Paternalism, readily accepted by those whom it treats as children, destroys jobs. In the modern welfare state, it ranks with the handful of major macro-economic parameters as a determinant of employment.

Reading last month’s Reflections from Europe (“Stamp Your Feet and Demand a Fair Deal”), the Nobel laureate economist Milton Friedman remarked in a letter to the author that he was not surprised that 10 per cent of the French labor force and 23 per cent of the young had no jobs, but wondered how 90 per cent did have one.

Why do they? It is a good question and economists do not really know the answer. In moments of despair and disgust, as one surveys all that has been done in this rich and talented country to pervert the normal functioning of the economy, combat reality, foster illusions and make water flow uphill, one is tempted to say that the worst has become plausible and anything better is a surprise. Perhaps one should not think it absurd that all jobs should just disappear. In any case, the question now is to explain any level of employment between 0 and 100 per cent, rather than minor shortfalls from the 100 per cent norm.

In a centrally planned and commanded economy, the state in practice owns the workers and employs such proportion of them as it wishes. It pays them with what they manage to produce. Even if all are employed, they cannot produce much, the system is hardly workable and too many of the potential workers have to be employed as policemen of one kind or another to keep down the rest. This ‘model’ is now confined to the museum, though some intellectuals still hanker after it and would dust it off if they had their way.

For an example of how minimum-wage laws can primarily burden youth and the unskilled, see Minimum Wages by Linda Gorman from the Concise Encyclopedia of Economics.

Employment in competitive economies based on individual ownership and freedom of contract is explained in terms of equilibria in which each producer and consumer is doing the best that is feasible for him provided that all or most others do the best that is feasible for them. The neo-classical model of explanation runs in terms of such equalities as the one between the marginal product of labor and the wage, between the (risk-adjusted) return on capital and the rate of interest, between the quantity of money divided by the price level and the demand for real money balances, and between consumption and abstinence rewarded by the rate of interest. Under not too implausible conditions, excess demand or excess supply is corrected, the necessary equalities are satisfied and the standard solution in general equilibrium is 100 per cent employment subject only to frictional losses.

The ‘Austrian model’ runs mostly in different terms (though the difference is often only one of semantics) and makes less use of the concept of equilibrium, but it produces a solution that resembles the neo-classical one. In a normally functioning free economy, employment will tend to be full. In the Keynesian scheme, full employment is a special case that may or may not be achieved according to certain variables. Two of these, the level of wages and the minimum achievable rate of interest (caught in the ‘liquidity trap’) are inflexible and this permits equilibrium to be maintained at some low level of activity and employment. Each of these explanatory models can be, and has been, refined almost out of recognition by generations of economists as they climbed the ladders of academic preferment, but the main outlines subsist.

A Machine To Grind Value

Enter the modern welfare state in the particular version that it took on in the main countries of Continental Europe, notably in Germany, France and Italy. With the welfare state, enters a paternalistic economy that operates to shred, grind and send down the drain some of the value it creates. A kind of paternalistic economic model might help to explain how it works and why it destroys jobs.

The ancestry of the value-grinding machine goes back to the custom in the English weaving and metal-working trades of the 17th century to pay workers not in cash, but in kind, usually in the very product—e.g. cloth or nails—they were making. Despite repeated Truck Acts prohibiting the practice, it survived into the mid-19th century. In America, it persisted into the 20th century in the form of the company store where workers had to spend the vouchers they were given in lieu of wages. Even if the worker was not cheated on the rate at which his nominal wage was converted into cloth, nails or groceries, the payment of his wages in kind instead of cash deprived him of the choice of spending the wage as he saw fit, hence reduced its value to him.

The modern version of the ancient truck system, practiced on a gigantic scale, is compulsory social insurance which the worker is legally obliged to accept in lieu of part of his wage.

A schematic illustration will make it clear what is going on. If in Germany or France the cost to the employer of employing a worker for a given length of time is $100, the employer pays $20 of that sum into publicly administered health, unemployment, disability and pension schemes on behalf of the worker. This is misleadingly called the “employer’s contribution”, though it is in fact part of the employee’s wage compulsorily deducted rather than paid out to him. Of the remainder, a further $20 is deducted and paid into the same insurance schemes on behalf of the worker. This is called the employee’s contribution. Though the fact is masked by a fraudulent vocabulary, the employee in reality contributes not $20 but $40, for both contributions come out of his wages. However, what he receives in cash is only $60.

The worker is told that his wage is $80, of which $60 is in cash and $20 is in kind, namely insurance against various contingencies. He is pleased to know that on top of this, his employer is also paying $20 to make his insurance cover more full. However, basic value theory tells us that cash of $100 is worth more to the recipient than a basket of goods—including a basket of insurance policies—that would cost him $100 to buy and that he has not himself chosen but that was chosen for him. Between the $100 cost of the insurance basket that he is compulsorily made to accept and the worth of the basket to him, the recipient loses value as it is shredded and ground to dust in the coercive social insurance machine. The lost value is subjective and cannot be readily measured, but it is a loss all the same.

The effect on employment is easy to diagnose. The demand price of labor is $100. The supply price is also $100 because the employer cannot hire labor that would cost him less, given the compulsory insurance premium included in the wage cost. However, if the whole wage were paid in cash, the supply price would lay somewhere at or above $80 but below $100 (though we cannot say precisely by how much below). At this reduced supply price, the demand for labor would expand until demand price and supply price reached equality again above $80 and below $100. It is this potential increase in employment that the compulsory conversion of part of wages from cash into kind (i.e. into ‘social’ insurance) prevents. Putting it the other way round, moving from payment in cash to payment in kind destroys jobs by forcing up the supply price of labor.

The paternalist takes the view that social insurance must be compulsory, for workers would otherwise not insure themselves. This is a vast topic that offers no simple answers except possibly the moral one that it is wrong to deprive workers of the freedom to spend their wages as they choose. It is highly likely that while some would insure themselves, others would not, and to this extent the paternalists are right. In the longer run, however, they would be less and less right, for bitter experience would gradually ingrain the insurance habit and buying some cover suited to personal circumstances would become part of standard behaviour.

In the meantime, compulsory social insurance keeps the cash cost of labor way above the supply price of labor that would obtain if the wage were paid in cash rather than kind. In the gap between the two, value disappears and chronic unemployment becomes the equilibrium in which the economy of welfare states maintains itself. It is a copper-bottomed bet that neither the paternalists nor the workers they treat as children realise the reason why this is so.


*Anthony de Jasay is an Anglo-Hungarian economist living in France. He is the author, a.o., of The State (Oxford, 1985), Social Contract, Free Ride (Oxford 1989) and Against Politics (London,1997). His latest book, Justice and Its Surroundings, was published by Liberty Fund in the summer of 2002.

The State is also available online on this website.

For more articles by Anthony de Jasay, see the Archive.