The Welfare State as a Fiscal Commons: Problems of Incentives Versus Problems of Cognition

Abstract

A mounting empirical literature clearly indicates that the core programs of the welfare state are unsustainable in their present form. The proximate cause of this growing fiscal instability is a demographic imbalance between younger contributors and older beneficiaries. The authors argue, however, that the ultimate cause is the institutional structure of the welfare state itself. Specifically, if its fiscal institutions are modeled as a common-pool resource, the tools and analysis emerging from the growing literature on common pools can be used. Such an analysis suggests that the apparent nonsustainability of current welfare state programs is rooted in the failure to resolve two distinct problems in institutional design. The first problem concerns how to limit the scope of opportunism among rational self-interested individuals. The second problem concerns how to limit the adverse effects of the knowledge problem among boundedly rational individual actors.