The logical foundations of social policy in the liberal society: Rethinking the welfare state

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Martin-Luther-University

Halle-Wittenberg

School of Business and Economics

Bachelor ThesisThe Logical Foundations of Social Policy in a Liberal Society:

Rethinking the Welfare State

Fanny Paschek Advisor: Prof Dr. Ingo PiesZschillestr. 1 Chair of Economics & Ethics01558 GroenhainPhone: 0172-9713883 Matriculation Number: [email protected] Submitted: 18th of September 2009
mailto:[email protected]:[email protected]:[email protected]


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The Logical Foundations of Social Policyin a Liberal Society

Rethinking the Welfare State


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Table of Contents

I. Introduction

II. Friedrich A. Hayeks Political and Social Philosophy

2.1. The Constitution of Liberty

2.2. The Logical Fundament of Social Policy in the Order of Freedom

2.3. The Welfare State under the Constitution of Liberty

III. James M. Buchanans Political Economy

3.1. Social Contract Theory and the Role of the State Within

3.2. The Logical Fundament of Social Policy in the Constitutional Order 3.3. The Reality of the Contemporary Welfare State

IV. Social Policy for the Market - Rethinking the Welfare State

4.1. Contract Theory as the Fundament of Social Policy for the Market

4.2. The Logical Evolution of the Social Order

4.3. Rethinking Social Policy as Overcoming Dilemma Structures

4.4. The Benefits of Cooperation

V. Conclusion

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List of Figures

Figure 1: Rethinking the Welfare State as a Social Dilemmawith the Solution of Orthogonal Positioning

Figure 2: Private and Public Institutional Forms

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The true end of Man, or that which is prescribed bythe eternal and immutable dictates of reason, and notsuggested by vague and transient desires, is thehighest and most harmonious development of his powers to a complete and consistent whole. Freedomis the grand and indispensable condition which the

possibility of such a development presupposes; butthere is besides another essential, intimatelyconnected with freedom, it is true, a variety of situations.1

Wilhelm von Humboldt (1767-1835)

I. Introduction

Liberalism seeks to create a society of [f]reedom, democracy, peace, and priva te property [...] , as the external factors allowing for the promotion of happiness and welfare of

all members of society. Through the satisfaction of all physical needs, the liberal societyallows for its citizens to aim at the development of their inner life, which constitutes theultimate end of the liberalist movement.

The apparatus of the state plays a crucial role in the organization and continuedexistence of civilization. He assumes the task of the monopolist in coercion to enforceexclusive proper ty rights and the citizens delimited private sphere, as these constitute the bases of freedom in society. Exchange in private markets becomes possible on these grounds,only. Furthermore, the state legitimately engages in the provision of public goods, which

cannot be adequately allocated through the market mechanism. In this productive activitygovernment is concerned not merely with the satisfaction of the needs of the collectivity, butit also aims at the reduction of unnecessary uncertainty, which every individual faces.

Social policy constitutes but one part of the productive function of the state in theliberal order, yet, proving to be an essential factor in the workings of a market economy.Traditionally, the social state is reconstructed as subs tituting for the market where the pricemechanism fails to achieve efficient allocation. This misinterpretation has let social policy tofail in its original purpose, the facilitation of market processes rather than their replacement.

The idea of this thesis is to provide for a different view on social policy and itsrealization in the modernliberal society. In reference to The Constitution of Liberty (1960),the first section of this paper will illustrate the logic and design of the welfare state in theliberal order based on the political and social philosophy of Friedrich A. von Hayek. In thesecond part, the paper will shed light on the constitutionalist-contractualist legitimisation of the productive state, as proposed by James M. Buchanan. The third component of this thesiswill, in turn, elaborate on the contemporary theory of social policy for the market, therein proposing a logical fundament on which we can rethink and ultimately reapply welfare

politics in the realisation of a truly liberal social order.1 Humboldt (1792)


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II. Friedrich A. Hayeks Political and Social Philosophy

The first author to be examined on his stance regarding the liberal order and the role of the welfare state within is Friedrich August von Hayek, an economist and social philosopher

of the Austrian School. Aiming to advance the liberal theory remaining true to the mindset of traditional liberalism he joined his teacher Ludwig von Mises in the effort to revise andreintroduce the liberal doctrine and its values at a time when [f]reedom and l iberalism [had]

become terms [...] used to describe the exact opposite of their historic meanings. 2In this pursuit Hayek set out to restate the bases of a Constitution of Freedom .

2.1. The Constitution of Liberty

The Liberal Order of Freedom and KnowledgeUltimately, liberalism strives to promote the welfare of society as a whole through

creating the external conditions which allow for the internal development of all members of society. In his book The Constitution of Liberty , Friedrich August v on Hayek depicts theliberal social order in which freedom itself is both mean and end of human cooperation. Thefacilitation of individual freedom is of greatest importance to Hayek as he designates thisvalue to be the source of all progress. In his mind, [...] civilization begins when theindividual in the pursuit of his own ends can make use of more knowledge than he has himself acquired [...] 3, by employing mechanisms like trade and specialization. This readily availableknowledge, although dispersed throughout the whole of society, grants each individual adegree of ignorance, which is of necessity when trying to efficiently realise individualobjectives. From the unhampered exercise of personal liberty new knowledge beneficial to thewhole of humanity may arise fostering the constant technical and intellectual progression of society as well as the enhancement of the general welfare of all citizens. This incalculable progress can be secured only by granting greatest possible freedom to all individuals as one

can not foresee [...] what freedom a person might need in order to do things beneficial tosociety. 4 Therefore, the liberal order seeks to establish and preserve an exclusive privatesphere to each member of the collectivity.

The Coercive and the Non-Coercive State

The indispensable sphere of private action, and therefore the individual liberty, isespecially endangered by the threat of coercion in human relations. Now, according to Hayek

2 Hayek (1939; p.1)3 Hayek (1960, 2006; p. 21)4 Hayek (1960, 2006; p. 29)


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in these situations [...] coercion of one individual by a nother can be prevented only by thethreat of coercion. 5 Hence, the free society is to appoint the state as the monopolist of coercion in order to warrant that only minimal coercion is carried out in the most objective

fashion possible. As all monopolies this one, too, poses a danger to the freedom of individuals, which is why a general framework of rules is to govern the states exercise of its

coercive powers. Such legal fundament is not merely of importance to allow for aconstitutional safeguard against governmental arbitrariness, but rather for creating a legalenvironment within which individuals can plan their activities independently facing legalcertainty as to what the implications of their actions are.

Apart from the coercive activities of the state aimed at preserving the order and theindividual freedom in it government also fulfils a wide range of pure service activities inliberal society. Hayek aptly circumscribes this non-coercive task as planning for freedom ,conveying just how substantial government activity is in this case. In its non-coercive role thestate is to employ reason in encountering the problems of social cooperation. Hayek, confinesthis purposeful planning to the design of a legal framework of rules that governs the game

of social interaction, while [...] individual initiative is given the widest possible scope and

the best opportunity to bring about effective coordination of individual effort 6 as thestrategies within the game can be chosen freely. The essential purpose of such rules is to avertunnecessary uncertainty, which may encumber the rationally risk averse individual in the

pursuit of his aims and objectives. Hayek especially warns of the dangers of central planning,although he admits that some such action may be required when it comes to the provision of public goods characterised by extreme jointness and non-excludability. However, in the samecontext the author ascertains that the price mechanism need not [...] be supplanted where the

conditions for its working exist or can be created 7 as the spontaneous collaboration inherentin the market may serve societys purposes much more efficiently.

Hayek can therefore be classified as an advocate of ordoliberalism in hisdifferentiation between loosely planning the rules of a game and the central planning involved

in deciding on moves within the rules of the game. An important point to be taken notice of isthat Hayek addressed the problematic of (social) justice with the same logic. It is not equalityor justice in the ultimate outcomes of market of governmental action that his liberal programme strives for, but rather justice in the processes generating these outcomes. To himthe determination of general rules equally applicable to all people and imposed for a long time period constitutes a just framework with just outcomes arising thereby.

5 Hayek (1960, 2006; p. 122)6 Hayek (1939; p.9)7 Hayek (1939; p.13)


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2.2. The Logical Fundament of Social Policy in the Order of Freedom

The Scope of Government Action

The political strand of the liberal doctrine has often been reproached for its anti-interventionist maxim and its advocacy of the minimal state. Hence, the author is determinedto shed a very different light on the misconceptions involved. There is no denying thatliberalism is to reject interventionist measures as it is to be f eared that [...] the centraldirection of economic activity might involve the destruction of freedom and of democraticinstitutions. 8 Hayek conforms in this conception with his teacher Ludwig von Mises, whoreproached policies of interventionism for being senseless, self -defeating [and] absurd [...] 9,ultimately posing as mere steps in the transformation of capitalism into socialism 10. As

radical as these assertions sound, they are in line with the general thought of men like JohnStuart Mill or Adam Smith who were also enthusiastic defenders of maximal freedom ineconomic activity. In The Constitution of Liberty Hayek urges critics to take a closer look

at the message that was actually being conveyed through these statements. The classicalliberals as well as Hayeks contemporaries did not refute government action on principle, butrather the interference of government against the rule of law and the infringement of the basicrights of members of society through the state. Therefore, conformity to the rule of law posesas one criterion for adequate government policies. A character that is non-infringing on the

private sphere of individuals is a second provision. And as long as proposed measures fulfilthese most basic requirements they cannot be refuted as acts of interference, but must betested for expediency. Considering this clarification of the non-interventionist imperative[t]he range and variety of government that is, [...], reconcilable with a free system is thus

considerable. 11 In his book Hayek rules: It is the character rather than the volume of government

activity that is important 12. The broad scope of possible state activities offers a number of policies that are indeed expedient, but at least as many are of detrimental nature. In the mindof the author, the basic mean to distinguish one from the other is represented in the rule of law. This superiority of the legal framework is based on the liberty it preserves for theindividual in the liberal society. In that respect, the legal certainty and the possibility for planning and adapting individual actions are but two important points provided for under therule of law. It is to be kept in mind, though, that the criterion of conformity to law is anecessity but not a sufficiency for the approval of policy measures. Activities that prove in

8 Hayek (1939; p.5)9

Mises (1927; p.85) and Hayek (1939; p. 17)10 Mises (1980)11 Hayek (1960, 2006; p. 202)12 Hayek (1960, 2006; p. 194)


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accordance to the moral law might still turn out to be inefficient when tested for expediency.On the other hand there will be efficient policies that will not be deemed realizable under arule of law. The vigorous admonition that liberals express in this context is simply that inorder to preserve the freedom of all in liberal society government is to refrain from enacting policies that are not in accordance to general rule of law and which are therefore considered to be of arbitrary nature. In this sense, even a majority supporting an unlawful activity to becarried out by the state cannot be considered enough to legitimize the pursuit of such. A practice like that carries the danger of opening the floodgates for further arbitrary desires of an oppressive majority. As a last consequence the recurrent contempt for the rule of lawwould effectively abolish it as the superior safeguard on individual freedom, and with it thevery foundation of a liberal order.

Three Categories of State Action

In essence, it is of great necessity to distinguish clearly favourable policies fromdetrimental or merely inexpedient ones. The basic logic with which Hayek differentiatesamong possible government activities has been laid out on the fundament of moral law. Usingthis rationale the multitude of government activities can be separated into three distinctcategories ranging from operations that are essential for a working market economy and tasksthat are on principle compatible with the free economy, to acts of interference that effectively

cripple the market forces.(1) First and foremost, there is the category of pure service activities in where

coercion does not enter [...] 13 although the coercive measure of taxation may be used in order to finance the provision of such. This category is limited to non-rival and non-excludablegoods, which naturally would not be supplied by the private sector. However, the practicability still has to be tested in order to avoid measures that do not balance costs and benefits to society as a whole. Common examples of this class include the establishment andsupport of a reliable monetary system, the introduction of standard weights and measures, the processing and provision of information for citizens and [...] the support, if not also theorganization, of some kind of education. 14 These activities pursued by the state constitute themost basic ones he is to fulfil in his non-coercive role. They are deemed essential to theworkings of the free economy and their provision through the state can therefore not berelinquished. Other types of material service belong also to this rubric including the buildingand upkeep of infrastructure, health services and sanitary provisions as well as a lot of theamenities, which municipalities offer their residents. These provisions are especially

13 Hayek (1960, 2006; p. 195)14 Hayek (1960, 2006; p. 195)


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characterised by their invaluableness not in terms of costs but rather in terms of benefit tosociety. Hayek further qualifies the description of this type of activities; hence governmentmay at any moment be best qualified to take the lead in such fields, [...] 15. However, fromthis general suitability one cannot infer that the organ of the state has and remains to haveexclusive responsibility of pursuing such activities. The danger in Hayeks eyes [...] is notstate enterprise as such but state monopoly 16. Productivity and efficiency in this sector, justas in any private sector, can be increased through the government assuming the role of afinancer while leaving the realisation of the particular project to private and competitiveagencies. Other state enterprises may also just be opened to general competition from privateagents, though in this case special advantages, e.g. subsidies, have to apply to both public and private providers.

(2) A second category of governmental operations is concerned with administrativetasks, e.g. the establishment of so-called factory-legislation , frameworks for theimprovement of work environments, governing production techniques as well as health andsafety standards. Building regulations may also be included in this category.17 Before suchregulation can be ordered they remain to be tested on whether they are deemed reasonable interms of overall costs and benefits. For purposes of efficiency these sets of rules are to be keptas general as possible in order to allow for a reasonable degree of discretionary power on

behalf of the government. However, [...] this need not be discretion unlimited by general

rules [...] as the safeg uard of judicial review remains in place to guarantee that singlemeasure are in adherence to the moral law.

(3) The third and last rubric of state action encompasses all governmental measuresthat are not realisable under the rule of law [...] because they cannot be achieved by merelyenforcing general rules but, of necessity, involve arbitrary discrimination between persons. 18 Such policies involve the state taking on the role of a planning agency, deciding andcontrolling the means of production, the persons to carry out this production or the terms of sale. In coherence with this, Hayek especially stresses the incompatibility of price and

quantity controls with the free market economy as arbitrarily determined prices throw supplyand demand off balance, while the signalling effect of prices on production is also renderedinoperative. Moreover, [...] this kind of controls [...] must in their very nature be

discretionary and arbitrary and [...] must be altogether excluded in a free system [...] 19.

15 Hayek (1960, 2006; p. 196)16

Hayek (1960, 2006; p. 196)17 Hayek (1960, 2006; p. 307, et seq.)18 Hayek (1960, 2006; p. 199)19 Hayek (1960, 2006; p. 200)


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2.3. The Welfare State under the Constitution of Liberty

From this general classification of the governmental productive efforts one can nowdetermine the legitimate role of the welfare state in the liberal society. According to F. A.

Hayek these state activities are to constitute part of the first class of productive efforts (1) asthey are not just feasible in a liberal order, but rather essential to the workings of the freeeconomy. The services provided for through the welfare state are to contribute to theendeavour of planning for freedom as they should aim at fostering the viability of the

market by eliminating avoidable uncertainty that individuals may be facing in the competitiveorder. For Hayek himself the institution of these social provisions is unquestionable in themodern industrialised societies, if [...] only in the interest of those who require protection

against acts of desperation on the part of the needy. 20

Just like the realm of general public policy the welfare state, too, can take on a varietyof different operations to foster an efficient market structure. Though, the author remainsunambiguous on the condition of these activities being carried out without the use of coercionvolume and diversity of possible measures are not restricted by any particular criterion. Aslong as proposed policies prove in accordance to the rule of law and stand the test for expediency there are no explicit limits to the means and methods that can be employed toincrease individuals welfare in the compet itive market economy. Moreover, as the liberalsociety allows for perpetual technical improvement and continuous enhancement of theoverall wealth the current state of affairs concerning social policy should not be consideredthe end of the flagpole.21 Since more freedom in economic and social affairs allows for greater gains from trade individuals will be inclined to socialise part of the increase in generalwelfare to continually extend the socially beneficial welfare state in order to evade further uncertainties involved in market exchanges.

The Problematic of Social Justice

Taking into consideration the very nature of this dynamic, it strikes the author as peculiar that many members of the contemporary society want to do away with the safeguardson the freedom that drive this constant progress. The reason can be found in a relic of thesocialist era biasing public policy, namely that of distributive social justice. However, theliberal government, which is restricted in its use of coercion, does not command the powers todetermine the material position of particular people or enforce any kind of distributive or

social justice. 22 In essence, such justness can only be achieved through surrendering parts

20 Hayek (1960, 2006; p. 249)21 Hayek (1960, 2006; p. 202)22 Hayek (1960, 2006; p. 203)


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of the individual private sphere and therefore individual freedom to the state. A sharpcontradiction exists, as Hayek offers to explain, [...] between the ideal of freedom and the

desire to correct the distribution of incomes [...] 23 for the purpose of increasing justice. The justice to arrive at would be legitimised only through the decisions of government which inturn raises the question of what is easier to bear: the injustice of a natural distribution of wealth or the injustice arbitrarily imposed by a discretionary government? Due to the fact thatmany advocates of distributive justice are not aware of the principal incompatibility of their aims with the rule of law circumvention of the same have become a habit.

Following from these premises the repeated neglect of the rule of law in modernsocieties can be reconstructed, though not reasonably understood. Hayek determines that [...]the traditional limitations upon the powers of the state have been rendered inoperative, by the

workings of the socialist utopia, leaving the governmental body in a state of power that needsto be restricted in order for the liberal society to thrive. Writing a great many of his books,24 F. A. Hayek especially attended to the errors and the imminence of the socialist order considering both the hot and the cold so cialism.25 In examining the socialist tendencies inthe contemporary politics of the welfare state the advocate of the Austrian School clearly sawa great deal of danger arising [...] not so much [from] the aims as [from] the methods of

government action. 26 The Constitution of Liberty incorporates this criticism as well. And,although Hayek shows himself convinced of the fact that [...] socialism has been generally

abandoned as a goal to be deliberately striven for [...] , he is at the same time quite wo rriedthat [...] we shall not still establish it, albeit unintentionally. 27

Hayek continues to emphasize the importance of the methods employed as opposed toa mere judgement of the ends these serve, since the pure desirability of a distinct aim is oftenconfused to justify all possible measures to reach that aim. Methods, which are based on theexertion of governments coercive strength to secure the state a monopolist position of some

kind, pose in fact a threat to freedom and the liberal social order. It is in this conception thatthe economist and social philosopher outlines a number of tasks that are to be assumed by the

liberal government in the pursuit of a comprehensive welfare state.

The Social Security Apparatus

According to Hayek, the system of social security has been thrown off balance due tothe creation of a detrimental incentive structure in the pursuit of distributive justice . It is as

23 Hayek (1960, 2006; p. 203)24 The Road to Serfdom (1944), Freedom and the Economic Order (1948), Law, Legislation and Liberty

(1973-79), The Fatal Conceit (1988), 25

Hayek (1960, 2006; p. 224), i.e. the passionate pursuit of the socialist ideology as opposed to the moreobjective aspiration for distributive justice and social security26 Hayek (1960, 2006; p.225)27 Hayek (1960, 2006; p. 224)


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a means of socializing income [...], that the welfare state has for many become the substitutefor old-fashioned socialism 28, as the author puts it in his publication of The Constitution of Liberty . In its original purpose it was intended as a comprehensive system of social

insurance in order for the individual to make provisions for the case of retirement, sickness or unemployment. In accordance to Hayek, his insurance structure has largely been turned into amere system of transfer payments out of the pockets of the productive population into the pockets of citizens, which are unable to maintain themselves. Furthermore there has been ashift from providing a minimal alimentation to securing an adequate standard of life. This

just distribution is provided partly without verifying the actual indigence of the beneficiary.

However, the author argues that this procedure is irreconcilable with a liberal statesince it assumes discretionary use of the governments coercive powers to determine the

just position of everybody 29. Again the arbitrary powers exerted by the body of the state prove not in line with the moral law, posing a threat to society as a whole. As a resolution for the continued existence of the liberal order, Hayek proposes a compulsory insurance structure providing for the needs in old age, during sickness, unemployment, etc. Compulsion in thiscase is only justifiable as it protects from the even greater coercion exercised by individualswho do not provide for themselves and who will in effect become a liability to the public. Incoherence with this, the author advises the state to finance and assist the development of appropriate institutional structures, though desisting from continuous supervision.30 It is

important to refrain from a national monopolisation of the social security structures as ahealthy degree of competition in these fields allows for the constant production of [...] new

answers to current needs, answers which no advance planning cancontemplate. 31 A first target of examination is posed by the provisions for the unemployed. As Hayek

apprehends, the nature of these provisions will very likely be [...] one of the most important

factors determining the extent of unemployment. 32 From the basic liberal notion of equaltreatment for all under the rule of law the provisions for the unemployed have to target both,the victims of sudden changes in the demand for labour as well as workers that face

foreseeable seasonal fluctuations in their trade, in the same manner. In Hayeks perceptionthese cases of unemployment can only be coped with if the workers themselves display ahealthy mobility while wages are to remain reasonably flexible. In contrast, a system whichguarantees unemployment payments at a certain percentage of the former wage effectivelyreduces both the flexibility of general wages as well as the mobility among workers. Fromthis reasoning Hayek advocates a genuine insurance structure [...] in which the different risks

28 Hayek (1960, 2006; p. 251)29

Hayek (1960, 2006; p. 252)30 Hayek (1960, 2006; p. 249)31 Hayek (1960, 2006; p. 254)32 Hayek (1960, 2006; p. 261)


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of various trades are reflected in the premiums paid. 33 The risk of unemployment in a particular trade is then pooled among all workers in that occupation. Resulting from this, thelabour supply in these fields will tend to regulate itself as opposed to the situation in whichgeneral redistribution schemes allow for the subsidization of employment beyond theeconomically desirable point. Generally, for the case of unemployment, social security is toinclude a minimal and uniform provision for all individuals unable to support themselves.This assistance is to be bound by proof of actual neediness, since claims do not result fromcontributory payments and consequent entitlement to such a provision. The further provisionfor an above-minimum standard of life should be individually provided for with the help of competitive agencies and unemployment insurances. Hayek even suggests that the labour unions could contribute a fare share in organising such assistance for their members.34

A further effort of the welfare state consists in the provision of medical treatment for the obvious reason that health care is part of securing the general livelihood of each citizen. InHayeks mind, the nationalization of health care carries not only the risk of mere

monopolisation, but also thedanger of uncontrollable invasions of the patients private sphereas doctors in effect become servants of the state. Just as inconceivable proves the idea of ahealth care apparatus free-of-charge as there exists no reasonable standard of which medicaltreatments can and should be provided for every single member of society. Such standardcould [...] at most, be the bad average standard of service that can be provided equally for

all.35

Hayek, in turn, strengthens the case for a system based on insurance. Utilising suchcompetitive structure enables each agent to secure for himself additional care and treatment, if he deems the added expense worthwhile. The author therefore advises to review thenationalisation of health care, because a competitive health insurance market, in which thestate may still partake as a competitor among many, is likely to serve the individual better.

The pension system constitutes one of the most important branches of the socialsecurity net. Next to the established provisions for old-age, this category also includes

payments made to otherwise disabled or unemployable people, and all kinds of dependents

provisions. In Hayeks eyes the serious issues arise from the states effort to provide

adequate old -age benefits as opposed to a fair minimum. Generally, such provisions are not paid from the accumulated capital based on prior inpayments of the beneficiary. To thecontrary, these pensions constitute mere transfer payments from the currently productive tothe unproductive, since individuals gain a claim irrespective of prior contribution or actualneediness. This constitutes the absolute relinquishment of the insurance character of thisassistance turning the complete welfare state into [...] a play ball for vote -catching

33 Hayek (1960, 2006; p. 262)34 Hayek (1960, 2006; p. 262)35 Hayek (1960, 2006; p. 260)


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demagogues 36, as the author puts it. However, in case of the contemporary pension systemHayek does not see an immediate point of vantage for reform. In his view, the establishedsystem has actually managed to put a [...] strait jacket on evolution [...] 37 since current benefactors generate their own claims in paying off the claims of current retirees. In thissense, Hayek remains definitive in honouring the claims that are in existence even if thesearise from institutions that are not in accordance to the liberal fundaments.

In conclusion, the author deems the liberal society capable of providing a minimumassistance to all individuals in need. This general level of welfare is, nevertheless, to be boundto proof of actual neediness. Any provision beyond the subsistence level has to be securedindependently through the help of competitive insurance structures or private investment.

Education & Research in a Society of Progress

The issue of education represents a further important feature of the welfare state in thefree society. As Hayek puts a great emphasis on the role of knowledge in the constant

progress of the liberal state he also recognizes governments obligation to finance a

compulsory standard of education for its citizens. This however does not mean that the stateshould also run the particular institutions that provide for schooling and research. In Hayeks

mind the educational system put into place is not to be state-dominated although [...]government should prescribe some of the content of this education. 38 In an attempt to

formulate a concrete policy proposal he points to Professor Milton Friedman who advocatesthe financing of school vouchers from government coffers allowing parents to send their children to a school of choice within a private and competitive education system.39 The

principle of academic freedom does not stop short of research and higher education within

universities. Though, centrally financed institutions of higher education managed to remainlargely independent from governmental influence in their research endeavours the author

proposes that a [...] multiplicity of private endowments [...] 40 would be more beneficial infinancing scientific progress. Hayek further expresses the idea of subsidizing higher educationin areas where additional training will not necessarily result in higher earnings for the beneficiary (i.e. medicine, engineering, law, etc.). On the opposite side the economistchallenges people who partake in vocational training that is likely to increase their prospectiveearnings to view their expenses as investment. Therefore such education should rather beoffered financing on credit instead of public subsidies.

36 Hayek (1960, 2006; p. 257)37

Hayek (1960, 2006; p. 264)38 Hayek (1960, 2006; p. 328)39 Friedman (1955)40 Hayek (1960, 2006; p. 339)


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III. James M. Buchanans Political Economy

3.1. Social Contract Theory and the Role of the State Within

In his book The Limits of Liberty: Between Anarchy and Leviathan , the American

economist James M. Buchanan elaborates on the bases of freedom in the liberal society. Inconformity with Friedrich A. von Hayek, the author upholds the value of freedom as a basic premise for social cooperation, which in turn serves every single agent to achieve hisindividual objectives most efficiently.41

Buchanan identifies a process of social contracting to be of huge necessity for designing the fundament of cooperation among people. Social contracting which the author describes to be a process of negotiating, that includes all of societys members, is applied at

two stages according to Buchanan: (1) The constitutional stage, at which the initialassignment of individual property rights takes place and (2) the post constitutional stagecharacterized as commencement of the negotiations aimed at reaching agreement on the jointconsumption of services and goods by the societal community.

Buchanan models the preconstitutional setting to mirror the natural state as proposed by Thomas Hobbes in his Leviathan . This anarchic state of humanity is characterised by the

absence of any kind of law. Given the scarcity of resources and the inequality in mens

production capabilities and consumption habits, disputes among the inhabitants become

inevitable in the state of anarchy. Predatory as well as protective behaviour will become thenorm amongst all individuals in this setting. Nevertheless, both thievish and protectiveactivities are always borne by the production function as these activities consume both timeand energy, which cannot be used for the production of consumable goods. As equilibriumarises from the individual adjustment to this war of all against all 42 humanity arrives at the preconstitutional stage of social contracting.

Merging into theconstitutional phase of Buchanans contract theory a first law isemployed: A comprehensive agreement on disarmament will arise as individuals come torealise that the effort spent on stealing and securing goods from competitors could well beexpended to increase overall production, thereby leaving everyone better off.43 Furthermore, asecond agreement will be put in place guaranteeing certain rights to every individual. Adelimitation of individual rights is of greatest importance for the stability of the constitutionalorder as some individuals may be inclined to fall back into their old predatory behaviour being faced with pareto-inferior outcomes under direct production.44 This initial social

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Buchanan (1975; Ch. 1, par. 7.1.1)42 Hobbes (1651; Ch. 13, sect. 14)43 Buchanan (1975; Ch. 4, par. 7.4.16)44 Buchanan (1975; Ch. 4, par. 7.4.17)


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contract derives its legitimacy from the unanimous consent of all individuals, which can only be warranted if the proposed setting is advantageous to all. Therefore, an initial redistributionof goods and resources has to take place leaving all individuals with endowments pareto-superior to the natural equilibrium and the distribution under direct production.45

Subsequent to the constitutional contract the private exchange of goods and servicesthrough markets is established. Although, individuals come to fulfil a great deal of their needsand objectives through such interchange a further aim for collective action becomes apparent:the trade in jointly consumable, i.e. public, goods.46 Due to the problematic of free riding,Buchanan does not expect such collective effort to arise naturally. Coherently, he advocates a

postconstitutional social contract comprising all members of society for the purpose of collective decision-making.47 In reaching collective decisions Buchanan explicitly resorts tothe standard of unanimity as a guarantor for efficiency of the chosen measures. However,recognizing the importance of transaction costs in such an extensive decision process theauthor acknowledges that less-than-unanimity or even simple majority rule may have tosuffice to warrant overall institutional efficiency.

In coherence with distinguishing two separate stages of social contracting Buchananalso identifies two distinct tasks of the state in each setting. At the constitutional stage citizensemploy the state to act as a mere enforcing agent reassuring and administering the propertyrights agreed upon. In this function the state is not actually producing justice but rather

objectively judging the compliance of individuals to the existent framework of rules. In this,Buchanan depicts government as an automat programmed to correlate legal sanctions to particular violations of the law. To clarify:the body of the protective state does not fulfilany legislative function. Instead government is entrusted with the straightforward enforcementand realisation of the social contract.48

In contrast, the state inherent in the postconstitutional setting has the command over legislative provisions. This task can be labelled productive in the sense that government i sfacilitating collective action so as to achieve greatest well-being of society. In coordinating

individual objectives and creating satisfactory trade-offs through compensation the productivesection of government engages in a complex adjustment process, unlike the clear-cut role asan umpire in the constitutional phase.In coherence, the outcomes of the states productiveefforts must not be judged as right or wrong . Nevertheless, every governmental policy on

behalf of its citizens constitutes a legal contract to be enforced by the protective body of thestate.

45

Buchanan (1975: Ch. 4, par. 7.4.25)46 Buchanan (1975; Ch. 3, par. 7.3.1)47 Buchanan (1975; Ch. 3, par. 7.3.12)48 Buchanan (1975; Ch. 4, par. 7.4.40)


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3.2. The Logical Fundament of Social Policy in the Constitutional Order

James M. Buchanan bases his conception of social policy on his comprehensive studyof collective action within a contractually designed liberal order. This theory of public goods

provision is concerned with the tasks of theproductive state in the postconstitutional settingapart from the protective function assumed in the constitutional phase of social contracting.

The states task of reinforcing the individual rights and property rights of its citizens inthe constitutional phase is important not merely based on the protective function that isenacted. Securing the most basic rules and thereby individuals positions in society alsoallows for much more complicated exchanges than the pure market exchange of privategoods. The government in its protective function builds the foundation for collective action inthe pursuit of providing goods publicly, which cannot or will not be provided through the

market. The productive state, in turn, is entrusted with the task of increasing the communitys

overall well- being through the furtherance of collective action in the case of goods [...]characterized by extreme jointness efficiencies and by extreme non-excludability [] 49, i.e. public goods. As has been said, such provision is based on collective action letting different policy options become evident, which aim to compromise conflicting needs and compensatefor disregarding one need in the face of another. In general, these processes do not onlyinvolve two options of public action to take, but as individuals needs and value schemes differ greatly so do the courses of action available to government.

The Economic Model of Politics

Facing such a broad variety of possible policy measures one is to review each optionfor the incentive structure inherent, for the results anticipated and the methods employed for this purpose. In order to identify expedient and legitimate policy options Buchanan deems itnecessary to conceptualize the relationship existing between the body of the state and itscitizens. In the pursuit of this he utilizes three essential elements, namely: the methodological

individualism, the model of homo economicus and his theory of politics-as-exchange.In his explanation of politics Buchanan advances the economic theory of politics ,

which ismethodologically individualistic : Ultimately each member of a society is affected bythe outcome of choices within politics and enacted policy essentially represents the aggregateof individuals choices in accordance to their preferences. Hence, explaining the process of

how these individual value schemes are translated into policy measures needs to be based onan evaluation of the individual choice behaviour. The methodological individualism allowsfor the analysis of this choice behaviour under varying frameworks of rules. Therefore, this

49 Buchanan (1975; par. 7.6.19)


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method can help to develop predictions concerning the outcomes of different institutionalsettings in the area of politics as well as markets.50

Analysing the results of politics on the basis of individual behaviour must then focuson what motivates citizens to join the collectivity in the pursuit of public goods provision.Here, Buchanan advances a fundamental idea from general market economics. The concept of homo economicus assumes individuals to be acting wholly self-interested in order tomaximize their individual utility. This notion is widely accepted for simple market exchangeswhere individuals seek to maximize their net wealth within a two-party exchange based ontheir preferences quantified in utility functions. In politics, however, net wealth, as implicated by a certain course of action, is not just restricted to one single individual that is beingobserved, but rather to a whole community of collective actors presumed to be possiblyaffected by the choice outcome. From this basic incongruence of market and politicsexchanges stems the reluctance of social scientists to approve of the application of homoeconomicus in collective action settings. Nevertheless, Buchanan is certain that the ideal of homo economicus is equally applicable to the realm of collective action, since [t]he minimalcritical assumption for the explanatory power of the economic theory of politics is only thatidentifiable economic self-interest is a positively valued good to the individual whochooses. 51 This self-interest is in no way contradictory to altruistic behaviour that may beexerted in the political arena. The model of complex exchange advanced by Buchanan

includes such behaviour as internal to the individuals subjective decision making processmeaning that the facilitation of the well-being of others can be seen as the self-interested pursuit of an altruistic actor.52 The author further clarifies that perceived disparity in the actualoutcomes of market and political exchange does not infer from differences in the motives of individual actors but rather from the basic differences in the institutional structures withinwhich choices are made.

From the theoretical assumptions of methodological individualism and homoeconomicus, Buchanan now models politics as an exchange institution resembling that of the

market. This mere exchange conception is challenged by the classical ideal that individuals join in collective efforts to further some common goal or good. In the authors perception,

however, the political process,similar to the process of market exchange, is not [...]motivationally functional. 53 In this sense markets and politics do not work because individualactors intend to further an overall allocation, but rather because actors utilize them to fulfiltheir own desires in the best way possible. In conclusion Buchanan defines politics to be [...]

50

Buchanan (1986; p. 244 et seq.)51 Buchanan (1986; p. 245)52 Buchanan (1985; par. 10.3.11)53 Buchanan (1986; p. 246)


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a structure of complex exchange, a structure within which persons seek to secure collectivelytheir own privately defined objectives [...]. 54 It follows from this that collective action is based on the voluntary support of individual actors.

Justice and Efficiency in Politics

In coherence, one can say that [...] politics as such has no aim or objective. 55 Itsimply embodies the institutional processes that allow citizens of a community to expresstheir individual preferences over different courses of collective action. As the provision of public goods is in this the result of mediating a broad range of individual values the outcomecan never be stated as being true or false, right or wrong. Such a judgement of the result of collective action would presuppose an external standard, which society is to strive for. If

knowledge of this supra-individual value existed and was known to society there would be nocase for politics at all since everyone would these commonly known goals. But as such astandard is nonexistent there is no basis on which to judge the outcomes of collective action.He concludes, that [w]hat emerges from a process is what emerges and nothing more. 56 .Further qualifying his statement, Buchanan admits that observing particular outcomes asresults of particular processes may ultimately lead to judging the process itself asunacceptable. Therefore, the ends of collective action cannot be judged, but they may still

provide a feedback upon which a process expediency can be judged.

Although evaluation may not be applicable to the ends of the process, nevertheless, the process itself may be evaluated, according to Buchanan. His idea is that the results of politicalmeasures can only be judged through the processes from which they come about. Therefore,the efficiency with which the political process translates the individual values and

preferences into desired outcomes is put into focus. Unfortunately, efficiency in this contextcannot be compared to the efficiency of decentralized trading in markets. The political

analogue [...] advanced by the public choice scholar, [...] must be that feature common over

all exchanges, which isagreement among the individuals who participate. 57 The unanimityrule is the proposed measurement of efficiency in political processes constituting the ultimateaim of normative improvement.

The requirement of complete unanimity among collectively choosing individualsconstitutes a very restrictive rule in the improvement process. This reasoning is in part trueconsidering that an ever extending range of governmental policy would have to fulfil thiscriterion before being put into action. Besides, the transaction costs involved in the endeavour

54

Buchanan (1986; p. 246)55 Buchanan (1985; par. 10.3.42)56 Buchanan (1985; par. 10.3.42)57 Buchanan (1986; p. 247)


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of approving all measures on the basis of unanimity would be detrimental to the overallefficiency this unanimity is to secure. Hence, Buchanan goes one step further and incorporateshis economic theory of politics in the social contract theory of the liberal social order.

Attaining Unanimity in Politics

In the pursuit of interlacing these two theories the public choice advocate aims atmitigating the restrictive character of the unanimity rule as such. Therefore, he proposes totranslocate the requirement of consentaneousness from the postconstitutional to theconstitutional stage of the social contract. Analogously to a game, the choice setting is shiftedfrom determining strategies within rules to determining the basic set of rules within which onecan develop strategies. The problem of choice within a given set of rules is that [...] interests

of individuals and groups are well defined and readily identified.58

Based on the fact that, atthis stage, individual actors can adequately estimate possible consequences of policies on their personal economic or social position, conflict among winners and losers of certain

strategies will arise and undermine any intention for cooperation. Shifting the unanimitycriterion to choices among rules or institutions, within which strategies can be implemented,which do not explicitly have to fulfil the unanimity rule, can solve this problem. According toBuchanan such an [...] in -period violation of the criterion does not imply the inefficiency of the rule so long as the latter is itself selected by a constitutional rule of unanimity. 59 Through

deciding unanimously on rules and institutions on the constitutional level individual actorsexperience a loss of interest identity 60. This inability to identify their particular interests isdue to the generality and permanence for which constitutional rules are designed. Buchanandefined this particular situation as a veil of uncertainty , behind which [...] a person faced

with constitutional choice remains uncertain as to what his position will be under separatechoice options [...]. 61 Ultimately, an individual, which is uncertain of how to best further hisown interest in the face of a variety of most general and long-term rules, will choose anarrangementof institutions that will generally appear fair to him. This fairness, in turn, isconstituted by a pattern of results that is widely agreeable to the chooser no matter what hiseventual position within the range of results may be. Under such circumstance the individualwill also accept a possible in-period disregard of his own interests if he expects them to be better suited under a possible long-run arrangement.62 Due to the fact that every member of society faces the same uncertainty in the constitutional setting unanimous agreement on ageneral set of rules and institutions is much more likely to arise than when individuals are

58 Buchanan (1985; par. 10.2.32)59

Buchanan (1986; p. 248)60 Buchanan (1985; par. 10.2.33)61 Buchanan (1985; par. 10.2.37)62 Buchanan (1986; p. 248)


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scale it will not work when applied in the small either.66 However, the small scaleinterventionism continues, which Buchanan ascribesto the curious [...] elementary logic of collective action 67, wherein single market interventions work through a concentration of the benefits, while the involved costs are dispersed throughout the whole collectivity.68 The beneficiaries of such policies naturally favour their implementation irrespective of whether the costs actually exceed the overall attainable benefits. To further their own interestindividuals will invest in rent-seeking behaviour trying to realise the offered benefits or evenattempting to modify the institutional structures directly. Meanwhile, the possible victims of such inexpedient measures incur losses as they stay politically ignorant due to the relativelysmall share of costs they are facing.69

Legitimacy & Liberty

Coherently, Buchanan speculates that efficiency may not actually pose as a sufficientcriterion for the welfare state in desisting from further interventionist policies. The author, inturn, advances the argument of legitimacy as the main criterion to rule social policy, sinceevery member of the liberal order shares in the moral right to partake in voluntary marketexchanges unrestrained from political intervention. However, Buchanan cannot help, butacknowledge contemporary state of affairs in which [... ] democratic procedures lendlegitimacy to the actions of bureaucratic agents. 70

Looking at the contemporary social security system Buchanan determines it to be notlegitimate and inefficient according to his economic theory of politics. Embodying theimposition of wealth and income transfers, these policies of the welfare state are unlikely tofulfil the proposed unanimity criterion due to their coercive nature. The individual entitlementto liberty, as freedom from state coercion, must pose as the ultimate argument in the revisionof allegedly legitimate institutions of the western welfare state.71

In accordance to his economic theory of politics Buchanan cannot help, but judge thecontemporary welfare state illegitimate. He bases this evaluation especially on the coercive

nature of the welfare state imposing a rather arbitrary scheme of wealth and income transfersupon his citizens. He further suggests that these measures did not fulfil the unanimity criterion beneficial policies are to conform to. As mentioned before an institution that does not fulfilthis requirement is inefficient and should in turn be subjected to normative criticism, which iswhy Buchanan offers a reform proposal aiming to achieve a pareto-superior set of rules.

66 Buchanan (2001d; p. 189)67 Buchanan (2001d; p. 191)68

Buchanan (2001d; p. 190)69 Buchanan (2001d; p. 259 et seq.)70 Buchanan (2001d; p. 193)71 Buchanan (2001d; p. 194)


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However, he insistently designates the status quo as the ultimate point of departure in suchconstitutional reform as [p]olicy options must remain within the realm of the feasible, and

the interest of political agents must be recognized as the constraints on the possible. 72

Dismantling the Welfare State

From these premises, Buchanan proposes a reform of the pension system, representingthe single most important measure of income redistribution in the modern welfare state. Asargued above the coercion involved in taxation itself and in the arbitrary transfer of the taxyield poses an illegitimate state measure, which could not have been approved of byunanimous consent. Nevertheless, Buchanan insists that the institution of the pension systemdoes constitute an enforceable contract between the state and its citizens and any reform musttherefore warrant the claims involved in this contractual arrangement of the status quo. Hence,the proposed reform must meet the obligations that arise from the pension system in order toobtain the unanimous consent, of both the people benefitting from reformation and the peoplewho currently maintain claims against the pension system. Furthermore, Buchanan asserts thatthe transfer system is not in actuarial balance meaning that the current claims amount to netliabilities in excess of the tax payments to be anticipated at any moment.73 These aggregateliabilities constitute implicit public debt, which cannot simply be forfeited, but must berecognized as a national monetary obligation.

Open default in an attempt to avoid the costs involved in reform does not constitute areasonable course of action in this situation, since credibility and legitimacy losses on the partof the state would testify a damning indictment of modern democracy. Dismantling thewelfare state, government cannot, therefore, violate the implicit contract with its citizens bycancelling its debts since it has to fulfil the existent claims in the course of any reformativemeasure. In order to do so net claims of each individual have to computed, i.e. the presentvalue of anticipated tax payments has to be subtracted from the present value of positiveclaims in benefits. In the next step a particular date has to be specified starting from which all

tax payments supporting the pension structure and all benefits arising in this system come to asudden stop. From this date on the old-age provision scheme ceases to exist, yet the nationaldebt remains as an obligation of the state: Persons with positive claims then have to be paidoff in cash value, while agents with negative claims have to pay their remaining tax burden.

As mentioned before the existent positive claims place a tremendous financial burdenon the state, however, Buchanan advocates [...] that funds for meeting the indiv idual claimswithin the system be raised by the explicit issue of general- purpose national debt [...] 74. The

72 Buchanan (1987; p. 248)73 Buchanan (2001a; p. 452)74 Buchanan (2001a; p. 453)


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interest charges that arise from this debt on perpetual basis will in turn have to be borneequally by all current and future taxpayers. Buchanan concludes that this proposition shouldin effect fulfil the requirement of unanimity, since the continuous increase in implicit nationaldebt is being stopped while individuals do not have to face any additional tax burdens or inflationary government policies to offset the discontinuance of the pension schemes. Ineffect, the interest arising from the issuance of public debt will not pose as an additional

burden to the current tax payers [...] since this group, even before any structural change, is

bearing at least this cost of the system. 75 In conclusion the reform may then achieveunanimous consent, due to the fact that current beneficiaries are left indifferent as they arecompensated at the full amount of their claims, while current and future tax payers are made better off through a reduction in tax burden as compared to their previous obligations.

Subsequent to the successful dismantling of the pension system Buchanan prognosticates an evident increase in economic productivity as the tax burdens on citizens andthe benefit burdens on government are decreased. This production increase will further enablethe community to carry the annual interest obligations forward so as to attain a [...] gradually

decreasing weight relative to annual gross product in the economy. 76 In anticipation of the abolishment of the transfer system Buchanan further elaborates

on the possible establishment of a [...] fully funded, actuarially sound pension scheme with

separated and identified individual accounts. 77 In effect, the author is proposing a

competitive insurance based structure offering individuals the choice of providing for themselves on a competitive market for pension insurance or with the help of state-organisedinsurance. However, both options require the individual to settle payments into a designatedaccount from which his own retirement benefits will be financed. This genuine insurancestructure is, by definition, to refrain from any redistributive efforts. Nonetheless, Buchanandoes not completely rule out any kind of auxiliary redistributive payments in the liberal order provided that this is desired by the collectivity.

In the proposal of this reform of the welfare state Buchanan has offered a way out of the strait jacket which had been put on social evolution, according to Hayeks

interpretation. It is to be kept in mind though that this reform is aimed at the abolishment of the existing pension scheme while the author did not explicitly offer a new structure insubstitution. Nevertheless, Buchanan clearly points out that the costs of continuing theaccumulation of implicit national debt outweigh those incurred in the dismantling of a system proven inefficient in a market context and detrimental to individual freedom in society.

75 Buchanan (2001a; p. 454)76 Buchanan (2001a; p. 454)77 Buchanan (2001a; p. 454)


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IV. Social Policy for the Market Rethinking the Welfare State

4.1. Contract Theory as the Fundament of Social Policy for the Market

The Welfare State Theory and RealityAccording to the theoretical fundament, which both Hayek and Buchanan have laid

out, social policy constitutes a governmental instrument to provide for those needs of thecollectivity, which cannot be fulfilled through market processes due to the inoperativeness of the price mechanism. What both economists emphasize is the purpose of the welfare stateactivity to reduce unnecessary uncertainty, which individuals in a market economy findthemselves exposed to. The general intention is an increase in individual freedom for citizens,who can in turn pursue their own goals and desires more efficiently. In essence, the social policy, which is prescribed by Hayek and Buchanan, aims at facilitating the market economy by offering a range of social provisions equally applicable to all societal members in order toenable them to partake in the risky ventures of the free market economy. Considering these premises their conception of state activity represents a social policy employed facilitate themarket.

In contrast, the structure of the welfare state, as known today, originated from thenecessity to cope with the social injustices that came about during the industrialisation in the

18th

century. Social policy came to be designed to correct the inhumane results of the successful market, basically protecting the individual from the ruthless forces of

competition. In conclusion the welfare state originated as social policyagainst the market.This conception is still prevailing today and the fundamental reason for this can be found inthe ongoing dualism between markets and social policy. It is generally conceived that social policy is not instrumental for the furtherance of the free market, but rather corrective of theoutcomes generated by the efficient free economy. The introduction of the programme of social market economy further accentuated these misconceptions as social policy came to be

identified as redistribution of income in the name of justice. As a result, the mere function of the market seems to consist, crassly put, in generating the resources that the social state canredistribute.78 The relation between the social factor and the economic one can therefore becharacterised as confrontational, insofar as the pursuit of a freer economy is thought to be borne by a reduction in social security, while a broadened social security net is expected to goat the expense of economic efficiency. The indicated value antagonism also accounts for thedeadlock in the ongoing debate about restructuring the welfare state. Neither the proponentsof social security nor the advocates of the free market are willing to give in, as they perceive

78 Pies (2000; p. 120)


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the competitiveness of the market as detrimental to individual security and social justice, andvice versa. This dualism of social policy versus free markets offers no point of vantage for anormative theory of the welfare state free of any value judgement. At this point the debate canonly concern itself with reform proposals of quantitative nature a discussion that poses onlya dead end due to its subjective character.

The Analogy of Protective and Productive State

Utilising and extending the constitutional approach of James M. Buchanan, theeconomists Karl Homann and Ingo Pies developed a theory based on the systematicinterdependence of the protective and the productive state. In shedding light upon the logic of the transfers, which occur in the social market economy they aim to resolve the dualistic

nature of the current social policy debate. On the basis of explaining in the constitutional-contractualist tradition what is commonly conceived as mere redistribution the tworesearchers offer a possibility of rethinking the welfare state.

As outlined in the previous section of this thesis the political economist Buchanandistinguishes a constitutional and a postconstitutional stage in his social contract theory. Atthe constitutional stage collective disarmament is enacted to warrant the members anindividual private sphere based on mutual recognition of exclusive property rights. Marketscan arise premised on the existence of the protective state entrusted with the preservation of

these property rights and the enforcement of exchange contracts. The productive state,which is emerging in the postcontitutional setting, organises the collectivity in the provisionof public goods, which cannot be provided through private exchanges. The term productive

might appear somewhat misleading in this context as the social state is not simply producinggoods and services to supply to society. Actually, government is providing insurancestructures for individuals to join in an effort of pooling the risks they are facing in the marketenvironment. Reducing the expected variance of market outcomes for each person through thetrade of risks, these arrangements also offer the chance to undertake high risk investments inorder to realise additional gains from trade. Furthermore, the collective effort in public goods provision can be reconstructed as a two party exchange in which the state supports theoriginating contracts through provisions made to each party of the contract.79 In essence, boththe protective and productive sector of government aim at enabling individuals to realise all possible gains from trade. From this, one can infer that neither the productive, nor the protective state constitute an end in itself but rather a means to realise gains from trade.80 The

79

Becker and Murphy (1998; p. 9):Taxes on adults help finance efficient investments in children. In return,adults receive public pensions and medical payments when old. This compact tries to achieve [...] efficient levelsof investment in children and support to elderly parents. 80 Homann and Pies (1998; p. 214 et seq.)


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welfare state must not be conceived as a substitute for the inoperative market mechanisms, butas a supplement to the market.81

The Complementarity of Protective and Productive State

Now, according to Homann and Pies, the two functional branches of government donot merely share the common goal of establishing and enabling markets they are alsologically intertwined. Their respective legitimisation rests upon each other. It is generallyagreed that the establishment of the social state is premised on the existence of the protectivestate guaranteeing individuals the protection of their private sphere and property rights. Onlythrough the undisputable constitutional protection of such can the individual citizen agree tosocial provisions being made under less than unanimity rule. An important correlation largely

disregarded in this context is that consent to the employment of a protective state is in turn based on the premise of the productive state.82 This interdependence becomes evident inBuchanans construction of the initial constitutional contract where he asserts that [...] some

redistribution of goods or endowments may have to take place before a sufficientlyacceptable basis for property claims can be established. 83 An initial redistribution is the basison which all individuals can consent to the constitutional delineation of property rights.Conceptually, the individuals interested in the protection of their endowments through socialcontract in fact compensate others, not in disposal of any endowments to be secured, for

agreeing to the contract anyway. Or, looking at it from a different point of view, their interestin protection of property can only be aroused through distributing an initial endowment tothem. In the proper sense, these initial transfers represent the creation of a foundation onwhich all individuals can partake and profit from a contractual organisation of thecollectivity.84 Ultimately, transfers are not an invention of the modern welfare state and theyare also not to be conceived as unilateral exchanges. From the setting of the constitutionalstage it can be inferred that these transfers actually represent bilateral exchanges as preconstitutional participation and agreement to the social contract is paid off in the form of postconstitutional transfers of gains from contractual cooperation.85

4.2. The Logical Evolution of the Social Order

Based on the logical foundations which Homann and Pies build the welfare state on,the evolution of the liberal social order can be reconstructed theoretically. In the

81 Pies (2000; p. 125)82

Homann and Pies (1998; p. 215 et seq.)83 Buchanan (1975, 1999; par. 7.4.26)84 Pies (2000; p. 125)85 Homann and Pies (1998; p. 223)


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constitutionalist-contractualist tradition of J. M. Buchanan, they resort to the differentiation of three particular stages of societal cooperation: (1) chaos, (2) taxis and (3) cosmos.

(1) The first, chaos, basically resembles the notion of the natural state, which is

characterised by complete absence of order or an underlying framework of rules. For the purpose of realising possible gains from trade individuals in the chaotic order willagree to subject themselves to a contract involving all citizens for the purpose of coordinating collective and individual efforts. The point in this undertaking is todelimit the individual sphere of action so to secure each person a private sphere inwhich he can act freely. To compensate for the constitutional restriction in range of action every individual is entitled to a share in the gains that arise from thecoordinated efforts.

(2) Now, in a first step from the natural state into the taxis the individual actors areexpected to agree to a constitutional contract in which coordination is aimed at producing equality of results. Due to the fact that the constitutional contract requirescomplete unanimity every party can exercise its veto right to their benefit. In thetransition from chaos to taxis this will result in an egalitarian distribution scheme,since everybody is well aware of their respective initial endowment. According toHomann and Pies, this equal distribution is unlikely to be persistent as net receiverswill come to learn that by extracting a lower relative size of transfers from net benefactors they can actually influence the incentive structure applicable to the productive. As those become able to keep a greater relative share of their income for themselves they also become inclined to invest greater effort in securing a higher income. This in turn translates into a rise in absolute transfers for the net receivers.Remarkably, an acceptable and anticipated level of societal inequality thereby becomes a literal factor of production. Although in the taxis setting it is justice inoutcomes that is initially aimed at members of the collectivity will soon come to find

that a healthy degree of inequality is essential for the progress and welfare of societyas a whole.(3) Realising that inequality makes markets work more efficiently, the members of society may, in a second transition, come to agree on an even greater degree of inequality and resulting insecurity for the purpose of increasing gains from trade. Inthe order of the cosmos an orientation towards procedural justice will take placemeaning that it is not equality in results which is striven for, but rather equality withinthe rules and institutions employed. This approach leaves much of the resulting

outcomes to factors that are beyond individual control. Hence, individuals are facingincreased insecurity and inequality in such an order. This consented inequality in


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return allows the society to achieve full productivity of its inherent markets andtherefore aids the realisation of gains from trade in excess of those possible in chaos or even taxis.86 The wider the range of freedom and inequality in such a society, the greater will be the

resulting welfare of all people in it. However, this touches the important issue of understanding the circumstances under which individuals are actually willing to consent to anever-growing inequality and insecurity affecting their existence. This question is crucial to thelegitimisation of a cosmic order since it cannot simply be imposed on society, but has to beassented to unanimously. Homann and Pies offer three integral requirements to be fulfilled toachieve consensus87:

(1) First of all, a framework to secure individual freedom and property rights must be

existent incorporating public legal institutions as well as private, which provide for fundamental and general security in the ever-progressing cosmic order.(2) Secondly, in agreeing to the more complex system the individuals anticipate thesharing in on all additional profits that arise. Thus, for unanimity to be achieved, everyactor in society must be warranted an income, a particular subsistence minimumenhanced through payments from various insurance arrangements. Ultimately, atransition from taxis to cosmos will only be approved, if it guarantees each individuala standard income above the one enjoyed in the order of the taxis. Even though thisstandard income has the character of an insurance payment, Homann and Pies also justify it as a sort of pecuniary compensation for tolerating the agreed order. Thisconstruction allows transfers to remain legitimate in their nature even if a personshould be unable to or not intending to participate in the created free market; on the basis of the income he is assured.(3) In a third respect, it is essential to understand the arising markets as artificialstructures that are highly dependent on a supporting framework designed by the state.

The support of the livelihood of each member of society through social security payments is equally important as the financing of a basic education. Besides thecommonly known compensatory function of these measures government alsofunctions as an investor initiating the establishment of structures to cope withdilemmas of cooperation that arise due to the constant progress of society. Such initialregulation of markets does not rule out an eventual deregulation for the purpose of allowing more competition and thus greater efficiency in some such fields of government investment.

86 Homann and Pies (1998; p. 217 et seq.)87 Homann and Pies (1998; p. 219 et seq.)


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In conclusion, social policy, which is to allow for a maximum of individual freedom andwelfare within a free market economy, has to guarantee to all members of society asubsistence level income to allow them to actually take the risk of participating in the freemarket. On the other hand, the state is also well advised to undertake certain investments toenable for a successful partaking in the market by financing for example the general educationof the population. In essence each individual should justly expect his needs to be served better in the cosmic setting as opposed to that of the taxis. Through compensatory payments andinvestment aids the state is to facilitate the transition from taxis to cosmos and therefore theestablishment, enhancement and development of markets. This identifies the range withinwhich a productive social policy is to prevail.

4.3. Rethinking Social Policy as Overcoming Dilemma Structures

The programme of social policy for the market as proposed by Homann and Piesestablishes an alternative interpretation of what is usually conceived as redistribution .

Therein, unilateral transfers of income within the contemporary welfare state come to be moreaccurately construed as postconstitutional compensations for preconstitutional investments, asrepresented by the initial unanimous agreement to the more productive order. Through theconstitutionalist reconstruction la Buchanan, the two economists manage to eliminate the

alleged dualism between the market economy and the social question. From this point on thedebate over the realm of the social state can break away from the restrictive value conflictsthat used to characterise the discourse. Value antagonisms can now be avoided with the resultthat the discussion can turn from assessing allocative aspects to the examination andreformation of procedural aspects. The discussion of the ends and aims of market and social policy have become irrelevant, insofar as they have been found to share a commondenominator: Facilitating the realisation of gains from trade. Through the identification of common interests Homann and Pies manage to achieve an orthogonal positioning, i.e. an

efficient outcome in their theory of the welfare state.88

From this general legitimacy of the productive efforts of the state, Homann and Piesgo on to elaborate on the normative content of the programme. The line of reasoning appliedto the constitutional reconstruction of the social market economy persists throughout thisnormative theory. The reconstruction of collective action problems as social dilemmas canthen provide the basis for analysing the underlying conflict structure in order to be able torethink the problem in a way that can generate consensus among the parties involved.

88 Efficient in the sense Buchanan proposed, meaning that differing values become reconcilable andunanimous consent is therefore possible.


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understanding of efficient policy measures as he highlighted the necessity of unanimous

consent to the rules rather than the judging of outcomes and their alleged efficiency . 91 In the pursuit of generating possible reforms an understanding of human cooperation is

indispensable, which is why social dilemmas are equally suitable to model the interaction problems of the status quo. The collective self-damage inherent in these structures brings theinstitutional setting into focus from which these unfavourable outcomes arise. The prevailingincentive structure is decisive of whether individual interests conflict with the interests of thecollectivity or whether they can be aligned.92 The investigated dilemmas visualize both theconflicting and the shared interests of all agents, thereby effectively indicating the optimal position attainable from the current status-quo. In turn, one is to identify a pareto-superior setof rules allowing for the realisation of the additional gains from trade. The pareto-superior framework is by definition beneficial to all parties involved, so that proposed reforms willgenerally attain unanimous consent. From this reasoning one can infer that social policymeasures are justifiable, if they allow for the resolution of a social dilemma. On the other hand, they are to be subjected to criticism, if they, in fact, give rise to such interaction problems.93

The modelling of collective-action problems as social dilemmas therefore incorporates both a normative value as well as a feasibility judgement. Based on this, the approach of Homann and Pies constitutes an advance from Buchanans economic theory of politics,

wherein he had to resort to unanimous constitutional decisions under a veil of uncertainty tolegitimise less-than-unanimity rule in the postconstitutional setting. The theory is aimed at acollective orthogonal positioning from the apparent value dualisms by appealing to thecommon interests among all parties involved.94

4.4. The Benefits of Cooperation

The modelling of collective action problems as social dilemmas should not lead to anarrow-minded view on how to enable cooperative action, though. Despite, this approachcontributing much to the understanding of how individually motivated behaviour can lead tooutcomes detrimental for the collectivity, it has encouraged [...] a tendency to think [...] that

the real problem with efficiency gains is just an incentive problem. 95 According to Joseph Heath, a professor at the University of Toronto, it is not merely a

question of getting the incentives straight. He remarks that there are a number of cooperative

91 Buchanan (1986; p. 247)92

Pies (2004; p. 8)93 Pies (2000; p. 130)94 Pies (2000; p. 130)95 Heath (2006; p. 350)


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benefits inherent in structures that seem to pose as collective action dilemmas. On closeexamination, however, the institutions necessary to resolve a certain dilemma structure ofteneliminate a beneficial institutional arrangement in place to avert a quite different socialdilemma.

In the pursuit of clarifying the involved misconceptions Heath is very particular on thefact that the role of the welfare state has to be rethought. Concerning governments role as the pioneer in the establishment of vital institutional structures it is to say that the state does notonly take on the role of an initial investor, who paves the way for the establishment of competitive markets. Hence, Heath is very agreeing that the welfare state embodies muchmore than an institution for the mere redistribution of income. According to the political

philosopher [...] there is no reason to think of the states role [...] as residual. 96 The criticism Heath voices, refers to the mechanisms of cooperative benefits, in his mind thefive dimensions of economies of scale, gains from trade, risk-pooling, self binding andinformation transmission. Now, the benefit generally undisputed by the market economy isthat of gains from trade. Figure 1 shows that the private sector is not only directed at theactualisation of these gains, but also commands other institutional forms that yield the benefits of risk-pooling or self-binding arrangements and support the transmission of information.

Figure 2: Private and Public Institutional Forms 97

According to the Canadian philosopher, though, it is in turn the welfare state, which[...] has often taken a lead role 98 in the facilitation of such important cooperative benefits asthe risk-pooling involved in the insurance structures of the social security net, namely: theunemployment provision as well as public health insurance. Allowing for the realisation of

96 Heath (2006; p. 317)97 In reference of Heath (2006; p. 348)98 Heath (2006; p. 348)


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various benefits of cooperation that are sometimes being disregarded in the market-based pursuit of additional gains from trade government is [...] not only the insurer of last resort,

but also [...] enforces a wide range of seemingly paternalistic policies [...] . The obligatory

pension provisions enforced by the state realise the benefits of a self-binding arrangement.Furthermore, Heath names the various kinds of social work that the welfare state provides for also constituting self-binding structures. Also, government represents an authentic source of information for all members of society, delivering weather forecast as well as certifying andenforcing [...] standards of veracity [...] in the private sector. 99

In essence, the collective action structure inherent in the productive state does notonly serve the preliminary purpose of enabling markets and competition, but sometimes thestate is the genuine provider of various measures beneficial to the realisation of cooperative benefits. The welfare state as such may even preserve benefits of cooperative actio

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The logical foundations of social policy in the liberal society: Rethinking the welfare state