SOCIAL POLICIES IN A
MARKET ECONOMY
Joseph E. Stiglitz
Beijing
March 2006
Objectives of Social Policies
• Redistribution
– Enhancing opportunity
• Access to education
• Access to finance
– Partially reflections of market failure
– Improving Outcomes
• Even if market is efficient, it may not lead to
socially acceptable distribution of income
Objectives
• Social Protection
– Market failures—absence of insurance to cover major
risks
• Huge loss of welfare
– Lack of security cited as major problem
• Problems in insurance risks: Unemployment, annuities,
disability, insurance against inflation
• Explained in part by theories of asymmetric information
– But government has sometimes acted as a catalyst
– Basic human needs
• Education
• Food
• Social obligation (specific egalitarianism)
Full Employment
• Most important social policy
– Unemployment represents waste of resources
– But also leads to adverse social
consequences
– Market economies do not automatically lead
to full employment
– And excessive focus on inflation can lead to
higher unemployment than necessary
Trade-offs
• Inflation vs. unemployment
– Little evidence that moderate to low inflation has any
effect on growth
– Social programs can insure poor against inflation
(indexing social security, etc.)
– Continuing debate about broader distributive effects
of inflation
• With many studies claiming inflation “cruelest tax” flawed in
identifying source of problem (oil price shock)
• Well functioning markets have unskilled wages adjust fairly
quickly
Trade-offs
• Do unemployment benefits lead to higher unemployment,
because of reduced incentives to search?
– If there is a lack of jobs, more search does not produce more
employment (search externality—just increases expenditures on
search)
– But in Efficiency Wage (Shirking—Shapiro/Stiglitz) models
higher unemployment benefits can result in higher equilibrium
unemployment
– But increased job security has more ambiguous effects on
unemployment
– What is clear is that markets by themselves do not necessarily
result in optimal levels of severance pay and unemployment
insurance (private markets typically provide little)
Thinking about Redistribution
• Neoclassical dichotomy—can separate
“efficiency” concerns from “distributional
concerns”
• Today, we recognize that such separation is not
possible (if there are imperfections or
asymmetries of information, incomplete markets)
– Social policies/concerns need to be integrated into all
government programs
• Assessing who benefits
• Though often incidence is a complicated matter
Redistribution
• Government needs to think of impact of policies on pretax distribution of income (not just adjustments to given
after tax income distribution)
• China today is in a markedly different position from many
market economies
– Who are worried about deficiencies in
savings/investment
– And hence have been pushing for low taxation of
capital
• In spite of adverse effects on distribution of income
• In spite of limited evidence on the impact of such
“incentives” on savings
– Tax preferences may actually lower net
national savings
• China today is trying to encourage consumption
– So can employ progressive capital taxes
• China is also in a different position from other
developing countries
– Traditional debates focused on need to extract
“surplus” from rural sector
– China needs to increase well-being of those in rural
sector
• But guard against problem in U.S.,EU, where agriculture
subsidies mainly go to large, corporate farmers—huge
distortion of resources and increase in inequity
Opportunities
• Unequal access to opportunities
– Education, finance
– affected by parental wealth
• Lowering social mobility
• Horatio Alger mainly myth
– But also discrimination—discriminatory market
equilibrium
• Gender, race
• Becker was wrong
– Impossible to undo fully
• Affected by differences in quality of public schools
• Location/geographic, network externalities
Opportunities
• Huge societal costs of unequal opportunity
– Efficiency—not drawing fully on most important
factor—labor
– Undermining Social Cohesion
• Huge costs of exclusion
• Manifested in anti-social behavior
• But government can make a difference
– Affirmative action programs
– Directed expenditure programs
– Promoting wider access to credit
Social Protection
• Huge costs to insecurity
• Widespread market failure
– Especially associated with adverse selection
– Market efforts directed at “cream skimming”
• At enormous economic and societal costs
• Helps explain huge transactions cost
– Help explain problems in private health
insurance market
• Public sector has to be worried about moral hazard (incentives)
• But an integrated social insurance system (Singapore’s provident
fund) can mitigate risk and minimize attenuation of incentive
• Key question: how much inequality in, say, access to
health/medicine should society accept?
– Vexing question, especially in societies marked with high levels
of inequality in other ways
– Probably need to accept basic level of health care, publicly
provided (financed)
• With high income purchasing additional services
– Good news—access to medicine only one of determinants of
health
• Government should work on other dimensions (nutrition,
smoking, drinking) as well
China’s Transition to a Market
Economy
• As China makes a transition to a market
economy, it needs to be aware of the limitations
of markets in providing basic levels of social
protection
– There is an important role of government
• Which virtually every market economy has recognized
– China should learn from the mistakes—the successes
and failures of others in designing its social programs
• But the strains imposed by China’s extremely rapid growth
make it all the more important for its government to assume
an important role
China’s Transition to a Market
Economy
• China’s decisions will affect not only the
performance of the economy
– Well designed social programs can even increase
productivity
• Making sure that all of the country’s talents are given the
opportunity to reach their potential
• Correcting, or mitigating, market failures
• And with a well-designed safety net, individuals may be freer
to take risks than they otherwise, encouraging innovation (the
Scandinavian model)
• But the nature of Chinese society itself