Globalisation, EMU and the European Social Model

Iain Begg*

The EU today is gripped by a malaise, brought on principally by the apparent intractability of unemployment. This manifests itself not only in the widespread doubts about the wisdom of EMU, but also in soul-searching about the continuing viability of the European 'social model'. The intensification of international competition as global markets become increasingly open has reinforced these concerns by exposing the high labour costs in Western Europe compared with other global regions, costs which are accentuated by the widespread use of taxes on labour to finance social protection.

The vibrancy of the dynamic economic powers of East Asia and the resurgence of US technological leadership highlight the contrasts with an EU economy afflicted by structural rigidities, inflexible labour markets and an inadequate propensity to innovate. These at least are the impressions conveyed by much current analysis of the EU's predicament.

The clear implications are that the welfare state needs radical surgery, that major labour market reforms have to be undertaken and that Western Europe has to wake-up to the fact that it cannot hide from globalisation.

This article explores these questions and asks whether the combination of EMU and globalisation rings the death-knell for the European social model. It is argued that although there are grounds for questioning elements of the model, notably the high dependence on social charges, the issue is ultimately a more profound one about how much redistribution takes place, and that this is a political choice that no society can avoid. The next section looks at the social model, emphasising its function as a redistributive mechanism. This is followed by an assessment of options for reform and by concluding remarks on the inter-play between social regulation, competitiveness and economic management.

The European social model: achievement or anachronism?

All societies evolve some means by which a proportion of the output of the economy is channelled from producers to those consumers who are not economically active. Various solidarity mechanisms exist to ensure that this segment of the population, which typically comprises children, the elderly and those unable to work - whether through sickness, disability or unemployment - receives a share of the national product. In East Asia, the extended family is one of the main mechanisms; in some countries, charities and other non-governmental organisations play a prominent part; in Western Europe, this function is assured principally by the State through the social protection system. In essence, what distinguishes different societies is the degree to which such redistribution happens through private rather than public sector channels.

For many, the social protection system that has evolved since the second world war in most Western European countries is an enviable achievement. Security of income is also assured by continuity of employment and stability in earnings, and in this regard the rights to employment protection and good working conditions enjoyed by workers are held to be desirable features of European society. Together with an expectation that the state will strive to assure a high level of employment and the provision of good public services, these are the essential components of the European social model. The details vary from country to country, reflecting national traditions and the delicate political compromises that went into them, but the underlying characteristics of the model can be discerned in most EU and EFTA countries.

Increasingly, however, this social model has been blamed for the economic difficulties affecting the EU and EFTA countries. Labour market regulation is criticised for having inhibited effective use of labour; high social charges to finance social protection are blamed for making businesses uncompetitive; and public spending is seen as the main obstacle to a successful EMU. All these concerns point to a need for radical restructuring of the social model.

The troubles can be summed-up in the title of the 1993 Delors White Paper: 'Growth, competitiveness and employment': to wit, a shortage of all three. The opening line of the White Paper makes clear its purpose by answering the rhetorical question 'Why this White Paper' with the statement:

'The one and only reason is unemployment'

Considering the magnitude of the unemployment problem, this is hardly surprising. Certainly, it is more pronounced than in competitor regions, and it is tempting to relate this to the way in which social policy functions, even if the often-cited distinctiveness of the American model is apt to be exaggerated. It is also important to note that the amount paid to obtain labour has to be offset against the productivity of that labour: typically the high labour cost countries have high labour productivity with the result that their unit labour costs (labour costs per unit of output) compare relatively more favourably.

Nevertheless, the sheer scale of the difference in labour costs between countries such as Germany and the low cost producers of the far East, or now in central and eastern Europe, is worrying when investors can more easily relocate production to lower cost areas. The fear is that unless labour costs in Western Europe are reduced and terms of employment become more flexible, there will be a flight of capital, made all the more easy by the advent of EMU.

Social protection, competitiveness and redistribution

In the light of worries about globalisation, will social protection have to be reined-in substantially? And must regulation of the labour market in the form of employment protection, health and safety rules, and the minimum wage be swept away? Much recent political rhetoric and economic comment - and not only from the UK - has pointed in this direction. For example, the third report of the Competitiveness Advisory Group (CAG), also known as the Ciampi group after its first chairman, makes a strong case for what it calls 'modernization of the labour market'. There may not be agreement on the alternatives or even on how much needs to change, but the message that emerges is that reform is both urgent and inevitable.

Yet, as noted above, changes in labour market conditions and in social protection are not just about competitiveness, but also turn on fundamental political choices about who receives what in society. Possible solutions have to start by acknowledging the social and political challenges, but the underlying issue of redistribution within society must equally be taken into account. Whether it is EMU, globalisation or new technology that is under review, there are bound to be distributional implications. Surprisingly, however, this rarely surfaces as a theme of debate, so that it is useful to reflect on what is at stake.

A conventional way of looking at the distribution of income is to distinguish between flows of income to labour and to capital, and it is not just Marxists who have analysed the share of profits or the rate of profit as a political objective. With a highly-developed social protection system, accounting for more than a quarter of GDP in Western Europe on average, this is too simplistic. Income in this context needs to be split into the three components shown in the accompanying figure:

Returns to capital (profits, rents etc,)

Returns to labour (wages)

Social protection expenditures (pensions, payments to the unemployed, etc.)


Those economically active obtain income principally from paid employment (including remunerated self-employment) and from returns on assets.

The economically inactive obtain income from transfers received through social protection and from returns on assets, or through redistribution within the family.

Seen from this perspective, the 'crisis' of the European social model is less about whether Western Europe can afford its social protection system, than a deeper debate about how much redistribution there should be towards the economically inactive.

However, with social protection expenditures averaging 26% of GDP in the EU, and as high as a third of GDP in some Member States, it is pertinent to ask whether the burden of social protection has now become too great. Certainly, the balance has shifted away from 'protection' in the narrow sense of providing safeguards against poverty or against unforeseen contingencies, to a much broader, publicly-mediated redistributive function. Because of this, there are persistent calls to reform the European system of social security so that it ceases to be so great a fiscal burden. A solution to the international competitiveness dilemma might, consequently, be to place more emphasis on private provision of income for the economically inactive. Even so, it has to be recognised that this would constitute a change in the mechanism for achieving redistribution between groups in society.

Options for reform of the social model

The knee-jerk answer to the competitive challenge of globalisation is to argue for lower labour costs in Europe and thus for deep cuts in social charges on labour. This, however, confuses the mechanism for funding redistribution via social protection with the broader aim of achieving such redistribution. An obvious illustration is Denmark where the high level of social protection (one of the highest rates in the EU) is funded principally from general taxation instead of direct charges on labour. Danish pre-tax wage rates are high, partly because the higher level of general taxation reduces the post-tax disposable income of the economically active. That said, there are countries where very high social charges do appear to affect competitiveness adversely, France and Germany being obvious examples.

The problem inherent in unduly glib comparisons can be further illustrated by reference to medical insurance cover. In the US, much of this is provided by employers and negotiations on its terms feature prominently in collective bargaining. Given that health care in the US accounts for some 14% of GDP, compared with between 6% and 11% in the EU, it is self-evident that this is a substantial part of US labour costs, even if it does not appear as 'social' charges.

There must also be doubts about whether Europe can hope realistically to compete on the basis of cutting labour costs. Even if social charges were eliminated completely, European wages would remain an order of magnitude above those in many of the emergent industrial competitor countries. Instead, it can be argued that what Europe needs to do is to upgrade its labour so that unit labour costs fall. This alternative strategy for international competitiveness relies on enhancing productivity and it can be argued that it is this approach which has underpinned the development of European economies up to now. It also coincides with much of the advice put forward by the CAG - a group made up mainly of industrial leaders - which sees no incompatibility between a high level of social protection and competitiveness. The key is to give priority to what has loosely been called positive flexibility: upgrading skills, enhancing opportunities for staff to work less conventional hours or to shift between jobs.

It is easily forgotten that many features of social regulation can contribute to improved flexibility. Thus, the social protection system facilitates movement between jobs, both by assuring workers of replacement incomes and by creating an administrative infrastructure for employment placement: if a country's system falls down on such criteria, the remedy is to improve them, not dismantle them. Equally, stability in employment gives employer and employee alike an incentive to invest in training and skills upgrading - an approach not lost on the East Asian countries.

In addition, the macroeconomic dimension to competitiveness has to be borne in mind. For some time now, the conduct of policy and the thrust of the institutional structures being set up at European level have emphasised objectives other than growth or employment. Thus, the mandate for monetary policy given to the ECB in the Treaty is to assure price stability, while most of the discussion about fiscal policy has centred on the need for a stability pact that will curb excessive deficits, but does not obviously provide for a fiscal response to other than a sharp downturn. The policy machinery, in short, is asymmetric: it will allow governments and ECOFIN to pursue stability objectives, but puts substantial obstacles in the way of expansionary demand-side policies.

Moreover, although the 1993 White Paper advocates a wide range of policy initiatives to revitalise the EU economy, few of these - trans-european networks being a prime example - have had much visible effect. Meanwhile the commitments on employment articulated at the Essen summit seem to have little tangible effect. With the attention of policy-makers having been focused on convergence and the pursuit of stability in order to make EMU viable, progress has been disappointing. Why has this come about? The principal reason is the legacy of the inflation of the 1970s and 1980s. Having endured so much pain to squeeze it back in, governments are understandably wary of any actions that might let the inflation genie out of the bottle again.

Concluding remarks

Because of the persistence of unemployment and lacklustre growth, and despite frequent disavowals of any gains from sweeping-away the social model, it is a solution that continues to attract support in many quarters. It has been argued here that reform of social protection has to undertaken with the greatest of care because of its central role in society.

Shifting the tax base for social charges, allowing greater scope for individual choice or control of pensions and other entitlements, and better monitoring of welfare policies are options that could improve the efficiency and accountability of social policy. But such reforms will not alter the fact that there are fundamental and complicated political choices to be made about redistribution.

In much the same way, a labour market policy that equates flexibility purely with cutting wages is unlikely to offer more than short-term gains for beleaguered employers. It will deter skill enhancement and upgrading, key determinants of improved productivity, and do little for social cohesion. The more far-sighted employers recognise this and act accordingly.

The European social model, in short, retains many virtues. Reform it, certainly, but consider the consequences and think hard before calling for its demise.