Equity, Efficiency, and the European Social Model

The Belgian economist André Sapir used a background paper for the September 2005 informal summit of the European Union’s economic and finance ministers to make a provocative claim about the European social model: Europe’s heads of state and government do not need to choose between equity and efficiency or between a welfare state and a market economy; with the right reforms to welfare programs and market institutions, it is possible to have both equity and efficiency at the same time. The British held the rotating presidency of the Council of the European Union and were quick to take up Sapir’s challenge. The quest to achieve both equity and efficiency moved to the heart of efforts to relaunch the Lisbon Strategy and to re-energize the European project. Unfortunately, these efforts were soon overtaken by events.

The onset of the global economic and financial crisis pulled attention away from any careful equilibration of relations between states and markets to focus on rescuing banks and avoiding economic collapse. As policymakers poured money into financial institutions, voters began to pay less attention to the requirements for systemic stability and to focus more attention on unemployment, life prospects, and the widening gap between rich and poor, haves and have nots. Books like Thomas Piketty’s Capital or Mark Blyth’s Austerity captured the zeitgeist of the moment. The system is rigged both in the longer-term (Piketty) and in how politicians respond to crisis (Blyth). If politicians do not engage in some radical change to focus more narrowly on equity, then the middle and lower classes will suffer the consequences. If such radical change necessitates a trade-off between equity and efficiency, then so be it.

National politicians were slow to embrace this new agenda, not least because it went against the grain of the European project. When then newly elected French President François Hollande announced his intention to raise taxes on high income earners, he was immediately accused of putting France at a competitive disadvantage within Europe. Hollande quickly walked back his commitment to combat inequality and began promoting pro-market reforms that would promote growth and employment. His was an old formula to achieve equity through efficiency – raising economic performance to bolster the fortunes of the lower and middle classes – that lacked credibility among the voters.

In France and elsewhere, populists exploited the gap between the policies on offer at the national level and the aspirations of national electorates. The message these populists offered has two strands: European markets foster inequality that only national politicians can address and so if national politicians have failed to promote greater equity it is because they corruptly benefit from the current arrangement. As evidence, such populists pointed to the impact of labor migration on low-income salaries and access to social benefits, they complained about the offshoring of manufacturing employment and unfair competition, and they underscored how large multinational took advantage of national tax differentials to avoid making a fair contribution to public services. Finally, these populists claimed that the creation of the euro as a multinational currency tied the hands of politicians, depriving them of instruments that could easily strengthen national economic performance. Again, the implicit (and often explicit) suggestion is that either the politicians who agreed to this monetary union were stupid or they had something to gain from putting the rest of the country at a disadvantage.

This populist challenge puts national politicians in an impossible dilemma. Political leaders can only demonstrate their determination to tackle specifically national forms of inequality by withdrawing from or limiting access to European and global markets – even if that damages national economic performance. And, they can only tackle the problem of inequality directly by introducing redistributive legislation that may or may not undermine market efficiency, and so damage economic performance even further. Worse, any national politician who chooses to go down this route can always be trumped by opposition politicians who promise something more generous and may soon find they have lost popular support as voters wake up to the personal cost of market disintegration and income redistribution. Consider the plight of the United Kingdom. Although the jury is still out on how Britain will fare after it exits from the European Union, the volatility in Theresa May’s polling numbers in the run-up to the 8 June British general election is one illustration of the dilemmas she faces in office; the fact that she has been outmanoeuvred by Jeremy Corbyn’s social program is another; the loss of her outright majority in parliament is a third.

The alternative of ignoring inequality is not an option. European populists may not have prevailed in recent elections in Austria, the Netherlands, or France; populists may even be losing ground in countries as diverse as Germany and Greece. But that does not mean the appeal of populism has disappeared altogether or that the complaints of average citizens who perceive that the whole system is rigged against them will soon be forgotten. There is always another election around the corner in Europe and the world remains a dangerous place – both in terms of the underlying potential for another economic crisis to emerge and in terms of the political risk emanating from Russia, the Middle East, North Africa, and, most troubling, the United States. Ignoring inequality is not just immoral, it also leaves too many political hostages to fortune.

Tackling the problem of equity without regard to efficiency is not the answer either. The problem, as the Nobel prize winning Swedish economist Gunnar Myrdal noted already in the 1950s, is that any effort to tackle inequality at the national level without regard to the functioning of international markets is likely to make countries poorer rather than wealthier. Myrdal recognized that there is a political logic to prioritizing national self-interest, but he cautioned that such logic is ultimately self-defeating because of the long-term consequences of withdrawing from the benefits of an international division of labour.

Hence the challenge for European politicians is to resist the call to achieve a more equitable distribution of wealth for its own sake and to push back with an argument along the lines that Sapir introduced shortly before the global crisis started. Europeans need to relaunch a reform agenda that promotes both equity and efficiency – not as a trade-off, but as complementary objectives. That agenda must include both national and European dimensions. Where possible, European Union institutions should use their combined leverage to push for compatible arrangements at the global level as well. Most important, given that this agenda is already in place both at the national level in many countries and across European institutions, European politicians need to explain to the people that this is in fact what they are doing. This explanation is sure to be difficult to make given the differences among European countries and, increasingly, across the Atlantic. Nevertheless, the results will be worth the effort. European politicians have a strong case: not only is this combination of equity and efficiency the essence of the European social model in an emotional sense, but it also appeals to reason as well as emotion. Pursuing equity by itself makes little sense if there is increasingly less (and not more) for Europeans to share.

This piece was drafted in early May and published as a ‘European Conscience’ column in the July/August 2017 issue of the EastWest Magazine.