Hayek and the welfare state

In the minds of many, the rigorous classical liberalism personified by Friedrich von Hayek is in direct opposition to the notion of the welfare state. But is this necessarily true? Three fundamental pillars to Hayek's thought are:

1. The price mechanism in the market economy is a decentralised information signalling system.
2. The competitive market is a spontaneous order (not centrally planned)
3.  The competitive market is the economic order that supports personal liberty.

Are these compatible with a welfare state? Contrary to what is often claimed, it can be argued that the state's welfare provision may not only be compatible with fair and competitive markets but can enhance their effectiveness.
In “The Free-Market Welfare State: Preserving dynamism in a volatile world.”  by Samuel Hammond, of the Niskanen Center, an attempt is made to bridge the divide between social and economic liberals. Hammond's paper provides a fundamental change to the conventional economic view on welfare as a cost to it being implemented as an economic benefit. The arguments in the paper are set out in an US context but draw on key mechanism from northern European market economies. Notably not the UK, which would be analysed as getting the relationship mostly wrong, but with the Swedish and Danish. In terms of income levels provided by cash minimum-income benefits (Figure 1 in the paper), the UK is one of the more generous nations whereas "the U.S. income security system one of the stingiest in the developed world". So the situation in the later is fundamentally different from the former. In the US nervousness about market disruption has led to very low levels of cash benefits and the  system is poorly implemented, whereas in the UK the problem is mainly poor implementation. The UK implementation deficient in at least two ways:

1. Welfare is poorly implemented as safety net and worse as a service (and made worse through recent reforms, as well as under funding).
2. Welfare, as implemented, is a negative for the economy as measured against all three of Hayek's pillars, above. 

Using the statistical evidence that shows Sweden and Denmark scoring highly on personal and economic liberty and examining the welfare mechanisms they use, Hammond proposes four design principles where well implemented social insurance can enhance market dynamism and economic freedom in Free-Market Welfare State. These can be condensed (with some simplification) as follows:

1. Risk and Entrepreneurship.  As the term “safety net” suggests, social insurance can enhance risk-taking and entrepreneurship by ensuring failure is not catastrophic.
2. Search and Adjustment Costs. Workers who are laid off in periods of market restructuring should be ensured a smooth transition through appropriate wage replacements and active labour-market policies. While your job may not be secure, your employment is. 
3. Benefit Portability. Markets work best when social benefits follow the individual and are detached from any particular firm or market structure. (In the UK many people are often trapped in a firm due to penalties imposed to their pension entitlement. In contrast the German system decouples this, as recommended.)
4. Migration Robustness. Welfare benefits should be payments or services resulting from insurance funds to which people have contributed while working in the host country, migrants who claim such benefits should not therefore be perceived to be a great problem. There needs to be other humanitarian safeguards for refugees and others in dire need;as opposed to economic migrants.

Hammond's paper shows a refreshing ambition to bridge the divide between economic liberal purism (bordering on the libertarian) and social liberalism with its focus on social safety nets.

The above is obviously at best work in progress from the point of view of policy formulation and implementation. The proposal is that, by adopting the four principles for welfare design, Hayek's three pillars of liberty can be maintained and their effectiveness even enhanced.