University of Guelph-Humber
Get article (pdf)
Abstract: With the fall of socialism in the late 20th century, a mitigated version of that regime, one more tolerant of private property, has come to the fore as the primary alternative to the free market ideal. That alternative is the social democratic welfare state. Ludwig von Mises is best remembered for his refutation of socialism, but he also offered arguments against the welfare state. Exploring that case, we describe his overriding claim that no real middle way exists between capitalism and socialism. Though the welfare state can subsist for a time, Mises holds that its inherent contradictions render it an unsustainable regime inevitably headed for a crisis that will be resolved either with the establishment of socialism or capitalism. As this prediction has yet to be fully borne out, Mises’ critique of the welfare state needs to be updated to account for its persistence. His fundamentally economic approach could also be made more forceful by integrating considerations of justice from the fields of moral and political philosophy.
Keywords: social democracy, welfare state, capitalism, socialism, free market
Mises’ Critique of the Social Democratic Welfare State
It has become a truism to say that socialism died as a political idea in the latter part of the 20th century. The funeral is commonly stated to have taken place after the fall of the Berlin Wall and the breakup of the Soviet Union, these events having made it obvious to all but the most intransigent followers of Karl Marx that socialism had turned out to be an economic disaster and a political horror. Looking at the situation now in the early part of the 21st century, it is clear that socialism has not imitated the fate of Lazarus in being raised from the dead. True, a few academics still occasionally publish books and articles defending the socialist world-view (Eagleton, 2012). Admittedly, too, socialism continues to characterize the economies of a few redoubts – North Korea and Cuba, for example — while more recently gaining political sway in countries like Bolivia and Venezuela. Even so, in the developed world especially, it has become a rare sight to find an influential politician or economist arguing that the entire economy should be centrally organized by the state.
Socialism’s demise as a practicable vision, though, has not translated into a complete victory for the free market cause. Socialism may have lost, but it bequeathed a mitigated version of itself that currently stands as democratic capitalism’s primary opponent in the ideological battle to define the good society. Traditionally referred to as the third way, this alternative has for all intents and purposes become the other way – namely, social democracy. Distinguished from its socialist parent by its toleration of the market, social democracy embodies a vision in which the exercise of private property rights are nevertheless politically superintended by the operation of a welfare state actively intervening in economic life with a view to promoting the common good. Despite all the talk about the retrenchment of the state over the past several decades, the social democratic ideal has clearly held its own versus its free market rival, at least if we go by the stability in government expenditures as a percentage of GDP throughout most of the advanced economies since the mid 1990’s. For OECD nations as a whole, that figure has risen slightly since 1996 from 41.3% to 42.4% in 2012 (OECD, 2013).
Ludwig von Mises is best known in the history of economic thought for the pivotal role he played in the struggle against socialism. His main contribution to that debate originated in the 1920’s when he first demonstrated that socialism, by doing away with money prices, rendered it impossible for economic calculations to be made by government planners. Did Mises, as part of his over-all defense of the free market, also provide a case against the social democratic welfare state? The answer is yes, for besides publishing an entire book on interventionism, he devoted a not insignificant portion of his magnum opus, Human Action, to what he more formally called the hampered market economy. Still, anyone looking to take up his arguments today will have to recognize the need for a supplementation.
An Excluded Middle
More than sixty years before U.S. President Bill Clinton and British Prime Minister Tony Blair made it politically fashionable, Mises had discerned a shift in strategy among the critics of laissez faire away from socialism towards the advocacy of a third way. In his 1929 book, A Critique of Interventionism, Mises saw this change arising out of Vladimir Lenin’s move in the early 1920’s to renounce the state ownership of the means of production in promulgating the New Economic Policy. In the wake of this, Mises (1996 ) observed: “Nearly all writers on economic policy and nearly all statesmen and party leaders are seeking an ideal system which, in their belief, is neither capitalistic nor socialistic, is based neither on private property in the means of production nor on public property” (13). Back then, as Mises notes, this approach was either seen as a transitional stage towards full-fledged socialism or as a permanent system, though everyone at the very least understood it as something meant to last for a long while. With the death of socialism, the former rationale naturally has disappeared such that the predominant view today among supporters of the third way is that it offers an enduring model for the organization of economic life. This is the assumption that Mises primarily targets. Similar to how he challenged socialism, Mises argues that the social democratic welfare state is ultimately impossible – not in the sense that it is incapable of economically functioning, but that it cannot be sustained as a viable politico-economic order. It is a house of cards.
To comprehend this thesis, we must start by locating the welfare state within Mises’ conceptual schema. Like the minimal government of classical liberalism that it historically displaced, the welfare state aims to provide the citizenry with security from foreign attacks, along with protection from acts of physical assault, theft, and fraud that might be perpetrated by other individuals within the domestic community, in addition to a few public goods that the private sector cannot profitably supply. Distinguishing the welfare state is that it goes beyond this restricted menu by furnishing a social insurance scheme, offering coverage against old age, sickness, disability, unemployment, and business cycles. Besides the hedging of risks to which individuals are subject in a market economy, the welfare state also endeavors to equalize economic opportunities, and even outcomes to a certain extent, while seeking to directly advance individual well-being by offering such goods as child care, education, and housing on a free or subsidized basis.
Contemporary governments use a variety of means to achieve these objectives. They do so either through entities owned and operated by themselves or via the issuance of orders to holders of private property. An example of the former method is Britain’s National Health Service in which the government runs the hospitals and employs medical staff. Illustrating the latter is part of the U.S. system of health care, recently made more pronounced through the introduction of Obamacare, in which the government dictates to private insurance companies the sorts of policies that they are permitted to sell. To the extent that the welfare state employs the first means, Mises would say it adopts the socialist principle in that the means of production over the good in question are controlled by the state. In such instances, the welfare state does not reflect a third way, but rather the partial socialization of the economy. Only to the degree that the welfare state adopts the latter technique of imposing edicts would Mises acknowledge the prevalence of an alternative to capitalism and socialism. He calls this interventionism, which consists of “a limited order by a social authority forcing the owners of the means of production and entrepreneurs to employ their means in a different manner than they otherwise would [emphasis his]” (ibid, 20). On the Misesian understanding, the welfare state is a mixture of socialism and interventionism existing with the framework of a market economy. Not only, then, will the welfare state embody the maladies inherent to socialism, it will be prone to defects unique to interventionism.
All these defects can be summed in the fact that interventionism destroys itself. While Mises indicates such policies come in various forms, he devoted special attention to interference with the price structure in displaying the contradictions of interventionism. In the free market, of course, prices are set at the point where supply intersects with demand. On the grounds that markets fail to generate the socially optimal outcome, interventionism is often carried out by having the state order, or otherwise induce, private businesses to apply a price to a good deemed publicly significant different from that which the forces of supply and demand would dictate. Usually, the price is set lower because it is alleged that firms are abusing their market power by charging too much, but the opposite can transpire when those same firms happen to be the buyers. This occurs in the determination of wages, where governments enforce laws favorable to labor unions empowering these to wield the threat of a strike to negotiate higher than market compensation for their members.
Either way, Mises observes, the interference with prices fails to realize the ends that its proponents sought to achieve. Where the price of a good is fixed below the market rate, less of it gets produced, defeating the goal of making that good more accessible to the public. Where the price of the good is set above the market rate, less of it gets purchased, which in the case of the labor market translates to unemployment, hardly the aim of interventionist policymakers. Instead of conceding their mistakes, however, their prior antipathy to markets leads governments to double down on their interventionist efforts. As these additional orders to businesses also fail to bring about the desired results, a sequence is established in which ever greater levels of intervention are implemented in response to the problems created by previous interventions. Eventually, the point is reached where the economy is private property based in name only, inasmuch as firms will be doing little else than complying with government decrees. At this stage, Mises claims, the economy will have effectively become socialist. It will not be the traditional kind founded on the nationalization of industries. Instead, it will be what Mises (1990) calls a “planning scheme” type of socialism, in which the control rights associated with property formally lie with private individuals but effectively reside with the government acting on behalf of the public (176-177).
One might question how relevant interference with prices is to the evaluation of the welfare state. Most observers would not identify that as a gigantic price control scheme. Yet when one factors in the consideration that many of the welfare state’s services could be provided by the private sector, a key difference that comes to light in contrasting these two scenarios is the difference in the prices associated with them. Take health care, in many ways the centre piece of the welfare state. The argument in favor of having that be a concern of the state fundamentally rests on the claim that the free market would price health care in ways that numerous people could not afford. For instance, those with a pre-existing condition, and therefore at a larger probability of becoming ill in the future, would have to pay a high price for health insurance. What the state’s provision of health care does in an attempt to remedy this is either remove price entirely out of the equation, by funding medical services to all citizens out of general tax revenues, or mandate private insurers to charge lower prices for higher risk individuals. The same goes for other key planks of the welfare state, such as unemployment insurance, old age pensions, education, and housing. These could also be entirely supplied in the marketplace, but the worry is that prices would be such as to not make them accessible to all. Nor should it be forgotten that public policies encouraging higher than market wages, not merely through the aforementioned sanction of the strike system but also by the various barriers imposed on the dismissal of workers, is a common feature of welfare states in the developed world.
Intervention via taxation is clearly germane to the social democratic welfare state. Taxation, after all, is one of the principal mechanisms by which that regime is financed. The contradiction that Mises detects here is that the proponents of interventionism assume that a reserve fund exists to readily finance the welfare state out of the wealthier members of the community. This assumption has both a moral and political basis in that interventionists believe that social justice demands a more equal distribution of wealth and incomes, while recognizing that the welfare state will enjoy greater public support to the extent that it is paid for by the moneyed few. The reality, Mises observes, is that the reserve fund can only go so far in paying for the ever expanding array of social programs that interventionists establish. Sooner or later, the costs have to be borne by the entire community, which ends up contravening the egalitarian objectives of the entire enterprise as well as undermining its political support. “The Santa Clause principle liquidates itself”, Mises (1963 , 858) concludes.
Recall that, by Mises’ lights, the welfare state’s claim to represent an authentic third way is entirely dependent on its practice of interventionism. But it turns out the dynamic of this practice is such that it subverts itself. Now it needs to be pointed out here, especially as it is easy to get the opposite impression from his writings, that Mises does not hold that the self-immolation of interventionism must necessarily give way to socialism. Nothing is completely fated in human affairs. Amidst the troubles wrought by interventionism, the possibility cannot be discounted that public opinion will harkens to those voices recalling the principles of laissez faire. It nevertheless follows that the welfare state does not transcend the nature of an ephemera and so is not a real option for societies. “Either capitalism or socialism: there exists no middle way” (Mises, 2005 , 53)
Shoring up the Case
In assessing Mises’ critique of the welfare state, the most glaring problem is that it is still very much with us. One can say that the fall of the welfare state is still to come and that signs of its inevitable expiry are growing by the day. But it has been quite a while since Mises originally made his prediction. At the very least, an explanation is in order as to why the welfare state has been able to persist as long as it has.
Part of the reason is surely that the reserve fund held among the wealthy has proven deeper than Mises reckoned. The bulk of government revenues is paid by the highest income brackets. In the U.S., for example, 68.8 % of federal tax revenues was derived from the top quintile of earners in 2010; the top 1% alone furnished 24.2% (CBO, 2013). Both those figures are up substantially from 1979. Another factor explaining the resilience of the welfare state has been the effectiveness with which central banks have been tapped to finance the government’s expenditures by money printing, a tool that has become more unfettered since the complete abandonment of the gold standard in the early 1970’s. The resulting increase in inflation has, with some exceptions, been kept to single digit percentage figures that the public has shown a willingness to tolerate. Finally, the growing role of financial markets in economic life, itself a product of the central bank’s dramatic expansion of the money supply over the past several decades, has made it easier for governments to fund their respective welfare states by providing a larger and more liquid market in which to place their bonds. Yet how much longer these counteracting factors can keep the welfare state afloat remains a big question, especially given that the aging of the population in the developed world portends a smaller group of younger workers paying into the system against a larger group of older retirees receiving benefits. By one estimate, the fiscal gap implied here, equivalent to the present value of all future American government revenues minus the present value of its future outlays, is currently 14 times US GDP (Kotlikoff and Burns, 2012). Perhaps the only mistake that Mises committed was in being too early with his forecast.
What would further strengthen the Misesian case is if more stress were to be laid on arguments demonstrating the poor incentives that the welfare state entails as opposed to merely emphasizing its fragility. Mises offers much to think about along these lines that we can draw upon in his book Socialism. Originally published in 1922, he put forward there a detailed appraisal of the social insurance principle underlying the welfare state. His overriding argument was that the welfare state posed a threat of moral hazard by making the very things it was trying to insure more likely and by fostering dependency (Mises, 1981, 429-32 & 438-441). Most startlingly, he claimed that health insurance would encourage people to practice less healthy behaviours, a proposition effectively endorsed by the framers of Obamacare, which exempted a person’s history of tobacco use from the general prohibition on insurers being able to take individual risk factors into account when setting premiums. Also consonant with Mises’ point is the dramatic rise in disability claims in the U.S. since the eligibility requirements were relaxed in 1984. It is not just that it is hard to account for how the number of disabled people could have nearly doubled as a proportion of the US population from 1985 to 2005, but that the amount has varied with movements in the business cycle (Autor and Duggan, 2006).
One more gap in Mises’ analysis that needs to be filled involves the moral and politico-philosophic issues posed by the social democratic welfare state. The majority of those who advocate that system do so not so much because it works to promote economic growth, but rather because they think it is what justice requires. By justice, what most of the welfare state’s contemporary defenders have in mind is John Rawl’s conception, advanced in his 1971 book A Theory of Justice, according to which the best society is that which leaves the socially and naturally disadvantaged best off among all the alternative possibilities. Mises did not live long enough to directly address Rawls’ thesis, even though one could well imagine how he would have responded: human reason is incapable of ascertaining the objective nature of justice. In evaluating any social institution or practice, all we can do is check whether it meets the goals of its proponents. With respect to the welfare state, though, this standard may not work as well as Mises thought. To its friends, the primary objective of that regime is to redistribute and that it does. One cannot begin to challenge this aim without seriously taking the possibility that the truth about justice and the best government can be arrived at by rational examination. Only by joining political and moral philosophy in this way to the arsenal of economics that Mises so ably wields can the most forceful case be mounted against social democracy and its welfare state.
Autor, David H. and Mark G. Duggan (2006) “The Growth in the Social Security Disability Rolls: A Fiscal Crisis Unfolding,” Journal of Economic Perspectives, 20 (3), 71-96
Congressional Budget Office (2013, December 4). The Distribution of Household Income and Federal Taxes 2010. Washington: Congress of the United States. Available online: http://www.cbo.gov/sites/default/files/cbofiles/attachments/44604-AverageTaxRates.pdf
Eagleton, Terry (2012) Why Marx was Right. New Haven: Yale University Press
Kotlikoff, Laurence J. and Burns, Scott (2012) The Clash of Generations: Saving Ourselves, Our Kids, and Our Economy. Cambridge, MA: MIT Press
Mises, Ludwig von (1963 ) Human Action: A Treatise on Economics. San Francisco: Fox & Wilkes
Mises, Ludwig von (1981) Socialism: An Economic and Sociological Analysis. Translated by J. Kahane. Indianapolis: Liberty Fund
Mises, Ludwig von (1990) Economic Freedom and Interventionism: An Anthology of Articles and Essays. Edited by Bettina Bien Greaves. Indianapolis: Liberty Fund
Mises, Ludwig von (1996 ) A Critique of Interventionism. Translation by Hans F. Sennholz. Irvington-on-Hudson, N.Y.: Foundation for Economic Education
Mises, Ludwig von (2005 ) Liberalism: The Classical Tradition. Edited by Bettina Bien Greaves. Indianapolis: Liberty Fund
OECD (2013, November 19) Economic Outlook. Paris: Organization for Economic Co-Operation and Development. Available online: http://www.oecd.org/eco/outlook/Fiscal-balances-and-Public-Indebteness.xls
Rawls, John (1971) A Theory of Justice. Cambridge, MA: Belknap Press.