McNair Paper Number 49 Chapter 1, March 1996
THE WELFARE STATE IN TRANSITION
Political philosophers once claimed that the basis of political democracy is virtue; today it is fashionable to think it is economic prosperity. Europe has been prosperous for centuries, a commercial and economic powerhouse commanding resources and capital and expertise to maintain its primacy. Following the devastation of World War II, political decisions were made that, unlike those of Versailles, encouraged Europe's recovery, with the Marshall Plan leading the way. Excessive reparations and beggar-thy-neighbor economic nationalism were avoided. The reach of modern industrial society penetrated into the rural world of most of Western Europe, creating a mass market. The rising tide lifted all boats: the war was followed by 30 years of growth.
In the wake of World War II, Western European countries sought ways to rebuild their domestic social and industrial infrastructure and mechanisms to integrate their economies. These developments went in parallel, largely complementing one another. Domestically, West European governments adopted a variety of economic intervention measures that helped shape the modern comprehensive "welfare state." National leaders, often coming from the anti-Nazi resistance, formulated plans for a social order that could resolve the bitter ideological conflicts of the l930s. Socialists, liberals and conservatives agreed on the creation of a uniquely European mixed economy, blending the rules of the market system with the principles of distributive justice. This was to usher in a period of social peace, facilitating economic recovery and growth on the continent. European workers earned and then became accustomed to high wages, excellent social benefits, long vacations, and munificent unemployment benefits. These conquests were deemed acquis sociaux, permanent gains. At the same time, the stage was set for economic and political cooperation across national borders. As a first step, six states agreed to place national industrial resources under a common European authority so as to deter future conflict.(Note 1) The process that began with the formation of the European Coal and Steel Community, the European Atomic Energy Agency and the European Economic Community eventually led to the historic Treaty of Rome in l957, formally creating the European Communities. In this way, just as the welfare state was meant to foster social tranquillity at home, so would increasing economic integration promote peace across Western Europe. A stable Europe became an affluent Europe.
The evolution of the European welfare state has been accompanied by a long series of economic achievements, leading Western Europe into great affluence and prosperity. By the early l990s, Western Europe had at its command more resources held by its 12 member states than the United States, in terms of gross domestic product (GDP); after the admission of three more members in l995, the European Union of the 15 enjoys an even larger aggregate income, twice the size of Japanese GDP. Per capita incomes in Western Europe have reached, and in some cases surpassed, the American one. The Europe of the 15 constitutes the largest single trading bloc, accounting for over 25 percent of total world trade; by comparison, the United States share stands at one-fifth, while Japan's remains much smaller at about 12 percent. The collective economic prowess of the member states of the European Union is represented by a single entity in international trade for a and negotiations. In the world of finance, the European Currency Unit (ECU) has become much more than an administrative accounting convention; financial assets of all kinds are now denominated in ECUs and the EU's planned monetary union will solidify the position of the ECU as a premier international currency.
But there is cause for concern. Unlike the welfare system in the United States, Europe's welfare state has not been faulted for perpetuating poverty or for contributing to social ills. Rather, the viability of Europe's welfare state has been called into question in recent years as the extent and intensity of demographic change and population movements across Europe increased. A perception has formed that in financial as well as inpolitical, social, and ideological terms, the European welfare state has begun to cost too much.(Note 2) In absolute levels of spending as well as in relative proportion, the resources required to sustain the welfare state in its present form can no longer be easily reconciled with emerging European policy priorities. The causes are domestic as much as international.
BUDGETARY
COSTS
Internally, the European welfare state has been characterized by high and rising expenditures on social protection. The budgetary implications of this trend are revealing and disturbing. The cost of expenditures on social well-being may be approximated by public outlays on health, education, income security, housing assistance--namely, expenditures on a variety of social services. By the mid-l980s, the cost of social protection spending was claiming about 17 percent of the gross domestic product (GDP) on average throughout the European Community (European Union since l993); the highest relative proportion, close to 28 percent of GDP, was in the Netherlands, the lowest, about 13 percent, in the United Kingdom. By contrast, public spending on social protection services accounted for only 11 percent of U.S. GDP and even less (just over 10 percent) in the case of Japan.(Note 3)
Since then, the cost of social protection has risen even more. In one of the newest EU members, Sweden, public outlays allocated to social protection amount to almost 35 percent of GDP. The Dutch share is a close second at 32 percent. Even in the least generous budget, that of the United Kingdom, the one with the lowest spending, in relative terms, expenditures on social protection services have risen to almost one quarter of GDP. Similar cost pressures have been evident in the United States, but U.S. spending on social protection has not exceeded 18 percent. Japan's share, by comparison, has been held in check.(Note4)
Without doubt, the most significant cost pressure is the result of demographics in conjunction with social norms and preferences. Across the board, Europeans place a high value on old age security; over a third of public spending on social benefits takes the form of payments to provide for such protection. Next, the cost of medical care amounts to about a quarter of total public spending. These two categories, old age protection and medical care, together account for nearly 60 percent of social protection payments.(Note 5) As matters stand, the demand for social protection can only increase. Improvements in health technology, universal access to health care, and low fertility rates have contributed to the aging of Europe's population, thereby increasing the tax burden associated with higher pension and medical care costs. As a result, Europe's senior citizens have become major beneficiaries of the welfare state, a situation very much resembling budgetary realities evident in the United States as well. But while demand for social services is increasing, the sources of revenue to finance expansion are becoming more scarce.
DEFICIT SPENDING AND INDEBTEDNESS
European governments have resorted to
borrowing in order to bridge the gap between public expectations
and resource constraints. Large fiscalim balances have generated
additional longer term economic costs associated with deficit
spending, now practiced by virtually all members of the European
Union. Recent data on general government deficit reflect heavy
economic burdens across all Western Europe. In some countries,
deficit spending has been chronic and relatively high: in
Greece, Italy, and Belgium, government deficits in the early
1990s reached 13, 10, and 7 percent of gross domestic product,
respectively. Even Germany's public finances have been affected
by the reunification process: the German government's deficit
accounts for over 5 percent of the GDP. Moreover, the
persistence of the imbalances between sources of revenue and
claims on resources over time is reflected in overall government
indebtedness: in the early 1990s, general government debt
expressed as a proportion of the GDP exceeded 130 percent in
Belgium, and was over 125 percent in Italy and Greece. France,
Germany, and the United Kingdom have lower government
indebtedness ratios, at 53, 59, and 52 percent respectively, but
even these are high by contemporary standards.(Note 6) By way of comparison, the U.S.
Government's indebtedness (the world's largest debtor nation in
absolute terms since the mid l980s) is reflected in a
debt-to-gross domestic product ratio of around 70
percent. In the face of these realities, the
end of the Cold War and the re-emergence in Europe of a common
economic and political space were greeted with enthusiasm and
euphoria for their implications on public finances. The
long-standing anticipation of the European left for a peace
dividend associated with demilitarization of the economy was
joined by the expectation of the right that expansion of
capitalism would generate profits, jobs, and economic growth. So
far, however, the financial benefits of the peace dividend and of
capitalist expansion into east and central Europe and Russia fall
short of earlier predictions. Demilitarization is proceeding
apace, but defense spending was never as important an element of
the public budget, especially the budgets of the larger European
economies, as in that of the United States. During the buildup
of the l980s, expenditures on defense claimed about 6 percent of
American GDP; in most of Western Europe, 3 percent was close to
maximum. As a result, defense cut-backs would be expected to
release more resources to the civilian economy, in relative
terms, in the United States than in Europe. Thus, the potential
to finance the expansion of the welfare state through
demilitarization of the West European economies was always much
more limited. As to capitalist expansion through the
creation of market economies in Europe as a whole, it will take
place over a much longer period of time than initially expected.
At present, it is the lack of economic expansion together with
high unemployment rates that is the main economic and political
problem on the European scene. Europe's welfare state could continue to be financed
by greater reliance on taxes. Taxation, however, seems to be
ranked worse than a solution of last resort. West European
citizens bear a tax burden that is already perceived to be high.
While international comparisons of tax burdens should be
approached with caution, it appears that taxes constitute a much
higher proportion of national income in Western Europe than in
both the United States and Japan. In the latter two, taxes
equate to about a third of aggregate economic activity. Among
members of the European Union, by contrast, taxes can claim a
much higher proportion of national income, in some countries
(such as the Netherlands and Sweden) amounting to around half of
total income. Thus, proposals for additional increases are
bound to be unpopular. Even if there were less political
resistance to higher taxes, increased taxation would be
counterproductive during the present period of low growth unless
its recessionary effects could be offset by more expansionary
monetary policy. However, membership in the European Union in
effect subjects monetary policy to constraints imposed by the
EU's exchange rate mechanism. This means that member states
cannot choose their monetary targets to meet domestic concerns;
instead, domestic monetary policy is made within the larger
context of the European monetary system. In the past, Western Europe used economic
growth to finance expansions and extensions of a variety of
social protection programs. Economic growth is, by far, the most
effective antidote to most economic problems. But economic
growth is no longer what it used to be. During the l960s,
Western Europe's real gross domestic product grew at rates
approaching 5 percent annually. In the l970s, rates were closer
to 3 percent per year. During the l980s, real growth fell below
3 percent. Since l990, economic growth has been around 1
percent.(Note 8) Western Europe's
economic performance has deteriorated and has remained below
potential for a considerably long period of time, with adverse
implications for living standards in general and public spending
in particular. If economic growth remains low, European
governments will be extremely limited in their ability to find
sources of revenue to finance expansion, or even to assure
maintenance, of social services.
UNEMPLOYMENT But the most
fundamental and visible threat to Europe's welfare state is high
and persistent unemployment. The direct, accounting cost of
rising joblessness is reflected in increased outlays on
unemployment insurance. In l992, about 6 percent of social
protection funds were spent on unemployment compensation.(Note 9) Of course, the indirect
economic costs of unemployment are much larger in terms of output
foregone. As to social and political ramifications,
unemployment remains the most explosive public policy issue in
all of the EU's member states as in all advanced industrialized
democracies. Europe's difficulties with job creation
became evident in the early l980s and have worsened since. The
prospects remain bleak and have significant political
implications. Unemployment rates of over 10 percent persist
across the European Union; for Europeans under 25 years of age,
the rate is over 20 percent. In Spain and Ireland, close to a
fifth of the labor force is without work, according to official
statistics. Among the larger economies, Germany's unemployment
rates were close to 9 percent at the end of l995, edging upward
since then. In France and the United Kingdom, unemployment has
exceeded 10 percent of the labor force since l992. The situation
in Italy is similar, if not worse.(Note10) This picture is the reverse
of what prevailed in the l970s and early l980s, when unemployment
was an American problem; today, it appears that the U.S. economy
is operating much closer to full employment, while Europe's work
force is significantly underutilized. Why has European
unemployment increased so dramatically? There are no clear
answers, but among competing explanations some deserve greater
attention than others. Economic conservatives on both sides of
the Atlantic blame labor market rigidities, which are the result
of social practices and legislation that make entry into and exit
from the employed labor force very expensive for employers.
Flexibility in terms of employment (and labor market) is high,
according to this view, if employer scan fire and hire to meet
production needs (more hours or more employees during booms,
fewer during recessions). Since the cost of hiring and firing is
high (because of the social protections afforded
workers),employers try to minimize changes to their payroll. For
their part, European workers have a high reservation wage,
counting on generous unemployment benefits, and choose to wait
out a recession. But the waiting has been too long. Long-term
unemployment has gone up, indicating that structural change
rather than temporary or cyclical adjustment may be at work.
A more powerful explanatory factor has to do with the limits
of national fiscal and monetary policies. In part, the current
unemployment situation may be the result of European
anti-inflation measures of the last decade, particularly in
connection with the exchange rate mechanism of the European
Monetary System (EMS). To maintain EMS parities, member
countries essentially gave up control of domestic monetary policy
and followed the anti-inflation monetary policies of the German
Bundesbank. The
European monetary crisis in the fall of l992 demonstrated the
nature of the dilemma faced by national governments: policies
consistent with the European exchange rate mechanism can be at
odds with national (that is, internal) priorities. This time,
domestic considerations had to be weighed against pan-European
monetary imperatives. Unwilling to pay the price in the form of
higher interest rates, the U.K. Government decided to opt out of
EMS, triggering a series of similar decisions elsewhere that
eventually led to reforms in the structure of the exchange rate
mechanism. While the search for measures to address
joblessness continues, the range of policy options seems to
become more limited. Thus unemployment remains a problem without
easy or even apparent solutions, economic or political, and
consequently is a major challenge to the very existence of the
European welfare state. WINDS OF
PRIVATIZATION The ideological premise on which the
European welfare state has been erected has become much less
solid in the post-Cold War era. Strength in unity, a sine qua
non during the period of East-West antagonism,
implied(indeed, required) economic measures to promote collective
well-being. In Western Europe, the tradition of state
intervention to achieve this goal has encompassed active
government participation in industrial enterprises as well as
direct spending by the public sector on a variety of social
services. But the end of military, political, and economic
bipolarity has generated strong winds of privatization on a
global scale. The evolution and future course of
privatization in Europe are larger and much more complicated
issues than perhaps anywhere else in the industrialized world of
advanced democracies. State intervention in economic activity to
attain specific goals enshrined in national legislation has been
part of the European policy landscape for a long time. In the
post-World War II era, the most comprehensive approach to state
intervention was developed in France through
planification, best known as "indicative planning:"
economic goals such as growth rates, investment priorities, and
other macroeconomic aggregates formed de facto policy targets;
targets were quantified and often made explicit for policy
implementation purposes; and an apolitical agency, the
CommissariatGeneral du Plan, was in charge of execution.
This approach was itself based on the foundations of "colbertist"
practice and St. Simonian theory. Scandinavian countries have
also developed their own brand of state intervention in economic
activity, characterized by centralized control, numerical
economic targets and implementing legislation. But other
countries in Western Europe, including the United Kingdom, have
followed similar approaches. The fundamental premise on which
European economic" statism" has been based combines centralized
government policy to achieve democratically derived economic
targets. As a concept, privatization is at odds with European
economic tradition in so far as it involves substitution of
market forces for state direction. In Europe, privatization
of government-controlled organizations or enterprises is
conceptually similar to deregulation as defined and implemented
in the United States (e.g., in telecommunications, banking, and
airlines) but may also entail outright sale of state-owned assets
(British Airways, France Telecom, etc.). To the extent that
state ownership of industrial enterprises is more common in
Europe, the potential revenue from the sale of such assets is
also greater. Given the budgetary situation of many West
European governments, it is not surprising that privatization is
now held to be the solution of first choice. Gauging the
potential for deregulation in Western Europe is a complicated
matter; however, if one considers that the public sector accounts
for about 45 percent of economic activity in the larger European
countries (and may exceed that figure in some cases), then the
possibilities seem large. By contrast, the U.S. and Japanese
public sectors account for about one-third of total economic
activity. For this reason, privatization is a much more powerful
policy concept in the European context than across the
Atlantic. Some government functions and activities are
contracted out; many others can simply be eliminated. Such
outright abandonment of traditional services to the dicta of the
market offers ways to create public savings. In a larger sense,
however, the result may simply be shifting the resource cost to
the private sector. The extent to which a net gain is realized
depends on whether efficiency is improved without impairing
income distribution. But with the focus on cost reduction, less
emphasis is placed on the distributional consequences, even
though they can be significant. If the national health service
can be privatized and thus run at a lower cost to the public
budget, there seem to be fewer reasons left for not doing so;
after all, there is no competing economic system to which the
disaffected could turn. In this climate, the ideological
foundation of the welfare state is not only open to question but
subject to stringent cost-benefit analysis. A new, post- Cold
War era calculus reveals costs that are growing continuously just
as benefits are perceived to be falling. The European welfare
state may have become a victim of its own success. Conceived and
put in place to promote social peace and solidarity in one-half
of a divided continent, it succeeded in distributing prosperity
in a socially acceptable manner throughout Western Europe and
also within each nation state. But the generation most
responsible for developing and installing the socioeconomic
structure now taken for granted in Western Europe is being
replaced. The average West European, about 35 years of age, has
not experienced the conditions that led his grandparents to
demand a comprehensive social safety net. Just as the end of the
Cold War has erased the East-West division of Europe, so has time
erased the memories of political turmoil accompanying the Great
Depression and east-west socioeconomic antagonism of the l930s,
'40s and '50s. Why hold on to notions and norms of distributive
justice formed in an era that has gone by? Instead, the
average West European (affluent, well educated and much traveled)
sees that the cost of maintaining traditional social services and
programs continues to grow for reasons that seem less and less
intellectually defensible. In fact, some of the reasons are
totally obscure, such as the reality that the national
government's control over fiscal and especially monetary policies
is slowly eroding; worse yet, expensive social services are
claimed by increasing numbers of foreign nationals and political
or economic refugees. In this setting, the plight of
unemployment is accentuated. The most visible and politically
explosive problem in Europe, joblessness, continues to be viewed
by voters as a domestic problem, even though it now a
pan-European problem, best described(and often explained) in
regional rather than national terms: eastern versus western
Germany; southern versus northern Italy; southern versus western
Spain. Unable to rely on aggressive fiscal or monetary policy
measures, national governments increasingly look either to the
private sector or to Brussels for help. END OF
ECONOMIC SOLIDARITY? Problems of uneven economic
development and economically depressed areas of countries and
regions within the European Union have been targeted through a
variety of economic development funds and programs. An extension
of the notion of distributional equity in the domestic setting,
social solidarity across regions and within member states of the
European Union was deemed imperative for social cohesion. This
principle was firmly embodied in the Single European Act of l987.
In the commercial sphere, the Act formed a visionary blueprint
for complete market integration before the end of the 20th
century. In the political sphere, the Treaty of Maastricht was
meant to establish a framework for a European Union into the 21st
century. The common denominator was a "Peoples Europe,"
eventually to be governed by a Social Charter spelling out the
rights of European citizens across national boundaries. The
fundamental principle on which the People's Europe was to rest
was social and economic solidarity. The financial dimensions of
solidarity, or social cohesion, were concrete and quantifiable.
In the preamble of the EEC Treaty, the member states had declared
their aim of "reducing the differences existing between the
various regions and the backwardness of the less-favored
regions." But the costs of inter-European solidarity are also subject
to review in the post German reunification era. Most EU members,
Germany among them, are balking at increased spending for
solidarity purposes. To be sure, the admission of three rich
states (Austria, Sweden, and Finland) will slightly ease the
burden of the 12, but the financial burden to the EU is likely to
increase dramatically in the future. France, Italy, and Spain
strongly advocate efforts to increase EU involvement in the south
in order to stabilize the Maghreb countries and prevent the
spread of the kind of Islamic extremism now affecting Algeria.
At the November l995 Barcelona meeting, the EU agreed to such a
program. Association agreements and eventual membership for the
countries of Eastern Europe will involve immediate economic
sacrifices by the Union in exchange for future economic and
political gains. Yet, to maintain the status quo promoting
distributional equity within the European Union, member states
are currently considering cutting back aid to the developing
world. This represents an additional policy dilemma: the cost of
spreading the wealth internally within the Union could mean a
lower European profile externally. Traditionally, the European
Union (and its predecessor, the European Community) has been,
through its member states, the most generous donor of aid to the
Third World, especially African countries; Europe's official
development assistance is much higher than aid given by the
United States. For the period l990-l995, the European Union had
pledged some $15 billion in financial
aid, In summary, the viability of the
European welfare state into the next century, while still
probable, is no longer certain. The gap between prevailing
economic conditions and sociopolitical expectations is growing
wider as a result of rising budgetary costs, growing fiscal
indebtedness, a lower than expected peace dividend, anemic
economic growth and weakened economic solidarity. The most
immediate and acute problem, unemployment, is also the most
explosive. The future of the European welfare state will depend
on the extent to which the gap between expectations and reality
can be narrowed.
LIMITS OF
DEMILITARIZATION
TAXATION
ECONOMIC
GROWTH
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