Protecting the Vulnerable: the Tradeoff between Risk Reduction and Public Insurance

In a risky world should governments provide public goods that reduce risk or compensate the victims of bad outcomes through social insurance? This article examines a basic question in designing social protection policies: how should a government allocate a fixed budget between these two activities? In the presence of income and risk heterogeneities a simple public insurance scheme that pays a fixed benefit to all households that suffer a negative shock is an effective redistributional instrument of public policy. This is true even when a well functioning private insurance market exists, and so the role of public insurance is not to correct a market failure. In fact, the existence of a private insurance market means that the public system has desirable targeting properties—all but the poor and high-risk take up private insurance. The provision of public goods that reduce risk for all should therefore be complemented with public insurance that (automatically) benefits those who are especially vulnerable.