It is plausible that a state-run universal social insurance system would be better able than a private company to detect and prevent exploitation of the system by malingerers. Maybe success would depend on the creation of a norm of good citizenship; something like that underlies the establishment of social insurance in the first place. It seems to work in the Nordic countries--though not without strain--where the tradition of social insurance is strongest. The US has a long way to go.
Solow mentions the usual problems with insurance--moral hazard and adverse selection. However, I believe that there is another problem that is much more important--mass delusion.
For example, with health insurance, people believe that what is unaffordable individually is affordable collectively. Uwe Reinhardt writes,
no one should not be lulled into a false sense of security by the idea that, equipped with a tax credit of $5,000 for a family, American families can procure adequate protection for themselves from the financial inroads of ill health merely by topping off the tax credit with an additional $800.
Reinhardt notes that the average family of four consumes over $15,000 per year in health services. So it seems silly of Senator McCain to suggest that a $5000 tax credit is sufficient.
Except...how do we manage to spend $15,000 per family if we cannot afford it? We have the delusion that corporations and Medicare pay for our health care. But we pay for it. If corporations did not pay for health care, the typical worker might have another $10,000 a year or more in take-home pay. That could be used for health insurance--or for something else, if workers choose. And with Medicare--guess what? We pay for that, too.
The main function of health insurance is not to provide insurance. Insurance would mean catastrophic coverage. The main function of health insurance is to maintain the delusion that health services are free. The main beneficiaries are health care providers, who have the demand for their services boosted by the illusion of no cost, even as they charge for their services. (Individually, doctors may hate insurance companies and think that the insurance companies drive down their incomes. But collectively, without the demand boosted by insurance, many medical practices would be out of business.)
Defined-benefit pension plans are a mass delusion. The promise to pay a specific pension, regardless of circumstances, is unsustainable. Solow implies that companies are moving away from defined-benefit plans because companies have become nastier. In fact, as the period of retirement lengthens and becomes more uncertain, defined-benefit plans are very likely to blow up.
Government is the only institution that can promise a defined-benefit plan. But are government plans a mass delusion? I suspect that they are. Certainly, if you include Medicare, we know that as currently structured it will not exist 20 years from now.
Solow says that a welfare state can be sustained by encouraging "good citizenship" and a work ethic. Yet all of the good social cues don't seem to stop the retirement age from falling, even as longevity goes up. I would not count on the Nordic social welfare system to remain in place forever.