A safety net for all society

September 21, 2001

Howard Davies welcomes a serious look at our need for state welfare.

Throughout the two great political campaigns of this year - the general election and the subsequent Conservative leadership struggle - the constant cry from politicians on all sides of the argument was that they wanted to discuss the real "ishoos" of concern to the British people. These "ishoos" were generally considered to be something to do with health, education and, perhaps, crime, though precisely what the dispute was in each case was never spelt out. Politicians argued that in some obscure fashion the media were collectively involved in a nationwide conspiracy to deflect debate away from these exciting topics and onto trivial matters such as Europe, foot-and-mouth disease, John Prescott's pugilistic skills, or Kenneth Clarke's mission to sell cigarettes to Vietnamese children.

This call for debate on the issues became a tiresome refrain, especially since, whenever politicians were briefly allowed to debate health or education policy, nothing very interesting or consequential emerged. During the general election campaign, the government's general line was that there are no longer any important questions of ideological principle in these areas of social policy, and that after managing the public finances prudently through its first term of office there would now be a significant uplift in spending in the next four years, which would deliver improvements in both the quantity and quality of all public services. In the meantime, the electorate should take the government's promises on trust. The opposition line was that it would maintain these spending commitments, but nonetheless find room for significant cuts in aggregate spending and therefore taxation. As a consequence, the debate was hardly engaged.

In the Conservative leadership debate the fare on offer was, if anything, even less intellectually nourishing. Ken Clarke talked of his record at the ministries of health and education, which, he maintained, demonstrated his high competence at public-service management. He once airily promised to abolish student loans, a policy that would not find approval with the author of The Welfare State as Piggy Bank . Iain Duncan Smith floated the extension of vouchers and parental choice in the education system, often sounding like Keith Joseph circa 1974, with little acknowledgement of subsequent developments that have raised some serious questions about the effectiveness of these quasi-market mechanisms.

But it would perhaps be unfair to criticise individual politicians for the poor quality of political debate this year. There seems to be a general lack of new and inspiring ideas about public-service management, in Parliament, the think-tank world or in academia. It may be that privatisation has a little more road left in it. There may, too, be some life in the general notion of expanding choice and encouraging the development of internal markets in public services, though the experience of the latter in the past decade is not wholly encouraging. But it is hard to identify any major new policy themes on offer, and certainly no radical new ideological departure, which we did see in the 1980s in the first phase of the Thatcher revolution. Or, since new Labour has now annexed this phase of radical conservatism, should we say in year zero of the Blairite revolution? New Labour now, indeed, professes to have moved beyond ideology. Its focus is exclusively utilitarian. They will do "whatever works". The aim is output, at all costs, and never mind the theory.

Some will be comforted by this plain-man approach. Others may worry that some version of Keynes's famous dictum about practical men being slaves to the ideas of some defunct economist may be appropriate. And, of course, one cannot begin to decide what works, unless one has a clear idea of what one is trying to achieve. That is the principal value of Nicholas Barr's excellent and timely book. His core aim is to demonstrate that the welfare state "exists for reasons additional to and separate from poverty relief, reasons that arise out of pervasive problems of imperfect information, risk, and uncertainty". He argues, persuasively, that the redistributive purpose of the welfare state has received a disproportionate amount of attention from economists, and indeed perhaps also from politicians, while what he describes as the "piggy-bank function" is much less well researched and understood. Barr's explicit aim is to redress that balance. His book is a paean of praise to the piggy bank. And he uses some quite straightforward and reader-friendly economic theory to support three simple contentions, but with quite far-reaching consequences.

He maintains, first, that the welfare state does have an important saving function that is additional to and, in principle, quite separate from its role in income redistribution and the relief of poverty. This leads to his second argument, which is that the welfare state is here to stay, and should not be expected to wither away as economic growth lifts people out of poverty. Even if we were all middle class, we would still find a use for it. His third argument is, however, perhaps less reassuring for social democrats. It is that the welfare state will nonetheless need to adapt quickly to economic and social change if it is to continue to perform its two key roles effectively. And the road ahead is scattered with pitfalls and traps for the unwary.

The approach Barr takes to the articulation of these arguments is straightforward. Indeed, at times it verges on the simplistic. But, in view of the volume of confused and confusing debate around welfare issues, that may be no bad thing. The book suffers, to a degree, from some uncertainty about its target market. At times, Barr appears to be addressing policy-makers in developed economies, at times university students of economics, and, near the end, international institutions and governments in transition economies. There is a closing chapter on the welfare state in a changing world that attempts, somewhat heroically, to summarise social-policy developments in post-communist countries, which sits somewhat uneasily with the rest of his material. But that is a quibble. At the core of the book we find a careful and extended analysis of three core topics of welfare policy: the role of social insurance, whether publicly or privately provided; the structure and funding of pensions; and the economics and funding of education. Since his main purpose is to educate and to provide an analytical framework for decision-making, The Welfare State as Piggy Bank is not a personal manifesto of policy proposals in each area. But Barr does not shrink from reaching firm conclusions about those policies that appear to him to be clearly inferior or superior to the alternatives.

In pension policy, he firmly rebuts the argument that funded schemes are unambiguously superior to pay-as-you-go arrangements, showing that pre-funding cannot shield tomorrow's pensioners from a drop in national output that results from an increase in the dependency ratio. And he points to the lack of sound empirical support for the notion that funded pensions increase investment and growth in themselves. He is also sceptical about the economics of individual pension accounts, especially for low earners, in view of their high administrative costs and the challenges they pose for financial regulation. In the insurance chapter, Barr sets out the rationale for state involvement in the provision of long-term care insurance, and provides a useful analysis of the current lively debate on the permitted use and potential abuse of genetic screening data by private-sector insurance firms.

It is, however, in the education chapters that his own slip shows most clearly. He points out that the United Kingdom spends 0.7 per cent of gross domestic product on higher education, compared with 2 per cent in the US and between 1 and 1.5 per cent in all the major continental European countries. He is strongly critical of the last government's first approach to student loans, which did not provide additional funding for the university sector and which, in its design, appears clearly inferior to schemes previously developed in Australia and New Zealand, for example. This is the only part of the book in which he affords himself the luxury of a clear policy recommendation. He argues that "flexible tuition charges supported by income-contingent loans redistribute from today's middle class (who lose a fraction of their tuition subsidies) to tomorrow's least well-off (who, with income-contingent loans, do not repay in full). This is redistributive beyond anything contemplated by successive governments. Reform is therefore at least as much an issue of political will as a policy design." Here is something approaching an "issue" indeed, but not one that has been explicitly debated in public this year.

Looking to the future of the welfare state around the world, his view is that the problems of information, risk and uncertainty that underlie the piggy-bank function will become even more acute in a world of more volatile financial markets and more interconnected national economies. Far from globalisation working simply to constrain the freedom of individual countries to tax and spend, there is likely to be growing pressure in developing countries to increase social provision. That pressure is already evident in middle-income countries such as South Korea or Mexico. Barr expects it to spread.

Barr's book can be strongly recommended to anyone with an interest in the development of social policy - anyone, that is, except the Rolling Stones fans among us. Discussing the possibility of an earnings-related graduate tax, he refers to the "Mick Jagger problem". He points out that Jagger's "enormous financial success has no obvious connection with his time at university, yet with a graduate tax he would repay amounts many magnitudes larger than the cost of his studies". To help that section of the population who has never heard of Mick Jagger, an explanatory footnote reads "lead singer of the Rolling Stones, an immensely successful rock group". You learn something every day.

Sir Howard Davies is chairman, Financial Services Authority.

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