The Welfare State as Extended Warranty

“Extended warranty?  How can I lose?”

            — Homer Simpson

Value is subjective, and taste for risk varies widely.  But every economist I’ve asked – and virtually every savvy consumer – concludes that extended warranties are a lousy deal.  The short case against extended warranties:

1. You normally get a very good warranty for free.  When you buy an extended warranty, you only receive a marginal increase in security. 

2. This marginal increase is usually grossly overpriced.  You often pay 20% of the purchase price to protect yourself against a 1% risk. 

3. In any case, by the time your extended warranty kicks in, your product has already lost most of its value.  Most of the time, the vendor just repairs and returns your original semi-obsolete device. 

The lesson: Even if you’re a deeply anxious person, self-insurance is the prudent course: Just take your chances, and use all the money you save to buy replacements when the need arises.

If extended warranties are such a bad deal, why are they so popular?  Psychological bias.  Vendors are preying on your absurd yearning for certainty – your desire to know that you’ll never lose what you have.  Why absurd?  Because true certainty is unavailable at any price.  Can you be certain that the vendor will remain in business?  No.  Can you be certain that the vendor will honor the contract?  No.  Can you even be certain that you’ll still be alive tomorrow?  The answer, I’m afraid, is no.  Extended warranties sell because they provide the illusion of certainty – and many human beings are too soft-headed to disbelieve the illusion.

Readers often misinterpret my The Myth of the Rational Voter as arguing that people are rational in markets, but irrational in politics.  My actual view is simply that people are markedly more irrational in politics than in markets.  Given the bustling market in extended warranties, then, my natural reaction is to ask: Does this absurd yearning for certainty play an even larger role in politics?  My answer is a resounding yes.  The absurd yearning for certainty lies at the heart of support for the welfare state.

Think about the populist case for fully socialized medicine.  What’s supposed to be so great about it?  The certainty.  You know that no matter what happens, the government will provide your health care.  Of course, this certainty is merely rhetorical.  Can you be certain that the government will cover the treatments you actually need?  No.  Can you be certain that the government will competently deliver whatever treatments it covers?  No.  Can you even be certain that your medical problems are curable?  The answer, I’m afraid, is no.  What is the point of this rhetoric of certainty?  To confuse voters so they don’t ask the questions that matter to savvy consumers.  Namely:

1. What is the marginal health benefit of socialized medicine?

2. How much extra does the government charge for this marginal health benefit?

If voters did ask these questions, they’d find considerable evidence that government health spending, like extended warranties, is a crummy deal.  You pay an arm and a leg, and the marginal improvement in health is slight.

The same goes for government retirement programs.  What’s so great about Social Security?  You know that no matter what happens, the government will provide your retirement income.  But once again, this certainty is merely rhetorical.  Can you be certain that Social Security will give you a decent standard of living?  No.  Can you be certain that Social Security will suffice for your basic needs?  No.  Can you even be certain that you’ll still be eligible for Social Security by the time you retire?  The answer, I’m afraid, is no.  But the rhetoric of certainty silences the awkward questions every savvy consumer should ask:

1. What marginal income security benefit does Social Security provide?

2. How much extra does the government charge for this marginal security benefit?

If voters did ask these questions, they’d find that projected Social Security returns are pretty crummy for most people – even according to the Social Security Administration itself.  The SSA’s own estimates look worse yet when they factor in probable future changes in the benefit formula.  There’s “certainty” for you!

Are there any important differences between the market’s extended warranties and the government’s welfare state?  Sure.  Most economists will highlight a difference that makes the welfare state look better: Extended warranties usually insure against relatively small losses; the welfare state, in contrast, often insures against relatively large losses.  These economists have a point, but exaggerate: The welfare state’s biggest programs “insure” against the rather foreseeable problems of old age and unprotected sex.   

Relatively few economists, though, will highlight a difference that makes the welfare state look worse: If you don’t want an extended warranty, all you have to do is tell the vendor, “No thanks, I’ll take my chances.”  Once you realize that extended warranties are a bad deal, you never have to get ripped off again.  The welfare state, in stark contrast, won’t take no for an answer.  Once you realize that the welfare state is a bad deal, the rip off continues until the day you die.  Or flee the country.

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