The Strength and Weakness of the European Social Model

Padraig Flynn This, in turn, has led some opponents Amsterdam will enable us to generate of the “European social model” to claim long-term growth and exploit the that, if Europe’s strongest economy can employment potential in the European ITHIN THE EUROPEAN UNION, THE no longer afford an extensive social-wel- economy. German economy was the star fare system, then Europe as a whole cer- W performer for many years, tainly cannot. They commonly argue for Reviewing Some Evidence achieving consistently high liv- a shift toward more private, rather than Assessing the state of Germany’s econ- ing standards and low levels of public, provision. omy, and to what extent its problems can unemployment, particularly among Despite the frequency with which be attributed to the plethora of social young people. Structural features of the these arguments against Europe’s exten- programmes, requires an examination of German political economy—its industri- sive social-welfare system are made, three key pieces of evidence: German al relations, education and training sys- there has been a dearth of serious sup- unemployment, the impact of unifica- tems, technology-transfer arrangements, portive analysis or evidence. We need to tion, and expenditures on social welfare. and methods of providing finance for ask some basic questions. First, has the I shall deal with these in turn. business—are widely admired. They are German economy suffered any serious • The Rise in German Unemployment. not all seen as transferable to other long-term deterioration in its perfor- Unemployment rates in Germany have member states since they are built on mance or potential? Or is it facing diffi- averaged 2-3 percentage points below particular institutional arrangements. cult, but surmountable, short-run prob- the EU average for the past 20 years— Nevertheless, elements of the German lems? Second, have exceptional cir- under 3% compared with the EU aver- system—for example, its apprenticeship cumstances—in particular, unification age of 5.5% in 1980, and under 5% com- and youth-labour-market arrange- and the additional arrival of large num- pared with the EU average of 7.7% in ments—have inspired the systems of bers of refugees, ethnic German and 1990 (see Figure 1). Youth unemploy- other member states. others—been a significant factor leading ment rates, in particular, have been In terms of macroeconomic policy, the to current difficulties? Or have they sim- between a third and a half of those in strong economic integration in Europe ply exacerbated an already existing most other countries of the EU. At the and the deregulation and international- problem? Third, are solutions to Ger- time of unification, unemployment in isation of capital markets have led all EU many’s and Europe’s employment diffi- West Germany had been falling steadily member states to accept the German culties to be found mainly in changes from its 1985 peak of over 7%, reaching concept of low inflation as one of the in our social policies? Or are they to be a low of slightly over 4% by 1991. keys to economic growth found more in changes The investment boom which followed and prosperity. Europe’s problems to our economic poli- unification was expected to maintain the Over the past few years, cies? employment momentum. This was however, German unem- are not due to I argue here that short-lived, however, and the subsequent ployment has risen over-developed Europe’s problems— recession was severe, reversing the sharply. Now we are being which are not to be easi- downward trend in unemployment. encouraged by some to social policies, but ly dismissed—are not Small increases in 1992 were followed believe that the German rather to under- due to over-developed by larger increases, taking unemploy- economic model is close social policies, but rather ment back to over 7% by 1996. Seasonal to collapse—notably un- developed and to under-developed and unemployment was particularly high in der the weight of its high- fragmented fragmented economic the winter of 1996. ly developed system of policies. And it is the lat- Though the current level of unem- social protection. In such economic policies. ter rather than the for- ployment in western Germany is high by views, nothing short of mer that explains much German standards, it remains well wholesale cutbacks in social provisions, of the different labour-market perfor- below the levels currently experienced the dismantling of its wider social mances of the United States and Europe by France, or those of the UK in 1992 arrangements, and the extensive deregu- over the past two decades. There is and 1993 when unemployment exceeded lation of its markets will enable Germany some optimism, however, that the June 10%. to regain anything of its former glory. 1997 Amsterdam Summit will spur • The Economic Impact of Unification. employment policies in the EU. The Unification would have involved far Social Affairs Commissioner, European Commis- political commitments and operational greater social and economic stress in sion, Brussels, Belgium. mechanisms agreed at Maastricht and the absence of the German system of

WORLD ECONOMIC AFFAIRS ● SPRING 1998 23 social programmes. Indeed, while some Companies agreed to these increases unemployment after 1991 was some- of the economic decisions that were because profits had been steadily how the consequence of increased made at the time of unification have increasing, a trend that was expected expenditure on social welfare, and that been subject to considerable criticism to continue. The Bundesbank then this has been making the German econ- within Germany, it is difficult for out- raised interest rates in order to slow the omy progressively less competitive, is siders, like myself, to envisage how uni- overheating economy. By 1993, the not supported by the facts. From 1980 fication could have been attempted economy had been pushed into reces- to 1990, the scale of social expenditure without the German system of social sion with output in western Germany in West Germany actually declined, solidarity. falling by nearly 2%. Wage inflation from 29% of GDP to 27% of GDP (see At the time of unification, differences declined sharply but interest rates were Figure 2). Yet, referring back to Fig- between West and East German living reduced only slowly. Meanwhile, the ure 1, it is clear that unemployment in standards were very large. The income German recession—engineered by a West Germany actually increased from gap has now been substantially reduced. monetary contraction and the resulting 1980 to 1990. This would suggest—if By 1995, wages in east- anything—the opposite ern Germany had risen relationship between to over 70% of western FIGURE 1 unemployment and levels. Households’ liv- European,West German, and US Unemployment Rates social-welfare expendi- ing standards (in terms tures. of purchasing power) 10 EU The increase in Ger-

had increased to 85% ce man social expendi- US or of those in western 8 ture—to over 30% of Germany. Part of the GDP today—was pri- improvement in living marily the result of 6 standards in eastern unification. This was Germany has been due necessary in order to 4 West Germany to improvements in cover the direct costs

manufacturing produc- per cent of labour f of additional transfer 2 tivity. In 1991, manu- payments to the East, 75 80 85 90 95 facturing productivity year and to finance the cost in the East stood at of the increasing in only 20% of western unemployment in the German levels—by West. The unemploy- 1995, this figure had FIGURE 2 ment, however, was not risen to over 50%. But Social-Welfare Expenditure caused by the social subsequent productivi- 32 expenditures; it was ty improvements have the result of the reces- Germany been slow, and the East Including East sions engineered by remains heavily depen- 30 central banks who suc- dent on transfer pay- cessfully fought infla- ments from the West to 28 tion. Similar increases sustain even modest West Germany in unemployment were growth in living stan- evident in all such dards. Each year, per cent of GDP 26 countries. beginning in 1991, There are Still western Germany has 24 1980 81 82 83 84 85 86 87 88 89 1990 91 92 93 94 Strengths made net annual trans- year fers to the East of Whatever problems roughly DM 150 bil- Germany may have, lion. Such transfers amount to only high interest rates—spread to other dwelling on them risks ignoring some of 4.5% of western German GDP, but cur- member states participating in the Germany’s strengths, and there are rently account for over 40% of eastern Exchange Rate Mechanism (ERM). some significant ones to keep in mind. German GDP. The widespread slowdown in eco- • Competitiveness. Contrary to some German trade unions negotiated sub- nomic growth was compounded by arguments presented in the popular stantial nominal wage increases in the the effects of member states simultane- press, the German economy does not early 1990s—5% in 1990, 6% in 1991 ously imposing tight fiscal policies in have a fundamental competitiveness and 6% in 1992. Workers demanded an effort to meet Maastricht’s fiscal problem, any more than does the Euro- these increases partly in response to a conditions. pean Union as a whole. Germany has range of tax increases implemented to • Trends in Social-Welfare Expendi- stable real unit labour costs—this means help finance the transfers to the East. ture. The argument that the increase in that productivity gains are keeping pace

WORLD ECONOMIC AFFAIRS ● SPRING 1998 24 with increases in real wages. In terms of tence of part-day schooling, and the tive success—reflected especially in our cost competitiveness, the economy is in fact that a very high proportion of productivity performance—has not the same position as it was at the begin- people under 25 are in education or been matched by the necessary eco- ning of the period of exchange-rate sta- training and thus have little or no nomic policy management to ensure bility following the Louvre Accord in the labour-force attachment (though they that our potential resources are fully mid-1980s. presumably will have when their train- employed. Over the past decade, Germany’s ing is completed). Europe’s persistent unemployment is manufacturing sector has experienced Moreover, and most significantly, not the consequence of over-developed some deterioration in its cost competi- when the employment rates of different social policies, although many should, tiveness. But this deterioration has not European countries are corrected for and are being, reformed. It is instead the appeared to affect Germany’s perfor- the extent of part-time working—that is, result of under-developed and frag- mance in world trade. when the employment mented economic policies, as well as This is commonly attrib- rates are expressed in insufficient investment in human uted to any cost disad- In the US, labour- terms of full-time equiv- resources. The very success of Europe’s vantage being offset by market policies alents—the gap is signif- Single Market—which has allowed the the quality advantage and social policies icantly reduced. For trade among its members to double over that German industry example, the gap in the past 20 years—has highlighted the retains, reflecting its high have led to costly employment rates growing problems arising from having level of investment, its social problems between Germany and economic policies based on the old con- strengths in niche mar- the UK is reduced from cept of fragmented national markets kets, and its capacity to that Europe has 6 to 2 percentage points. rather than on the reality of the Single innovate. more successfully Furthermore, when European Market. • Investment. By his- workers under 25 years This is reflected in the different fates toric standards, invest- avoided. of age are excluded from of Europe and the US during and after ment rates in the Euro- the comparisons, the dif- the major recessions of the 1970s and pean Union are relatively low, although ference between these two countries’ the early 1990s. In the US, the policy they are higher than in the United employment rates falls to under 1 per- guidelines and instruments of counter- States. Germany, however, has contin- centage point. vailing action exist in order to respond to ued to invest at an above-average rate of prolonged recessions or booms. The US 21% relative to GDP (compared with an Europe’s Main Problem central monetary authority, the Federal EU average of 19%). The debate over German unemploy- Reserve, is obliged to pursue both full Due to its high rates of investment in ment has led some commentators to employment and price stability. And the plant and equipment, the German econ- question the competitiveness of Europe Fed appears to have used its influence omy is structurally very strong. Germany as a whole. In fact, Europe is compet- with increasing effectiveness in both also has high levels of human-resource itive on any criteria that makes eco- respects. skills, notably at the middle and lower nomic sense. We have In contrast, Europe has ends of the labour market. These differ- low and stable infla- Europe now has lacked such a framework. ences are being perpetuated by new tion—a little over 2%— We have had 14 separate entrants into education and the work- that has created a posi- the opportunity to currencies and only a force; 95% of 16-18 year-olds and 55% of tive and predictable emulate the loose commitment to 19-21 year-olds are participating in edu- environment for busi- economic policy co-ordi- cation. ness. We have steady pro- positive aspects of nation. The result? The • Low Labour-Force Participation. ductivity growth of 2% US employment US has recovered rapidly Despite western Germany’s relatively per year—considerably after each recession, low unemployment rate, Germany does faster than in the US, performance while Europe has not. Without have a low employment rate. This is steadily narrowing the maintaining the the means to manage commonly attributed to the existence of real income gap between common action, Euro- the generous social-safety net which us. Our businesses have inherent strength pean recovery has been allegedly creates disincentives to work. declining unit labour of the European slow. And each recession But it is important to keep in mind that costs, and are experienc- has left a legacy of high, low employment rates are entirely con- ing the highest levels of social model. and increasingly structur- sistent with low unemployment rates, profitability in 35 years. al, unemployment. so long as labour-force participation Europe’s problem is not that our The paradox is that most commenta- rates are also low. Low labour-force par- economies are weak, or even that our tors never cease telling us that we ticipation is indeed a long-standing budgets are fundamentally unbal- should learn from the US with its flexi- feature of the German labour market, anced—3 or 4 years of economic ble labour markets. On the contrary, I partly reflecting low, although rising, growth, in the range of 3%, should bal- believe that we can learn much more levels of female activity. This is related ance our public budgets. The basic from the US in terms of economic poli- to cultural factors, including the exis- problem in Europe is that our competi- cy management than in terms of labour-

WORLD ECONOMIC AFFAIRS ● SPRING 1998 25 market policies and social-policy the tools and policy guidelines we need ductivity-enhancing investment in peo- design. The former has enabled the to ensure the long-run growth and ple and capital. US to maintain a high level of employ- development of employment in the Well-regulated labour markets are as ment. The latter has led, directly or European economies. essential to long-run economic success as indirectly, to costly social problems Two political consequences follow. are well-regulated product or financial that Europe has more successfully First, full monetary union, scheduled markets. They enable entrepreneurs to avoided—something that Robert Reich, to go ahead in January 1999, can no create jobs, just as much as they enable for one, had always been willing to longer be seen as some kind of “optional workers to equip themselves for chang- acknowledge when he extra”. It is the necessary ing demands for skills. They also help to was the US Secretary of counterpart to the emer- create the essential precondition for eco- Labour. Contrary to gence of an increas- nomic and social well-being: a skilled, the rhetoric, ingly integrated Euro- flexible, secure, and mobile workforce. Amsterdam and pean economy, in which To achieve this, the regulatory frame- Maastricht: The deregulated labour national economic poli- work cannot remain static in a changing New Opportunity markets do not cies lose much of their world. We must reconcile the flexibility Europe now has the force if exercised alone. which firms need with the security opportunity to escape its produce higher Second, monetary union, which workers require. This is the key to own policy “traps”—to levels of though necessary, is not bringing our success as productive emulate the positive sufficient. Our objective economies and societies into the new aspects of US employ- employment than must be full economic century. In the new, more fluid, labour ment performance while well-regulated and monetary union, market, the need for security will not maintaining the inherent with effective and posi- diminish. But its purpose and its form strength of the European ones. tive co-operation and needs to change in order to serve, and social model. The recent co-ordination of nation- help create, a more dynamic labour mar- Amsterdam Summit in June of 1997— al policies and objectives, including ket and economy. wrongly played down by some—was a employment policy. An important part of this emerging watershed in this process of European economy must be a stronger focus on policy-making. The new European Still Room for Reform social-protection systems, employability, Treaty has put employment “centre Though weaknesses in economic pol- and access to skills. And, just as impor- stage”, alongside the other criterion of icy have been the root cause of Europe’s tant, labour law, and the collective success—price stability. It has created unemployment, it is the inadequacies in arrangements governing future working an opportunity to shape the long-term our social-protection and labour-market patterns, must offer recognition to new growth and employment potentials of systems that have often been responsi- forms of working conditions and con- the European economy. ble for the serious problem of long-term tractual arrangements. Two phrases from the Treaty tell it all. unemployment. Too little emphasis on We in Europe see economic and social First, “Member states ... shall regard employability policies—such as low- policies as part of an integrated and employment as a matter of common wage employment subsidies—and too comprehensive strategy for raising liv- concern and shall co-ordinate their much emphasis on unemployment ing standards for all. Actions must be action.” Second, “The objective of a high insurance and other pursued within a frame- level of employment shall be taken into income-maintenance work of supportive consideration in the formulation and schemes—both of which We must macroeconomic policies. implementation of Community policies introduce serious disin- They must be backed up, and activities.” The identification of centives to working—has reconcile the however, by institutional employment as “a matter of common weakened our capacity flexibility which reforms, creating nation- concern” reflects awareness of the inter- to adjust. al labour-market institu- dependence of the EU’s member states. We need to modernise firms need with tions and social-protec- If one country, in an attempt to stimulate not only our economic the security which tion systems that are output in its own economy, resorts to a policies, but also our “employment friendly”. competitive devaluation, distortionary labour-market policies workers require. That is the challenge industrial subsidies, or a weakening of and social-protection sys- facing Europe as it pre- labour standards, this will adversely tems. But reform and modernisation do pares for EMU. It is one for which all affect job prospects in all other member not mean wholesale deregulation. Con- member states are politically prepared states. trary to the rhetoric, deregulated labour and committed. We have lacked the The aim of the Treaty goes further markets do not produce higher levels of machinery to turn that potential into than just stopping bad behaviour; it employment than well-regulated ones. action. The necessary reforms are now aims to promote a positive-sum game They tend to reduce standards. They being put in place, and they will enable in economic and social policy from widen the income spread between rich- us to put Europe onto the policy high- which all EU members will benefit. er and poorer members of the work- road leading in the direction of sustain- Amsterdam, with Maastricht, gives us force. They reduce overall levels of pro- able full employment. ࡗ

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