Tuesday

18th Dec 2018

Opinion

Can Europe still afford the welfare state?

It's amazing how many people seem to think the answer to the above question is ‘no'. Globalisation, one hears repeatedly, makes the world increasingly competitive, driving down prices and killing off manufacturing industry. If Europe is to survive, it must cut costs, particularly the tax burden shouldered by business.

That means shedding our dependence on long paid holidays, lavish unemployment benefit, generous pensions and other such luxuries we can ill afford. This argument is repeated by respectable economists and politicians in London, Paris, Berlin and Brussels. It is particularly popular in America where Europeans are seen as ‘welfare addicts'. Nevertheless, it is nonsense.

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There are three main reasons why globalisation doesn't mean abolishing high levels of welfare. First, it is simply untrue that we can no longer afford welfare. Secondly, the EU is not becoming ‘less competitive' because of globalisation. Finally, decent job protection, social insurance provision and universal health care correlate strongly with high levels of prosperity.

Can we afford it?

The EU is rich: the EU-25 has a combined GDP higher than the United States. Germany is the leading manufacturing exporter in the world, while output per hour worked in the core EU states is as high as in North America. As we become richer, whether to devote more of our extra income to private consumption or to public provision is a political choice. In Britain under Mrs Thatcher, extra income went predominantly to private consumption while the rest of the EU, particularly the Nordic countries, spent more on social and economic infrastructure.

Of course, higher public provision usually means higher taxation, but these extra taxes are what economists call ‘transfer payments', money put away during the good years to cover the years when we are unemployed, ill or retired. Ordinary working people like you and I may not like paying higher taxes, but we know that in the absence of collective provision, we might not save enough privately to cover our needs. Employers, too, cover part of these costs, but what they recoup is an educated, healthier and more productive work force.

Globalisation and Competitiveness

A second fallacy is that globalisation results in Europe becoming less competitive; ie, we must ‘cut costs' to keep up with China and other rapidly industrialising countries in our trade. The American economist, Paul Krugman, rightly dismisses this view as ‘globaloney'.

Anybody who has studied basic international trade theory knows that what a country trades depends not on absolute cost advantage but its comparative advantage. China can produce both textiles and machine tools more cheaply than Germany, but China's comparative advantage at present is in textile production (which is why Germany still exports so many machine tools).

Of course, comparative advantage changes over time as textile producers in Italy are finding. That is why the Multifibre Agreement was drawn up: to give advanced countries time to adjust. Thankfully, the Agreement is now history. It would be silly to continue protecting our less competitive industries since such protection prevents richer countries from developing new areas of comparative advantage while denying poorer ones to opportunity of moving up the industrial ladder. A generation ago Sweden and Finland exported mainly timber and raw materials; today they excel at exporting mobile phones and other high-tech goodies.

Not only have leading industries in the rich countries changed, but these countries are becoming increasingly service industry orientated. Despite the growth of call-centres in India, service industries are far less globally mobile than industry. Take the case of Britain, once Europe's industrial powerhouse. Today, a higher proportion of its GDP comes from financial services than manufacturing. Globalisation may affect the sort of jobs we do, and doubtless has social costs. But it does not make us poorer, less competitive and less able to afford welfare.

High prosperity means more welfare

The most telling argument of all is that social provision and prosperity go together---as statisticians say, they are positively rather than negatively correlated. There are a variety of reasons why prosperity implies good social provision (and vice-versa).

For one thing, as societies grow wealthier, the importance of public goods increases. Public goods are those things we consume collectively: education, health and protection from the unforeseen---including, incidentally, environmental catastrophe. Put simply, when people are very poor they devote nearly all their energy to keeping food on the table and a roof over their heads.

As they grow richer, they want not merely more private consumption items like fridges and cars, but more public goods. Because public goods make everybody better off, their provision is part of what we mean by living in a civilised community, one characterised by social solidarity and cohesiveness. Societies which lack such goods---or where their provision is not universal but limited to the wealthy few---are more likely to suffer from anxiety, conflict and individual and social breakdown. This point is a key theme of Richard Layard's book, ‘Happiness: the lessons of a new science'.

The causal relationship runs not just from higher prosperity to higher social provision, but the other way around. A higher level of provision leads to higher prosperity. This is because advanced countries need a healthy, well educated workforce. Once again, the Nordic experience provides an excellent example: sustained levels of high social provision have acted as the glue needed to remain cohesive under conditions of rapid economic transformation. Had it not been for strong social provision, countries like Finland and Sweden might have found it much more difficult to weather the economic shock of the early 1990s resulting from the disintegration of their giant eastern neighbour.

All this does not mean, of course, that European social provision is perfect in every respect. We don't know the ideal trade-off between employment protection and active labour market policies. We have only just begun to think about how to solve the long term problem of pension provision and retirement. What we do know is that private sector market-based solutions cannot be the answer. So the next time somebody tells you that we can no longer ‘afford' the European social model, don't just nod your head in reluctant acquiescence. The argument is neither logically nor economically well-founded; ie, it's wrong!

The author is is Research Professor at SOAS in London and author of the recent book ‘Regaining Europe'.

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