European and US Social Models compared

Critics have alleged the superiority of the US system in terms of growth,and employment, but since the turn of the century, the euro zone has created more jobs than the United States and income inequality is lower in the EU than in the US. However In the last ten years many factors have diluted the EMS.

The European Social Model (ESM) is a controversial subject. Some deny that it ever existed. Other contrast it with the American Model, but debate where the UK should be placed. Some argue that there is not one but three or four European models. The ESM has been praised for positive aspects of European economic performance, such as social cohesion and the non inflationary composition of conflicts, and blamed for the alleged lower ability to compete in the global economy and to create employment and growth. The model is claimed to be in a crisis, to be on the wane or to have collapsed. I believe that the European Social Model is one, recognisable in spite of European diversity, it is alive and well, and has considerable merit.

Hall and Soskice (2001) and Freeman (2005) compare the ESM or European model of social dialogue or Coordinated Market Economy (CME) with the American model. Freeman argues that in some respects the two economies are like “two peas in the same pod”: advanced capitalist systems, abiding by the rule of law, protecting private property, guaranteeing freedom of association and enterprise, with various degrees of social safety and welfare systems, combining “institutional regulations and markets to determine economic outcomes.” The difference is in the weights they place on institutions versus markets, not the qualitative differences that divided capitalism from communist state planning” (Freeman 2005).

The US economy, in its idealised form, conforms to the neoclassical theory of markets “where the Invisible Hand of exit and entry determines outcomes”. Trade Union membership has declined to a low level and wages and employment have become largely market-driven. Firms’employment policy and wages policy do not have to be negotiated with employees, who can take it or leave it. Product markets are little regulated and firms can enter and exit easily. Employment is the primary form of social protection, including access to health care.

The EU “relies more on the non-market institutions of „voice‟, particularly in the labour market”. The EU requires dialogue between social partners at company level, through Works Councils (EC 94/45/EC), at sectoral and inter-professional level through Sectoral and Social Dialogue Committees, at the aggregate level through the Standing Employment Committee, and Advisory Committees (e.g. on social security); and so on. Wages are determined by collective bargaining between federations of employees and employers, applying also to firms that are not party to it. Firms entry and closure, and employee lay-offs, face greater administrative obstacles. The welfare state requires higher taxes.

Both the EU and US models partake of the advantages of market economies and are viable systems. “Some theories, such as the Coase (1960) analysis of property rights and efficient bargaining predict that a social dialogue system will work as well as a competitive market driven model” (Freeman 2005). This conclusion is strengthened by game theory (the prisoners‟ dilemma): an inter-temporal social pact between employees and employers’ representatives, monitored and guaranteed by the government with fiscal incentives and penalties, can deliver wage restraint today in exchange for price restraint and higher investment and growth tomorrow.

In addition, ESM redistribution provisions can alleviate the distributive impact of globalisation (e.g. the European Globalisation Adjustment Fund 2007-13).
Critics have alleged the superiority of the US system in terms of growth, job creation and employment. Goodin (2003) claims that CMEs [Co-ordinated Market Economies, i.e. the ESMs] “are naturally doomed to extinction”, that the system is vulnerable and unstable. “LMEs [Liberal Market Economies] ultimately [will] prevail”. The US outperformed the EU in the 1990s up to the mid-2000s. But some of the smaller EU social dialogue countries, like Ireland, Austria, the Netherlands and Denmark, had an exemplary performance in the same period, while the EU outperformed the US from the 1950s to the 1990s. Relative EU and US performance depends strictly on the periods selected. After the second World War labour productivity in the west of Europe was only half that of the US, whereas now it is not far below.

“Since the turn of the century, the euro zone has created more jobs than the United States” (The Economist, 27-1-2007). In the first half of 2007 Europe’s  growth rate had overtaken that of the United States. Income inequality is lower in the EU than in the US, also, and with better universal health care at lower cost in the EU than in the US. Comparative performance during the 2009-2010 crisis should not neglect that the crisis itself originated in the United States and was caused by US institutions and policies. A major problem in system comparison is to what extent performance differences can be attributed to institutional differences (Freeman 2005).

ESM dilution: rising costs and EU enlargement

In the last 10 years ESM has suffered some dilution, due to several factors including 1) the rising pension burden of an ageing population, 2) the rising cost of available health treatments, 3) opportunistic behaviour (moral hazard), 4) the parallel greater fiscal discipline of the Maastricht 1992 and the Amsterdam 1997 Treaties.

Another major factor diluting the ESM has been EU enlargement to the post-socialist countries of central eastern Europe (the Czech Republic, Hungary, Poland, Slovakia; Slovenia; Estonia, Latvia and Lithuania on 1-5-2004; Bulgaria and Romania on 1-1-2007). It has been argued (Vaughan-Whitehead, 2003) that EU enlargement has diluted the ESM model because of: 1) its non-affordability by new members averaging 40% of the older members‟ GDP per capita; 2) the lack of EU solidarity with new members; or 3) the cost of enlargement itself. But the impact of these factors has been exaggerated. The ESM has been diluted by EU accession of transition economies that had adopted a hyper-liberal socio-economic model. This has greatly diluted the ESM, both in the new EU average characteristics and – by imitation, competition and active promotion of hyper-liberalism – in some of the older EU members (see Giannetti and Nuti, 2007).

On the re-bound from the old system, transition countries gave shape to their systems at the peak of Reaganite and Thatcherite ideology. They were subject to the strong pressures of Bretton Woods institutions. Instances of hyper-liberalism abound: 1) An immediate unilateral opening of international trade, frequently revoked and therefore premature; 2) a much faster capital liberalisation than in the earlier experience of other European economies, which caused currency and financial crises such as those of the Czech Republic in 1993, and Russia in 1998 which affected other central European countries; 3) an unprecedented form of mass privatisation (everywhere except Hungary), a veritable experiment in social engineering of questionable effectiveness, which did not change governance mechanisms, nor access to investment funds and managerial resources; 4) a pension reform from a Pay as You Go to a capitalisation system which made a hidden form of public debt come to the surface while at least partly it could have remained buried; 5) particularly bland and non-progressive taxation of companies and households, as witnessed by the widespread “flat tax” and by the lack of a capital gains tax, with greater incidence of indirect taxes; 6) a central bank of exceptional independence and not subject to any control, and without any coordination with fiscal policy; 7) a particularly restrictive monetary policy, with real interest rates at usury levels, that contributed greatly to the deep and protracted recession that accompanied the transition, discouraging investment and unduly strengthening exchange rates; 8) a particularly flexible labour market (in spite of the occasional protection of employment in some crisis sectors), with weak Trades Unions and scarce diffusion of collective bargaining; 9) a lack of mechanisms for consultation and concertation between social partners and with the government; 10) in general, a dominant weight of markets with respect to institutional mechanisms.
In the end the transition economies embraced a hyper-liberal version of the market economy, very different from the European Social Model, converging instead with the US model of capitalism and beyond.

European authorities monitored the convergence of major monetary and fiscal parameters, and of market institutions. Thus EU candidates adopted EU competition policy; restrictions on state aid; improvements in state governance associated with implementation of the “acquis communautaire”. But the EU authorities did not require of the new members the convergence with those policies that add up to the social dialogue model that – though to different degrees and in a flexible and non-codified fashion – characterised the European model. Hanson (2006) utilises several indices: World Bank Ease of Doing Business, Kaufmann-World Bank measures of governance, Transparency International Corruption Indices, and the Srholec index placing a country on a scale between liberal market and strategic coordination. He finds a significant partition between old and new members, which he attributes to entry negotiations neglecting the elements of a distinctive economic regime.
Vaughan-Whitehead (2003) notes that: 1) The scope of collective bargaining in the new member countries is only of the order of 10-20 per cent of the labour force; 2) Social dialogue is practically non-existent in small-medium enterprises; 3) EU Directives on Works Councils, profit-sharing and other forms of workers‟ participation are not being implemented; 4) A large scale informal sector is totally unaffected by ESM policies. The exceptions are Slovenia and, to some extent, Estonia.

ESM dilution: Globalisation and the recent crisis

Another important factor of ESM dilution has been the weakening of labour bargaining power due the globalisation, which involved an increasing globalisation of labour markets, due not only to the more spectacular phenomena of de-localisation (caused by capital mobility) and of labour migrations, but above all to trade growth, which has already been mentioned. Labour markets globalization has threatened employment, real wages and tax revenues in the more advanced countries which had adopted the ESM. Competition in the global labour market is best illustrated by the growth of the export-weighted world labour force, of over 250% in 1980-2005, relatively to an un-weighted labour force growth of 70%. This is what in 1995-2005 lowered by 10 points the average share of labour income in GDP in advanced countries, from 65% to 55% (see IMF World Economic Outlook, June 2007). The crux of the matter is that it is impossible to maintain current relative and often absolute standards of living in the more advanced countries while, at the same time, following policies of the free mobility of factors and free trade. Protectionism, and/or constraints on migrations and on capital mobility, would have to be introduced to support living standards and welfare states in the more advanced countries, at the expense of lower overall productivity and lower living standards and growth in the emerging countries. This is the dilemma facing advanced countries, including all those adopting a European Social Model.

The stringencies of the Growth and Stability Pact had already forced a certain dilution of the ESM, but eventually the Model was wrecked by the cuts in government expenditure adopted as a response to the global economic crisis of 2008-2010 and to generalised concerns about the sustainability of government debt. In the European Union expenditure cuts have apparently reached a total of the order of €300bn, plus another €90bn in the UK in the October 2010 budget adopted by the new Coalition government.

At the same time, the provisions of the ESM, though diluted, have allowed the older EU members to fare better, during the recent crisis – in terms of social costs - than the less welfare-minded New Member States of Central Eastern Europe. This, of itself, is causing internal migratory strains on EU cohesion as central and east Europeans move to high welfare EU countries but bring neo-liberal wage and conditions flexibility with them, thus destroying the “voice” of the ESM in older member states. And the US model has also been transformed in the crisis, re-instating the state as a major actor, taking care of the welfare not just of workers but of shareholders, creditors and managers of bankrupt private financial institutions.


In conclusion:
- The European Social Model is alive and well;
- It has a distinctive identity in spite of cross-country diversity;
- It is not a superior model but it partakes fully of the advantages of a market economy and has specific merits in social protection and the composition of conflicts;
- It has been diluted in the last ten years as a result of various factors, including its rising costs, the adoption by nearly all transition economies of a hyper-liberal socio-economic model, the deterioration of labour‟s bargaining power caused by globalisation, the fiscal discipline imposed by the Maastricht and Amsterdam Treaties and, finally, the cost of expenditure cuts undertaken – rightly or wrongly, for lower government expenditure does not necessarily leads to a lower deficit – with the purpose of consolidating public finances.
- It appears to be still a viable and sustainable alternative, but only 1) after consolidation of public finances, or at any rate conditionally on the continued feasibility of such consolidation; 2) subject to the constraints of global competition, and 3) as an alternative to competing uses of public resources. 

(This article is part of the following paper: The European Social Model: Is there a Third Way? )


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