. Literally. If you are involved in, say, a traffic accident, you will be left to die on the street, unless you are, or someone else (in case you are unconscious) is willing to guarantee payment for an ambulance to come and pick you up and take you to an A&E ward in hospital. Even if you manage to crawl to a hospital, you will not be allowed inside unless you pay a deposit toward the costs of your treatment. Same goes for any other form of medical service.

    There are some mechanisms which mitigate the brutality of the system. Members of the government, police, army, fire brigade etc. have their own network of medical facilities which provide health care for them and their extended families. Employees of state-owned enterprises also have insurance coverage. Private enterprises often insure their employees. For permanent residents of cities such as Shanghai there are various voluntary municipal insurance schemes, which can cover a large part of the costs of treatment.

    But what really prevents this from becoming some horrible Darwinian dystopia is the structure of Chinese society. To put it briefly, every Chinese individual operates within extremely complex and extended networks of family and friends. Membership in such networks carries with it very specific rights as well as duties. This structure is probably hundreds if not thousands of years old, and is totally internalized in the Chinese psyche. There is no analogue to such structures in modern Western societies. In times of crisis, an individual can draw upon the resources of his networks. The traditionally extremely high savings rate of the Chinese also contributes to the effectiveness of their networks. The networks can also be utilized for other purposes. I've seen a couple of cases in which a very large extended family put up a lot of money to finance the foreign education of one of its more promising children. Of course, the sacrifice of the group for that child is expected to be paid back in the future in some way (not necessarily in money). It is a group investment.

    As Mark noted in one of his posts, this "structural" feature is a major contributor to the competitiveness of the Chinese economy. It is not just low labour costs. But to a sentimental Westerner like me, enough people visibly "fall through the cracks" to make the system really unsympathetic. The Chinese are immune to it - in their culture there are no universalist superstitions about the "brotherhood of man"; what counts is family and people within your network - everyone else is just a competitor for scarce resources. The people at the bottom of the pile (and believe me, their plight is often absolutely heart wrenching)are too weak to do anything about it (if they were, they wouldn't be at the bottom). This confers a measure of stability to the entire structure - enough people are covered in one way or another to prevent massive discontent.

    Another feature of the Chinese system worth noting is that it is "self policing". Because all the links in the informal networks are personal, "free loaders" are immediately punished. This makes the networks efficient (in an economic sense).

    For reasons which are obvious, the Chinese model is not transposable to western societies. My hunch (and it is only that) is that no welfare scheme is sustainable without some mechanisms for self policing to prevent abuse, and this self policing must come from society itself. In the past, things such as the social stigma associated with having children out of wedlock would prevent the massive abuse of welfare benefits for unwed mothers. In some societies, such as Japan, being unemployed is (or has been) an object of shame for the individual and his family. Some years ago, I saw ex-bankers working as taxi drivers in Tokyo, after the Japanese banking crash (they made terrible taxi drivers). I doubt whether I shall ever see a similar situation in London.

    The other condition for a sustainable welfare system is what may be called "national solidarity", i.e. a willingness on the part of the more affluent parts of society to support the less affluent. This is something which is quite apparent in countries such as Germany.

    Unfortunately, the trends in the development of Western societies lead us away, rather than toward conditions which would support a sustainable welfare system. Our societies are consistently atomized into selfish, pleasure-seeking "consumers". Traditional and moral restraints are dismantled, community bonds are eroded, any sense of communal or national responsibility is disappearing and so on. The situation is particularly bad in the UK, where traditional class divisions are augmented by the dogmas of "multiculturalism" and massive foreign immigration. But let us not go there...

    P.S. Sorry for the recent volume of comments from me. I'm taking advantage of the fact that during the Olympics, the PRC has relaxed its internet censorship. In the past I found that was often blocked, and posting comments via a proxy server was iffy at best


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