Hayek did not believe that “if you begin with welfare policies of any sort” that you were necessarily on the road to serfdom. In fact, the entire last part of his famed The Constitution of Liberty is dedicated to explaining how many modern welfare-state policies could be implemented in a manner that would not unduly threaten liberty and the rule of law. Hayek never said that the basics of the welfare state were incompatible with individual liberty.
Hayek’s concern was that comprehensive economic planning of the economy by the state was incompatible with individual liberty and the rule of law over the long run. His attack on the New Deal was not about Social Security, but rather the National Recovery Act and other interventions designed to cartelize industries, erect barriers to entry, raise prices for producers at the expense of consumers, fix wages, and divide markets among incumbent producers. Central planning, not the welfare state, is what was incompatible with individual liberty.
Hayek’s point is that given this reality–scarce resources and unlimited wants–there are fundamentally only two ways to allocate scarce resources among unlimited wants. The first is through impersonal processes such as the market process, or more accurately, the market process consists of billions of individuals making billions of decisions every single day on how to spend their time and other resources. In the market process, the guiding principle is the price system–prices are fundamentally amoral in the sense that they simply provide information about what these billions of people believe is the most important allocation of scarce resources. It may be that this means it is children’s vaccines or it may mean Honey Boo Boo marathons. In this sense, the price system is completely bottom-up–it is the aggregation of all these marginal and constantly-changing expressions of preferences of people deciding how to allocate their resources and a signal of how resources are valued by other people. Which individual ends are satisfied and at what cost is thus fundamentally driven by billions of individual decisions. You may wish for a career as a Knight of the Roundtable, but in the modern economy it will be prohibitively expensive to pursue that career. In this world, then, Hayek says the role of the government is provide the rules of the road, i.e., should be organized around the rule of law, which is a set of purpose-independent rules that tell people how to go about pursuing their own freely-chosen ends, but doesn’t tell them what ends they must choose. To put it another way, the rule of law provides traffic rules, but doesn’t tell you which exit you have to get off when you are on the highway.
Hayek’s great insight was that moving economic decision-making from individual decision-making through the market to collective decision-making through the state does not eliminate the economic problem. The reality of economics is still present: scarce resources and unlimited wants. The only question is “Who decides?” Do you decide for yourself (through markets) or does someone else decide for you (through politics)?
There may be times when the welfare state evolves to central planning if it just grows too large and expand to cover large portions of the population for extensive periods of time. Politicians in a democracy tend to promise benefits and not pay for them. They create political Rube Goldberg bureaucracies and mandates to hide the true costs from everyone including themselves. If we accept the premise of the government ultimately being responsible for the costs of individual behavior, it becomes a wedge to dictate the behaviors of individuals. But in its limited sense the welfare state can bring stability. Our challenge is how to contain it.