The Future of the Welfare State

European Straits #18

Nicolas Colin

Dear all,

Since my new book ‘HEDGE’ covers the future of our social compact, a large part of it will be dedicated to discussing the welfare state and how it must be reinvented for the current Entrepreneurial Age.

One of the core beliefs at the heart of The Family’s investment thesis is that the current techno-economic transition does not call for more or less state intervention. Rather it should lead us to redraw the map and reapportion the respective perimeters of the market and the state. There are areas in our economy where the rise of technology calls for more, not less state intervention. Conversely, there are other areas where new technology-driven models end up correcting imperfections that long rigged the functioning of the market: with those imperfections gone, state intervention becomes a nuisance rather than a value-creating institution.

I think that social insurance is one such area in which there will be more room for entrepreneurial ventures as opposed to government agencies. Indeed most of today’s social insurance programs find their roots in local, entrepreneurial efforts. The first attempts to implement social insurance were not made by the state, but by individuals that organized their own pooling of risks at the local scale.

In France, for instance, the fraternal benefit societies, which pooled risks within certain communities or professions, succeeded the Ancien Régime corporations that were abolished by the revolutionaries in 1791. They were legally recognized in 1835 and obtained full freedom of establishment and support from the government in 1898—decades before social insurance became a domain of the state.

The main reason why the state had to take over was that the self-organizing efforts of individuals could not prosper up to the point where the entire population would be covered. A large part of France’s fraternal benefit societies’ success was due to the strong mutual bond that their members could forge because they lived in the same area or belonged to the same profession: obviously this couldn’t work at a larger scale. Also, market-based initiatives were unable to cover certain risks effectively: either risks were too critical, with the probability or magnitude of a loss higher than average, or the market to cover them was ridden with imperfections, such as moral hazard or adverse selection. Thus those risks, including old age, illness and unemployment, were better covered at the scale of an entire country rather than on a local or individual basis.

There are two reasons why this could all change in the current Entrepreneurial Age:

  1. Lower barriers to entry—Harnessing the power of personal computing and networks makes it easier to cover many kinds of risks. This was an argument made in 2003 by Robert J. Shiller in The New Financial Order, a book dedicated to explaining how a “an electronically integrated risk management culture” could be “designed to work in tandem with the already existing economic institutions of capitalism to promote wealth”. The strength of Shiller’s proposal was somewhat obscured by the financial crisis that followed, but now various factors—increased processing power, regular and systematic monitoring of user activity, and the strength of peer-to-peer networks—as well as many examples in the startup world suggest that pooling certain kinds of risks is easier and less costly than in the past.

  2. Increasing returns at scale—The power of technology now makes it possible for non-state risk-pooling initiatives to rely not only on local communities but on what Balaji S. Srinivasan calls “cloud communities”. In those, members can be far away from each other, and yet very close in terms of profile and interests. And as compared to local communities in the past, cloud communities have a major advantage due to their networked structure: the power of networks tends to increase, instead of diminishing, as the underlying community grows. While in the past state intervention was necessary to render a social insurance universal, in the future increasing returns at scale could be enough for cloud-based initiatives to reach a universal scope. There will be cases in which network effects will trump selection effects!

It all leads to many problems. One is related to words: what do we call the ‘Welfare State’ if it’s no longer run primarily by the state? Another is political: how do we prevent conservatives from using the entrepreneurial argument to scale back state intervention without supporting the emergence of cloud- and network-based versions of social insurance?

What do you think?

Warm regards,

Nicolas