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The Privatization of Risk and the Growing Economic Insecurity of Americans
The Privatization of Risk and the Growing Economic Insecurity of Americans
Published on: Jun 07, 2006

Acting to Preserve Opportunity as well as Security

Americans, in short, are more economically insecure. And this insecurity not only creates unnecessary hardship for individual workers and their families, it also has serious social costs. The most obvious of these costs are the growing expenses that are picked up by our bankruptcy and social assistance systems and by private relief—none of which are well designed to handle the basic functions of social insurance. Yet there are much larger costs that fall on our economy and our society when families are burdened by excessive economic risk. These include the well-documented psychological dislocations associated with large drops in families’ standards of living—from the blows to mental health caused by job loss to the tensions for families created by downward economic mobility. Importantly, these larger costs also include the reduction of families’ incentives to invest in work, education, parenting, and other foundations of economic advancement when the risks of these investments are not adequately insured against.

Researchers and policymakers have long recognized that policies that encourage risk-taking can benefit society as a whole, because a sufficient number of these risky investments may well pay off. Yet individuals may be unwilling to undertake the investments that involve this level of risk. First, from an individual point of view, the risks of failure may be too high. Second, behavioral research indicates that individuals are highly “loss averse,” meaning they fear losing what they have more than they welcome even substantially larger gains (Kahneman and Tversky 1984). Third, the gains of risky investment may entail positive externalities—that is, benefits that are not exclusive to the individual making the investment, but accrue to others outside the transaction—and thus individuals may not have as much incentive to invest in achieving these gains as they otherwise would.

Many economic investments made by families have this character. And unlike high-rolling investors, who may be used to dealing with large losses and to seeing their present holdings as merely means to further ends, families are likely to see many of their investments or their payoffs as intrinsically valuable components of their basic endowments—and, hence, as something they acutely fear losing.

Owning a home, for example, is beneficial to families and society. But it entails substantial financial risk (Shiller 2005). As families have bid up home prices in areas with good schools and strong communities (Warren and Tyagi 2003), more and more of family finances are tied up in risky home investments. Similarly, education—and particularly education of children—is an investment that pays off handsomely. But the returns to education are highly variable, and there is evidence they are becoming more so (Bernhardt et al. 1999; Farber 2005). Moreover, parents who invest in raising productive children do not reap many direct economic benefits, as they once did when children contributed to household production. The costs of investing in children are immediate and direct, the gains are long-term and societal. In short, the wellsprings of economic opportunity assets, education, good parenting—are high-risk investments, often with positive externalities.

Unique among social institutions, government can encourage such investments. It has the means—and, often, the incentive—to require participation in broader risk pools and to foster positive externalities that no private actor sufficiently gains from to encourage individually. This is a major reason why government has long played a central role in managing risk in the private sector (Moss 2002). Corporate law has long recognized the need to limit the downside of risk-taking as a way of encouraging firms to take a socially appropriate amount of risk. The law of bankruptcy and the principle of limited liability—the notion that those who run a firm are not personally liable if the firm fails—allow entrepreneurs to engage in risky investments knowing that they will not be forced into penury or debt servitude if their risky bets fail. Deposit insurance increases the likelihood of savings and decreases the possibility of devastating bank runs, by allowing depositors to feel secure that they can obtain their money when they need it.

A similar logic holds for ordinary Americans. When workers and families are faced with fateful economic choices that place them at grave risk—about, for instance, the level of education to get or whether to retrain for new jobs—they may be unwilling to take the socially desired level of risk. As a result, more people choose the safe option, rather than the option that represents a socially desirable level of risk-taking. By providing basic security for families faced with these decisions—not complete protection, but a floor below which they are prevented from falling—government improves not only their own standing and opportunities, but also social welfare more generally.

This argument is not merely analogical. A growing body of evidence backs it up. Comparative statistics indicate, for example, that generous personal bankruptcy laws are associated with higher levels of venture capital (Armour and Cumming 2004). Research on labor markets shows that workers who are highly fearful of losing their job invest less in their jobs and job skills than those who are more secure (Osberg 1998). And cross-national studies suggest that investment in education and job skills is higher when workers have key risk protections (Esteves-Abe, Iversen, and Soskice 2001; Mocetti 2004).

This last finding, which may surprise those weaned on the view of social insurance as an inevitable drag on the economy, is perhaps the most telling. Workers, it seems, invest in highly specific assets—such as skills that do not transfer easily from one firm or occupation to another—only when the risk of losing the potential returns of those assets are mitigated by basic insurance protections that are not job-specific. When insurance is not present, workers under-invest in the most crucial asset in most families’ portfolio—namely, the value of family members’ human capital (see also Neal 1995).

In short, a foundation of social insurance is not merely critical to providing economic security. It is also critical to ensuring economic opportunity and advancement in a dynamic economy.
Social insurance protects families when they “fall from grace” (Newman 1999), and for this it should be welcomed. But it also encourages families that do not experience misfortune to make investments that benefit them and society, and for this it should be celebrated. Social insurance is about efficiency and growth as well as equality and justice (Barr 1998).


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