Europe’s Mixed Economy:
(“The Commanding Heights” – Chapter 1)
(“Economics” – Chapter 13)
During the 20th Century, the role of government in the
economy and the economic systems which dominated
changed dramatically. In most developed economies there
was
 very little government at the start of the century
 an increasing role for government from about 1930 to
the mid 1970’s
 a decline in the role of government from the mid
1970’s onward
Government
Intervention in
Economy
0
time
1900
1930s
1970s
 Why did these shifts occur?
 What are the consequences of such shifts (political,
social, and economic)?
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Increased role for government in the economy is most often
justified by claims that markets:
 could readily fail;
 will not provide many valuable goods and services;
 give outcomes which are “too risky” for individuals;
 potentially allow firms to “exploit” individuals.
Intuitively, increased expansion of government in the
economy often occurred after “bad times,” such as
revolutions, World Wars, Great Depression, financial
crises, etc.
 individuals in society looking for government to “do
something” in order to provide a “better outcome.”
3 sources of post WW-II “mixed economy consensus”:
1. WW-II devastated Europe – the war caused destruction,
misery, and disruption over the entire continent =>
Consensus that government needed to “help”
 Tens of millions of people starving
 Total loss of life in WW-II of roughly 72 million
people – several countries lost over 10% of population
 Homes and factories reduced to rubble
 Agricultural
and
transportation
infrastructure
destroyed
2. Before World War II the world experienced the “Great
Depression” (during the 1930’s)
 Unemployment rates over 20% in many countries
 Appeared as if the market system had failed miserably
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3. Prestige and Respect for Soviet System
 Soviet “5 year plans for industry,” “command-andcontrol economy,” and “claims of full employment”
seemed to argue that socialism was the answer to
controlling the economy (Full Employment – a
situation in which every person in the labor force who
wants to work is able to find a job – that is, the
unemployment rate is “0%”)
 Limitations of central planning (particularly “lack of
incentives” and “resource allocation difficulties”)
were still decades away from being evident
Governments promised to reconstruct, modernize, and
propel economic growth, in order to deliver equity,
opportunity, stable economic outcomes, and a decent life.
 governments in many countries chose to (i) capture
and control the “Commanding Heights” of the
economy and (ii) establish a “Welfare State”
 Commanding Heights – “most important” or
“strategic elements” of an economy, consisting of
sectors which produce outputs that are essential for
other sectors to operate (e.g., transportation, energy,
financial markets, etc. => G.E. Turbine ad:
http://www.youtube.com/watch?v=ds5hVzrkoKI).
 Welfare State – a system in which the government
assumes the responsibility of improving the welfare
of its citizens, particularly with regards to health
care, education, employment, and social security.
 Great Britain is an example of a previously free
market oriented country that did both of these
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Britain:
 Fabians – British Socialist who sought to replace the
“scramble for private gain” with “collective welfare.”
 Fabian Society in UK founded in 1884: sought to
implement socialism by peaceful means within the
existing political system (i.e., “voting”), not by way
of “revolution”
 1930’s: Fabians saw other governments intervening
in the economy with the objective of improving the
outcome for individuals, and wanted to do the same
in Britain => Fabians greatly influenced the
philosophy of the UK’s Labor Party
 Clement Atlee of the Labor Party was elected Prime
Minister in 1945 in a Landslide over Winston Churchill,
right before the end of WW-II
 Labor government that took control after WW-II sought
to “make government into the protector and partner of
the people” and to “take on responsibility for the wellbeing of its citizens.”
 Beveridge Report – set out social programs to “slay the
five giants” of: Want, Disease, Ignorance, Squalor (i.e.,
filthy and wretched living conditions), and Idleness (i.e.,
unemployment); written by William Henry Beveridge
 The Labor Government and the Beveridge Report
forever changed the way Britain (and much of the rest of
the industrial world) viewed the role of the state in
regards to social welfare.
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 Following Beveridge Report recommendations, the
Labor government established a “welfare state” by
 providing “free” medical care
 creating new pension systems
 promoting better education and housing
 seeking “full employment”
 Labor Government under Atlee also committed to
“nationalizing” the commanding heights of the economy.
 coal, iron and steel, railroads, international
telecommunications, utilities were all “nationalized”
 in the end, about 20% of Britain’s workforce was
employed in nationalized enterprises
Nationalization – the acquisition of ownership/control of a
privately owned enterprise by the national government,
either with or without compensation to the original owners.
 Policies of the Labor Party appeared to work –
unemployment, which was well over 12% throughout the
1930’s, was as low as 1.3% in the late 1940’s.
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France:
 No increase in the standard of living between the start of
WW-I and the end of WW-II => urgent need to
reconstruct and modernize
 Under Charles de Gaulle (President from 1944 to 1946):
 key sectors of the economy were nationalized
 increased social welfare programs were put in place
 reliance upon indicative planning began
 Consensus for a “new” France, built upon an economy
divided into three sectors:
 Private: resources owned and operated by individuals
 Controlled: resources owned by individuals, but the
use of which was heavily guided by the state
 Nationalized: resources owned and directly operated
by the national government (“Nationalization Acts of
1945 and 1946” gave the government control of:
banking, electricity, gas, coal, and other industries)
 Active role in economic planning: government
established the “General Commission of Planning” in
1946 (headed by Jean Monnet)
 Monnet Plan – set targets and priorities for
investment in order to modernize key sectors (e.g.,
coal, electricity, steel, railways, and agriculture).
 French notion of Indicative Planning (intended as a
middle ground between markets and socialism) known
as: Planification – efforts by the government to focus,
prioritize, and guide the actions of private business
 Jean Monnet created a credible model for an active
role for government and planning in a modern market
economy => helped to create a consensus for the
“mixed economy” in France and throughout Europe
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Germany:
 Appalling conditions after the end of WW-II:
infrastructure destroyed, worthless currency (crippling
markets), mass starvation
 Appeared as if Germany was destined to become a
Socialist country => leaders of the Social Democrat
party were committed to replacing capitalism with
nationalization and central planning, much in line with
the policies of the British Labor Party
 Lack of food in Germany part of a “global food crisis”
 By 1947, European wheat production was half of its
1938 level
 U.S. was providing a great deal of food relief to
Germany
 January 1948: Johannes Semler (German Director of
Economic Administration in the American/British
Occupation Zones) noted in a speech that much U.S.
aid was not wheat, but rather corn, which he
sarcastically pointed out was what Germans fed to
chickens
- the word he used translated as “chicken feed”
- Semler was fired and replaced by Ludwig Erhard
 Ludwig Erhard belong to a group of free market
economists called the “Ordoliberals” who had a vision
of the “German Social Market Economy.”
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“German Social Market Economy” – system which relied
primarily upon free market institutions, but with a
significant “social safety net” (subsidy and transfer
payments to take care of disadvantaged members of
society)
 June 1948: America and Britain executed massive
currency reform, replacing the worthless reichsmarks
with new deutsche marks.
 This stronger, more valuable currency created a
much more solid economic foundation
 However, German markets still constrained by an
inefficient system of allocation and price controls,
put in place when Nazi’s had power
 Price controls could not be altered without the
approval of U.S./U.K. => Ludwig Erhard did not
alter them, but rather completely abolished them
 Without price controls, Germany again had a
functioning market economy => this was the birth
of the “Social Market Economy”
Overall embrace of a larger role for government:
 following WW-II, socialist ideas dominated much of
Europe
 most all countries moved toward a “welfare state”:
public health insurance, family benefits and
allowances, increased social security programs,
mandated prenatal care, guaranteed generous vacation
time, universal child care
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Unintended impact of Government Policies on Markets:
 As governments began to play a larger role in economic
matters, fewer answers were determined in markets =>
countries often found that government policies resulted
in outcomes that were not intended…
 Observation on Labor Market Outcomes: throughout
Europe unemployment rates are systematically higher
than in the U.S. For example, in Spain it is about “(1.85)
times higher” than in the U.S.
Year
2003
2004
2005
2006
2007
2008
2009
U.S.
5.8%
6.0%
5.5%
5.1%
4.8%
4.6%
7.2%
Spain
“ratio”
11.3% 1.95
11.3% 1.88
10.4% 1.89
9.2%
1.80
8.1%
1.69
8.3%
1.80
13.9% 1.93
“average ratio” = 1.85
Other “average ratios” during this period:
 Germany – “(1.74) times higher” than U.S.
 Greece – “(1.70) times higher” than U.S.
 France – “(1.65) times higher” than U.S.
 Finland – “(1.44) times higher” than U.S.
 Italy – “(1.40) times higher” than U.S.
 European Union – “(1.62) times higher” than U.S.
 Question: Why is the unemployment rate in Spain
“(1.85) times higher” than in the U.S.?
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 Possible Answers:
 People in the U.S. have a greater work ethic…
 Spanish people are lazy…
 Correct Answer: differences in “the cost of being
unemployed” between the countries
 that is, the “decision making environments” differ
across the two countries; individuals in each countries
are “behaving rationally,” given the relevant costs and
benefits which they face
 Americans rely more heavily upon employment to
meet “basic needs” (e.g., health insurance provided
through employer in U.S. but through government in
Spain)
 Extent of unemployment compensation differs greatly
across the countries (e.g., in Spain there is support of
up to “70% of working wage rate” for up to 2 years,
while in the U.S. there is support of “less than 50% of
working wage” for typically half a year)
 Overall “Social Welfare Programs” are more generous
and less restrictive in Spain than in the U.S.
 In total, fewer people in U.S. are unemployed, since
the costs of being unemployed are greater
 Bad side of unemployment support – reduces the
incentive for the unemployed to find new employment in
a timely manner, leading to higher rates of
unemployment.
 Good side of unemployment support – reduces the bad
outcome for workers laid off beyond their own control;
allows unemployed to have more time to find a “better
match” when seeking new employment (i.e., improves
overall labor market outcomes)
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Trade and National Power:
Just as there was a “dual shift” regarding the role of
government in the economy during the 20th century, there
was also a “dual shift” in regards to trade barriers and the
resulting levels of international trade…
 Before World War I, barriers to trade were relatively low
 World War I (from 1914–1918) disrupted international
trade and global commerce
 Post WW-I movement toward economic separatism
 in the late 1920s and early 1930s there were increases
in trade restrictions and trade barriers (both a cause of
and a consequence of the Great Depression) =>
subsequent decreases in levels of international trade
 starting in January 1929, for 53 straight months the
volume of international trade decreased from its level
in the previous month
 from the late 1920s to mid 1930s, manufactured
imports declined by roughly
- 33% in Germany
- 40% in Italy
- 50% in France
 In the decades following WW-II there was a dramatic
reduction in trade barriers and a subsequent increase in
international trade (both globally and particularly in
Europe)
 Common acceptance of Keynesianism, a larger role
for government in regards to social welfare policies,
and other elements of planning drew the “mixed
economies” of European countries together
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 GATT (General Agreement on Tariffs and Trade –
developed at the U.N. Conference on Trade and
Employment, Havana, Cuba, 1947)
 Initial agreement was signed by 23 countries,
including: Australia, Brazil, Canada, China, France,
India, Netherland, Norway, South Africa, United
Kingdom, and United States
 Provided mechanisms for negotiating multilateral
reductions in tariffs (tariff – a tax placed on goods
imported from abroad; tariffs raise the price of
imported goods and therefore discourage trade)
 One of the primary propellants of postwar economic
growth; helped create a “global economy” in which
economic activity transcended national borders
 Treaty of Rome (1957) – established a “Common
Market” (known as the European Economic Community;
precursor to the “European Union”)
 An unprecedented joining of diverse economies, built
upon: the mixed economy consensus, the drive to deal
with issues related to the reconstruction of Germany,
and the threat of the Soviet Bloc
 European Central Bank – the central bank of the
European Union, which administers monetary policy for
the 17 nations which directly use the Euro as their sole
currency
 bank created in 1998; circulation and official use of
Euro began in 2002
 economies of Europe further integrated and drawn
together by this institutional change => in many
respects, Europe is now a “single economy”
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Postwar Economic Record of Western Europe and U.S.:
 Period following WWII was one of considerable
economic growth in both the U.S. and war-devastated
Europe
 “Mixed Economies” in Europe delivered a standard of
living and a way of life that could not have been
imagined a generation before
 European countries enjoyed brisk economic growth,
low levels of unemployment, and low levels of
inflation from mid 1950’s through mid 1970’s
 France: “Thirty Glorious Years”
 Germany: “Economic Miracle”
 Good economic performance reinforced the notion
that planning and an active role of government (i.e.,
the “mixed economy”) was the route to economic
prosperity
 Again, the limitations of central planning (“lack of
incentives” and “resource allocation difficulties”)
were still decades away from being evident
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