DESIGN INSURANCE BEFORE THE FACT

A second rule to prevent the politicization of relief is to design the guidelines for future relief before the event that prompts relief rather than after it. There are a number of reasons why this makes sense. Governments, though, typically prefer to wait for the event to take place before responding instead of preparing for the uncertain eventuality: not only can the magnitude of the relief required be better gauged after the fact, but resources do not have to be held in reserve, crowding out other activities that the government deems essential.

One reason to design relief in advance is simply that a well-designed plan provides people a greater sense of security. Moreover, it eliminates the need for the distressed to organize to obtain relief. Since the actions of their political organizations are not likely to be friendly to the market, a plan for relief before the fact eliminates a significant threat to the markets. This, in fact, is suggested by our brief account of the history of the U.S. bankruptcy law. Once a flexible enough law was put in place, the need for debtors to organize to press for relief during each recession disappeared. Also, they could obtain relief based on individual circumstances rather than wait for collective misery to tip the political scales.

Relief provided after the fact is not insurance but pure redistribution. As such, it is driven solely by the political power of the parties involved, not by the needs of people. As an example, consider the Federal Emergency Relief Act, a large ($3.6 billion) New Deal program implemented between 1933 and 1935 to provide assistance to all persons whose income was inadequate to meet their needs. Since the United States entered the Great Depression with no unemployment insurance, the decision on whom this relief was distributed to was made after the fact. It turns out that the amount of aid received in each county was positively correlated with the number of radios owned in the area, even after accounting for the wealth of citizens in the county.⁶ In the 1930s, people who owned a radio were better informed politically and more likely to vote, so this suggests that relief went to counties that were more able to press for it. In addition, counties with more illiterates received less aid, suggesting again that informed voters obtained more assistance. Even though all relief is determined by political power rather than economic need, relief after the fact tends to be particularly driven by political power.

Therefore, one of the most important benefits of putting in place a system of relief before a crisis is the veil of ignorance on who will be affected and how. Most people will not know whether they will be the beneficiaries of the scheme or will be the ones who will have to pay for it. As a result, they do not have strong incentives to distort the system one way or another. In fact, they would prefer the system that is most effective in terms of cost per unit of benefits. By contrast, after the fact, it is very clear who will receive the transfer and who will have to pay for it. Thus, the return to lobbying is extremely high. Relief provided on an ad hoc basis is thus much more a slave to vested interests than an insurance scheme designed before the fact.

One of the problems with the current system in developed countries is that it was designed during a time of crisis and targeted only certain groups. These systems are not universal in their coverage. It is a travesty that children in the United States, the future of the nation, do not have health insurance as a matter of course, while politicians are vying with one another to offer prescription drug benefits to the predominantly wealthy elderly.⁷ It is equally worrisome that so many working families have no medical insurance. The system will no doubt provide in the wake of a severe crisis, but benefits will have to be extracted through political action, with all the attendant consequences. Moreover, in the United States, too much of worker health insurance and retirement benefits are closely tied to the survival of existing firms. In Italy, too, workers in the largest and most politically influential firms have a special deal and therefore strong incentives to press for their survival. The system of insurance needs a dramatic overhaul—a broadening of the base and a more direct relationship between the individual and the insurer without involving others like the employer.