The Economy of Obligation: Incomplete Contracts and the Cost of the Welfare State

Aug 2012 | 103

Authors: Avner Offer

Western governments typically pay out some 30 percent of GDP for social purposes.  This is financed by taxation on a pay-as-you-go (PAYGO) basis.  How efficient are these transfers, and can market or other mechanisms do it better?  The problem arises since no individual stands alone.  During the life cycle there are several periods of unavoidable dependency, in which there is no earning and little to bargain with: motherhood, infancy, childhood, education, illness, disability, unemployment, old age.  The problem is how to transfer resources from 'producers' to 'dependants' over the life cycle.  The market solution is for individuals to accumulate financial assets and to transfer them over the life cycle by means of long-term contracts with financial intermediaries.

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