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Part II: The European Economies
Chapter 4 The Social Market Economy
(latest revision 2009)
Market capitalism has been categorized in a variety of ways. Liberal market capitalism was
the version of the market economy described in Chapter 2. This chapter will consider the social
market economies. Both the liberal market economy and the social market economy are
variations of capitalism. This means that in both systems, most of the capital goods are privately
owned. But there are significant differences in the two variations of capitalism. What is called
“the social market economy” has also been called “Social Democracy” or “Democratic
Socialism” and is associated mostly with Europe. But it should be noted that not all of the
European countries are social market economies. The countries we will consider as social market
economies are Germany, Austria, Switzerland, Belgium, the Netherlands, and the
Scandinavian countries of Denmark, Sweden, Norway, and Finland. Britain once was a
social market economy. But today, Britain is much more like the United States – a liberal market
economy. Britain will be the subject of Chapter 5. The same can be said for Ireland. Ireland, as
the Celtic Tiger, will be the subject of Chapter 6. France, Italy, and Spain have elements of both
types of capitalism. Japan is quite different from either type and will be considered in some detail
later in the course.
1. The Basic Philosophy of the Social Market Economy
Let us begin by examining the philosophy of the social market economy. As we will see,
people who support this variation of capitalism accept many aspects of the theory of liberal
market capitalism that was explained in Chapter 2. But they also accept some aspects of the
Marxian view that was described in Chapter 3.
The first aspect to emphasize about the philosophy of the social market economy is that it is
democratic. Unlike the Marxian view, supporters of the social market economy do not seek
violent revolution. They believe that all social changes should be accomplished peacefully,
gradually, and only after they are widely accepted by the people. Supporters of the social market
economy usually form political parties and stand for elections. These parties, often named
“Social Democratic” or “Labor” Parties, sometimes win the ability to govern and sometimes do
not. When they do not win, they become a “loyal opposition”.
Rather than rejecting democratic government, as Marx did, supporters of the social market
economy believe that democratic government needs to be extended. For example, they
believe that the modern large corporation has important social effects and therefore needs to be
brought more under democratic government control. This contrasts with the views of supporters
of liberal market capitalism who see the modern corporation as the private property of its owners
with the singular task of trying to earn as much profits as it can. (In the United States, this
contrast is illustrated by the dispute between some communities and Wal-Mart over attempts by
Wal-Mart to open superstores in the community. It is also illustrated by the disputes as to what
government should do with very large financial institutions that are “too big to fail” but are facing
bankruptcy because of very poor financial decisions.)
Supporters of the social market economy also often desire to extend democratic government
into areas such as work relations and education. They believe that a worker should have the same
rights as a citizen does. Just as one is not subject to the arbitrary control of a superior in a political
democracy, they believe that one should not be subject to the arbitrary control of an employer
while on the job. This contrasts with the view of supporters of liberal market capitalism that the
job is the private property of the employer. (For example, I cannot be punished for criticizing the
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President of the United States in public. But I can be fired for criticizing my employer in public.
Is this right?)
The second aspect to emphasize about the philosophy of the social market economy is that it is
moralistic. Unlike Marx, the supporters of the social market economy do not reject religion.
Indeed, many supporters are religious clergy. Is participating in liberal market capitalism
consistent with being a moral person? Many of the supporters of the social market economy
believe the answer is “no”. They see a goal of an economic system as being “to eliminate all
unnecessary suffering caused by economic or social structures”. They argue that liberal market
capitalism often creates such unnecessary suffering. The creation of an adequate “social safety
net” is a big part of the social market economy, as we will see later in this chapter.
The third and most important aspect to emphasize about the philosophy of the social market
economy is that it is egalitarian. This does not require that everyone have the same income or
wealth. But it does require that “no one is so much richer or poorer than another that they cannot
mix socially on equal terms”. Supporters of the social market economy realize that some people
will earn more than others. This ability to earn more provides incentives to work hard, to improve
one’s skills, to develop new products, and so forth. But supporters of the social market economy
believe that inequality should be sufficient to provide such incentives, but no greater. Or as a
famous Danish bishop put it, each country should be such that “no one has too much and no one
has too little.” The supporters of the social market economy have provided several arguments on
behalf of egalitarianism.
First, it has long been accepted in Economics that as people have more of a product, an
additional unit of the product brings less additional satisfaction. So, for example, having a car
would bring great satisfaction if one had never had a car before. But how much additional
satisfaction could there be to having another car if you already had ten cars? Based on this
reasoning, taking income away from very rich people would not cause them great hardship. They
already have so many goods and services that the loss would mean little to them. (The manager
of a leading hedge fund recently had an income of $3.5 billion in one year. If $500 million were
taken away from him in taxes, leaving him with $3 billion, how much would he lose? After one
has spent $3 billion in one year, what more is there to buy?) On the other hand, giving income to
poor people would bring them great satisfaction. So for example, imagine we took the $500
million and used it to give $50,000 each to 10,000 people whose total income had been under
$20,000 per year. How much would these 10,000 people gain? Each would go from being poor
to being middle class. For each, their life situation would improve dramatically. The argument
here is that the gain to these 10,000 people would be greater than the loss to the hedge fund
manager. Society as a whole would be better-off by redistributing income from the very rich to
the very poor.
Second, an American philosopher came up with the following argument for equality. He
asked you to imagine that you are about to be born. You can create the distribution of income
that you wish for the world you are being born into. You can have many rich people and many
poor people. You can have everyone equal. You can do as you wish. The only problem is that
you do not know where you will be in this distribution. If you have few rich and many poor, you
don’t know whether you will be rich or poor. He argues that in this situation, most people would
choose the distribution to be relatively equal. This minimizes the worst thing that could happen
to you. Since people would choose relative equality if they did not know their own position,
that must be the most desirable distribution.
A third argument made by supporters of the social market economy is that inequality in
income generates inequality in political power. While everyone has only one vote, those who
can provide large campaign donations are more likely to have their favored policies enacted.
Democracy does not work well if some people can buy more political influence than other can.
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Supporters of the social market economy see inequality as fostering divisiveness and
breaking down social cohesion. The rich live in gated communities. The poor live in ghettos.
There is no sense of community or common purpose between them. This is especially likely to
be true if the rich and the poor are of different ethnic backgrounds. And supporters of the social
market economy see economic inequality as destroying equality of opportunity. One
economist wrote of a crew race that has taken place in London for over 200 years. Each year, the
race begins where the race of last year left off. So if one side were ahead by 500 yards at the end
of last year’s race, they begin this year’s race 500 yards ahead. Needless to say, if one side had
been particularly bad 100 years ago, that side would have no chance in this year’s race. The
analogy is that if one side (the rich) is well ahead of the other side (the poor) because of
something that happened over 100 years ago (such as slavery), the other side would have little
chance of ever catching up. There would be no real equality of opportunity.
In a fourth argument for equality, supporters of the social market economy see market
transactions as analogous to voting. Every time you buy something, you are, in essence,
“voting” for it to be produced. In the political process, each person has one vote. But in a market,
some people have many more votes than others. Obviously, the goods and services they desire are
the ones that are produced. So, for example, wood is used to produce yachts for rich people while
other people are homeless. Supporters of the social market economy believe there are some
goods and services that are just too important to be mere commodities in the market. These
would include education, health care, and housing. In their view, these should be available to all.
For all of these reasons, supporters of the social market economy are strong believers in
policies that will make people more equal. We will examine some of these policies, especially
those that relate to labor markets and those that relate to the “welfare state”, in later parts of this
chapter. It should be noted that surveys show that Europeans are more likely to believe that
high incomes are due to luck or to one’s social class at birth. Americans are more likely to
believe that high incomes are the results of individual effort. The differences in these beliefs
are large.
Supporters of the social market economy also provide criticisms that are similar to the
Marxian criticisms of capitalism. They believe that liberal market capitalist countries are
subject to too many periodic recessions with all the difficulties that unemployment brings. They
believe that major parts of the liberal market capitalist economy are subject to monopoly. And
they believe that having all countries become liberal market capitalist economies would increase
the disparities between the rich countries and the poor countries of the world.
But supporters of the social market economy also strongly criticize communism, as it was
practiced in Eastern Europe and China. They criticize communism for being non-democratic
and not legitimate (that is, communism was not accepted by a majority of the people). They
criticize communism for its restriction of personal freedom and for its lack of concern with basic
liberties and human rights. They see communism as an alienating and dehumanizing economic
system that simply replaced one ruling class with another ruling class. Communism, as it was
practiced, with be discussed in detail in later parts of this course.
Supporters of the social market economy used to call themselves a Middle Way or a Third
Way --- a view of an economic system that is between liberal market capitalism and communism.
As we examine the workings of the social market economies, we will see that over the past
twenty years, they have shifted more in the direction of the liberal market capitalist economies.
But they are still different. It is that difference that we will be studying here. There are three
important aspects that differentiate social market economies from liberal market capitalist
economies. Before we discuss these three, we will briefly discuss two other aspects that once
were major differences: social ownership and economic planning. These are not significant any
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more in social market economies. Then, we will turn to the main differences that still exist.
First, social market economies have much more tightly organized business communities.
Second, social market economies have strong labor unions, institutionalized collective
bargaining, and strong employment protection. Third, social market economies have largescale government provision of social welfare.
2. Social Ownership (Nationalization)
One institution that distinguished some of the social market economies after World War II was
social ownership or nationalization. Unlike the situation we will discuss in the former Soviet
Union, this nationalization was to be done only for certain companies, not for all companies. And
also unlike the situation in the former Soviet Union, this nationalization was done with
compensation to the former owners. The companies that were chosen for nationalization varied
among the countries. But generally, they fell into the following categories. First, supporters of
the social market economy believed that certain industries are prone to monopoly. These are
industries in which the amount of capital goods needed to produce is very large. Therefore, only
large companies can afford the capital goods. Once the capital goods are in place, the additional
cost of producing additional units is very low. (To produce more, the company just gets more use
of the capital goods it already has. So for example, Microsoft spends millions of dollars to
develop a software product. But once it is developed, the cost of making one more copy is just
pennies.). In some cases, an industry in which capital goods require a great amount of money will
evolve to one in which there is one company (or perhaps just a few companies). With little
competition, the companies in these industries could exploit the consumers. Industries in which
companies were nationalized for this reason included electricity, natural gas, railroads, and the
post office. In Britain and France, the government also owned some automobile companies as
well as shipbuilding companies, some steel companies, and the aerospace companies. (In the
United States, electricity and natural gas are allowed to be produced privately but are regulated by
government agencies.) Second, in some countries, companies were nationalized to remove
what were seen as excessive private economic power. The main example of this was the
nationalization of banks in some countries. Third, companies that were in industries seen to
have great national importance but in which the companies could not make satisfactory
profits were often nationalized. An example was the television networks, such as BBC. Fourth,
some companies were nationalized because the government wanted to force them to pursue
what were seen as important social purposes. So in all European countries, payment for health
services has been nationalized. The National Health Service in Britain will be described later in
this chapter. And finally, in some countries (especially Britain), companies were nationalized
when the government believed that it could reorganize them so as to improve economic
performance. Examples include the airline companies (the British airline British Airways, the
Irish airline Aer Lingus, and the German airline Lufthansa were government owned for many
years), the coal mines, and the steel companies.
These nationalized companies were organized as typical government bureaucracies. Each
came under a Ministry (in the United States government, this would be called a Department). The
Minister would appoint a Board of Directors for each nationalized company. The Board of
Directors would, in turn, appoint a Director to run the day-to-day operation. The goal of the
company was to make as much profit as it could as long as it fulfilled other important social
purposes. If the company incurred losses, it would be subsidized by the government.
The critique of bureaucracy was discussed in Chapter 2 (see Page 11 of that chapter). From
the viewpoint of liberal market capitalism, bureaucracies are seen as desiring to become as large
as they can (called “empire building”). They are seen as often rather inefficient. That view was
upheld by the relatively poor performance of many of the nationalized companies. The
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government in several European countries continued to subsidize these companies and these
subsidies became costly. So in the 1980s, in many of the social market economies, the
government reversed itself and began privatization. The most well-known of the European
privatizations came in Britain under Margaret Thatcher. This is discussed in Chapter 5. As we
will see there, prior to the 1980s, Britain would have been included among the social market
economies. Now it must be considered as a liberal market capitalist economy. A number of
French and Italian companies have also been privatized. Privatization is a topic we will encounter
later in this course in analyzing Russia, China, and Mexico.
In most cases in western Europe, privatization occurred by having the government create
shares of ownership and then sell these shares of ownership to the public at an Initial Public
Offering (IPO). In only a few cases were the shares of ownership sold specifically to the
employees of the company or to the management of the company. (As we will see, selling shares
of ownership to the workers or the management was a very common practice in Eastern Europe in
the 1990s.)
There are still some areas that are public in Europe and private in the United States. For
example, BBC is funded by a tax on every home that has a television set. BBC operates six
television stations and five radio stations. A similar situation is found in the other European
countries. Public transit is much more commonly used in Europe. And it is still much more
common in European cities to find public housing.
3. Economic Planning
Economic planning in social market economies is best associated with France. But it was also
used in some other European countries. It was nothing like the economic planning we will
describe in the chapter on the former Soviet Union. This kind of economic planning has been
called “guidance planning”. It was designed to overcome the “anarchy of the market” and
therefore shows the influence of Marx (see Chapter 3).
In this kind of economic planning, the government would first gather information in
consultation with the leading economic actors (big corporations, labor unions, and so forth). It
could do this in Europe because European economies were, and still are, corporatist. In
corporatism, people act politically through special groups. So, for example, companies all
belong to trade associations for the particular industry they are in. Companies also belong to an
employer’s association that represents the interests of all employers in the country. This is
described in more detail in Section 4 below. And workers belong to labor unions. (Labor unions
are covered in Section 5 of this chapter). In turn, the labor unions belong to a large national
federation that has considerable political influence, unlike the AFL-CIO in the United States. The
government only needed to consult with the leaders of the employer’s association, the trade
associations, and the labor federation. It needs to be added that, in Europe, the “best of the best”
in the universities go into the government bureaucracies. Therefore, government officials are
held in high regard in Europe, in contrast to the United States, and the main economic actors
would give great weight to the opinions of the government officials.
After the consultation and information gathering, the government would set growth targets for
each sector of the economy. This would then be broken down into specific production targets for
industries (but not for individual companies). The plan would also list foreign trade goals (how
much to export and how much to import) as well as social goals (advances in education and so
forth). The plan had to be consistent. So for example, the growth of steel production had to be
consistent with the growth in iron and coal production, as coal and iron are used to produce steel.
Fulfilling the plan goals was never mandatory for the companies. However, the government
would provide incentives for companies to do as the plan requested: tax breaks, special loans at
low interest rates, government purchases specifically from those companies, and so forth. The
idea was to use this plan to push the companies toward decisions that stimulated economic
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growth. Companies who were reluctant to expand their production if left alone might be cajoled
to produce more. When growth rates in Europe were high, many people thought that economic
planning was a positive factor.
But economic planning in Europe declined beginning in the 1970s and was basically
abandoned in the 1990s. There were too many variables not subject to the control of the planners.
As countries became part of a global economy, much that happened in a country depended on
events in other countries. Many of the plans were not successful. Economic planning was not
able to overcome the periods of high inflation, the periods of very slow economic growth, and the
periods of high unemployment. It is no longer part of the institutional makeup of the social
market economy.
Neither nationalization nor economic planning is of any significance today in understanding
social market capitalist economies. However, they may have value in understanding the thinking
of people who support social market economies. However, in the discussion of businesses (part
4), of labor unions (part 5), and of the welfare state (part 6), we will see great differences between
the social market capitalist economies and the liberal market capitalist economies --- differences
that still pertain today.
4. European Businesses
Before we highlight the differences between European businesses and American businesses, it
needs to be stressed that most European businesses are capitalist, as are American businesses.
Most of the capital goods in Europe are privately owned. Indeed, as we saw in Section 2,
because of privatization, more capital goods are privately owned than used to be the case. But
there are still some major differences between European and American or British businesses.
First, as mentioned earlier, European companies participate in associations more than is
found in the United States. Virtually all large and medium sized companies belong to an
employers’ association that bargains with the labor unions. They are also more likely to belong to
trade association to lobby government officials. Second, more of the financing for European
companies comes from bank loans and less come from stockholders than is typical in the
United States or Britain. The following data for the 1990s is the ratio of stockholder equity (the
share of assets paid for by the owners) to bank loans:
Table 1: Ratio of Stockholder Equity to Bank Loans
Austria
Belgium
Germany
.08
.70
.22
Denmark .52
Norway
.31
Netherlands .55
United States
.89
United Kingdom 1.03
Canada
.98
The three countries at the right of the table are liberal market capitalist economies. Notice how
much more significant stockholders are. Third, among the owners of companies, large owners
are more important in Europe. Ownership of companies in liberal market economies is
more widely dispersed. Indeed, in Europe, banks are often large owners of companies. On
the other hand, banks owning companies is not allowed in the United States. The table below
shows the percent of large companies in the country whose ownership shares can be considered to
be “widely held”:
Table 2: Percent of Ownership in Large Companies that is Widely Held
Austria
Belgium
Germany
0
20
50
Denmark 40
Norway
25
Netherlands 30
United States
80
United Kingdom 100
Canada
60
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Again, ownership is much more “widely held” in the liberal market capitalist economies. With a
few large owners, European companies have investors who are likely to be deeply involved
in the management of the companies. On the other hand, American companies have investors
who will simply sell the stock at the first sign that something is not going well. This means that
European investors are more likely to think for the long-term than are American investors.
European companies may be better able to invest in products and processes that will only pay-off
in a long time. And European investors may be better able to monitor the management of
the companies. (We will find the same situation when we consider Japan in later chapters.)
European integration and overall globalization have changed the European companies. The
importance of the banks and the large investors has been reduced. The importance of outside
shareholders has increased. But these differences are still important. European corporations are
more likely than American or British corporations to be owned or controlled by a small
number of large investors who know the company and its management well and can plan
for the long term. And European corporations are more likely than American or British
corporations to belong to trade or employers’ federations and to act as a group
(corporatism).
5. The Labor Market
The most important aspects that still distinguish social market capitalist economies from
liberal market capitalist economies involve the labor market and the welfare state. Section
5 will consider the labor market. In this section, we will first discuss unionization. Second, we
will consider employee participation. Third, we will consider employment security. Fourth, we
will consider active labor market policies. The final section will consider skill formation. The
resulting picture will be of a labor market very different from that found in a liberal market
capitalist economy such as the United States or Britain.
(A) Unionization
The first distinguishing feature of the social market is the extent of unionization and the
nature of collective bargaining. In 2000, only 13% of American employed workers belonged to
a labor union (this percent is called the “union density”). Contrast that with the percent of
employed workers belonging to labor unions in the following countries in 2000:
Table 3: Union Density in 2000
Denmark
Finland
Norway
74%
76%
54%
Sweden
Austria
Belgium
79%
37%
56%
Germany
25%
Netherlands 23%
Italy
35%
But even these figures understate the influence of labor unions. In most of the European
countries, labor unions bargain for all workers in a company whether that worker is a
member of the labor union or not. So for example, the labor union bargaining for production
workers (who are members of the labor union) would also bargain for office workers (who are not
members). So if we look at the percent of all workers who are covered by a collective
bargaining agreement, whether that worker is a union member or not, we get the following for
the year 2000 (the corresponding figure for the United States is 14%.):
:
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Table 4: Percent of Workers Covered by a Collective Bargaining Agreement in 2000
Denmark
Finland
Norway
80%
90%
70%
Sweden
Austria
Belgium
90%
95%
90%
Germany
68%
Netherlands 80%
Italy
80%
In many of the European countries, collective bargaining is handled at a different level
than it is in the United States. In the United States, national labor unions are broken down into
“locals”, usually one at each place of employment. The American national labor unions are also
affiliated with a federation of unions, called the AFL-CIO. In the United States, collective
bargaining is usually done at the national union level. So, for example, the United Auto Workers
labor union bargains with General Motors over wages and working conditions. Some collective
bargaining is done at the local level. But the AFL-CIO does not bargain with employers over
wages, benefits, or working conditions. In many of the European countries, this is reversed. The
overall federation, the equivalent of the AFL-CIO does the collective bargaining for all
labor unions. As mentioned in Section 4, employers are also affiliated with a federation. That
federation of employers does the collective bargaining with the federation of labor unions
on behalf of all workers. (There is no parallel to the federation of employers in the United
States.) This has been called “coordinated wage bargaining”. In recent years, there has been a
move to greater decentralization of bargaining in many of the European countries. But the system
of economy-wide collective bargaining is still very much intact.
Since collective bargaining is done on an economy-wide basis in many European countries,
there are some important differences with the United States. One is that the European labor
union federations have pushed for much smaller wage differentials than are found in the
United States. This is called a “solidaristic wage policy”. The difference in wages between the
most skilled workers and the least skilled workers is much smaller in Europe than is found in the
United States. So is the difference in wages between the most senior and the most junior
workers. The idea behind this policy is to take away from employers the ability to exist
specifically because of low wage workers (we might call this the Wal-Mart Option!). Since the
labor unions act to increase the wages of low skilled workers, the employers are forced to
undertake actions to make these workers more productive. These actions could include better
training or enhancing the worker’s productivity by providing more advanced machinery.
Companies that cannot do this will be forced by competition to go out of business. In this labor
union thinking, wages can rise for workers but, because productivity is rising as well, companies
would not need to raise prices. It has been said of a country like Denmark that “there are no bad
jobs”!
Another major difference with the United States is that economy-wide collective bargaining
can improve macro-economic performance. Especially, it can help hold down inflation. Keep
in mind that most European economies are relatively small and depend on foreign trade to a much
greater extent than does the United States. The argument here is that economy-wide bargaining
that covers most workers in the country makes it easier for the labor union federation s to
exercise restraint in their wages demands. If labor union bargaining is able to achieve wage
increases that exceed the growth of productivity, companies will raise their prices to get this
money back. If the labor union bargains for all workers in the country, it will realize that all of its
members will be hurt by the increase in prices. What the labor union members will gain from the
higher wages will be offset by the higher prices. On the other hand, if the United Automobile
Workers in the United States gains an increase in wages only for its workers exceeding the
growth in productivity, all of these union members will gain by the increase in their wages. But
only those union members who buy new cars will be hurt by the rise in prices. The other people
hurt by the wage increase will be people in other industries who also wish to buy new cars –
people like you or me. But since these people are not members of the United Automobile
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Workers, the labor union has no reason to consider the effect on them. In addition, if the wage
increases force an increase in prices, the companies in the country may become less competitive
internationally. Some workers are likely to lose jobs. In Europe, since all workers are covered by
the collective bargaining agreement, the labor union federation has a reason to consider the effect
of lost jobs. But the United Automobile Workers has no incentive to consider that its wage
demands may cost American textile workers their jobs. (As American prices rise, started by the
rise in automobile prices caused by the wage increase, foreigners will buy fewer American
products – including textile products.) So, economy-wide bargaining under European
conditions may bring greater wage restraint and therefore hold down inflation. In the period
from 1990 to 1998, in those countries in which the central bank was independent of the
government in making its decisions (the United States is one of those countries), the average
inflation rate was 2.6% in countries like the United States with decentralized collective
bargaining and 2.3% in the social market economies with economy-wide collective bargaining.
Before leaving unionization, it should be stressed that in the liberal market capitalist
countries like United States and Great Britain, the relationship between labor unions and
employers can be adversarial. Among labor union people, the word “corporation” is pejorative.
Corporate executives are given all kinds of name, including “fat cats”. On the other hand,
corporate executives despise labor unions. They will go to all kinds of extremes to avoid labor
unions. In Canada, when the workers voted for a union, Wal-Mart closed down the store.
President Reagan was hailed by business executives for not allowing unionized workers to be part
of his inauguration and for firing the air traffic controllers when they engaged in a strike. On the
other hand, the relationship between labor union federation leaders and employer
federation leaders in Europe is often much more cordial. They are on opposite sides, of
course. But trust between them is quite noticeable. The wage restraint that the labor unions have
shown may be part of this. This is somewhat surprising since “class” as Marx defined it has been
important in Europe and has not been very significant in the United States.
(B) Employee Participation in Decision-Making
Most European companies allow considerably greater employee participation in management
decision-making than would be found in the United States. (This is called “codetermination”.)
Probably the European country that goes the farthest in doing this is Germany. But other
countries have arrangements somewhat similar to the one found in Germany.
German companies have two parts to their governing structure. First, there is an Executive
Board made up of top management. Second, there is a Supervisory Board. The Executive
Board is involved with the day-to-day operation of the company. The Supervisory Board is
involved with the major decisions – new products, cutbacks, and so forth. By law, one-third of
the representatives on the Supervisory Board must be selected by the workers. They are
either chosen in a direct election of the workers or are appointed by the labor union. (In
companies with 2,000 employees or more, the workers get one-half of the seats on the
Supervisory Board.) Clearly, the worker representatives cannot outvote the shareholder
representatives. But the presence of worker representatives on the Supervisory Board does force
the management to know about and to consider the concerns of the workers. It also allows the
workers to be better informed as to the situation faced by the company.
Most European companies also have Works Councils. The members of the Works Councils
are elected by the workers in the company. The Works Councils have the right to veto
management decisions involving the redeployment or dismissal of individual employees. The
Works Councils also have “co-decision rights” (meaning that the management must bargain with
the Works Council in good faith) in matters such as work schedules, holidays, piecework, work
organization, company training programs, and so forth. The management must also at least
consult with the Works Council in any other matter that affects the workers.
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Supporters of employee participation argue that it improves the communication within a
company. They also argue that employee participation makes it easier to implement
decisions because the decisions are more legitimate to workers since they had a voice in the
decision-making. As a result, employee participation should make companies more efficient.
There is some evidence that companies with considerable employee participation have lower
absentee rates than other companies and are able to handle worker grievances more easily.
Employers have complained that this system makes decision-making more difficult and timeconsuming. But employers have never attempted to have the system eliminated.
In Sweden, there once was a proposal for “economic democracy”. There would have been a
0.2% increase in the payroll tax and a 20% tax on corporate profits above a certain amount. This
money would have gone into a fund administered by the federation of unions. The fund would
have used the money to buy shares of corporations. The fund would not have been allowed to
own shares representing more than 8% of the total number of shares of any one company. But
the workers, through their unions, would be partial owners of companies. This proposal was
never enacted in Sweden. But it does tell us much about the kind of thinking that differentiates
supporters of a social market capitalist economy from those of a liberal market capitalist
economy.
(C) Employment Security
Many of the social market capitalist economies have laws that make it difficult for
companies to fire or lay off workers. Indeed, among the rich, industrial countries, the United
States offers the least employment protection to its workers and the greatest freedom to its
employers. The most extreme country in offering employment protection is France. In 2006, a
proposal by the Prime Minister that would have allowed companies more freedom to dismiss
young workers caused riots all over France.
In Europe, workers can indeed be dismissed; companies were able to reduce their labor forces
significantly in the 1990s. But the notification period is much longer than in the United
States. For example a worker who has worked at a German company for at least 20 years must be
given 7 months notice before he or she can be dismissed. And the German Works Council may
choose to oppose the dismissal of a worker in court. This can delay the dismissal much more.
The concept of “unfair dismissal” is much broader in Europe than in the United States. And
since a much higher percent of the work force is unionized in Europe, a much higher percent of
the work force will get severance pay upon dismissal (severance pay is usually negotiated in
union contracts).
Many economists criticize this employment security. They argue that with employment
security, workers are more likely to stay working for the same employer. Indeed, the average
number of years one has worked for the same employer is greater in the social market
capitalist economies than in the liberal market capitalist economies. Because workers stay
with the same company, workers are less likely to move from less efficient companies to more
efficient ones than would be desirable. This would slow the growth of the entire economy. It is
also argued that, because workers are so hard to terminate, companies will be reluctant to
hire them in the first place. This makes it harder for the unemployed and for new workers to get
jobs.
Those who support employment security argue that it facilitates a long-term relationship
between the employer and the worker. This provides a greater basis for trust. Worker loyalty
and motivation may be greater when workers know they will work for the company a long
time. Greater loyalty and trust may make workers more productive. Secondly, as we will also see
with the case of Japan, long-term employment may give the employer an incentive to invest in
the training of the employees. If I know that I will employ you for many years, I will provide
11
you training so that you can be as productive as possible. If I think you will be gone in a few
years, I may be unwilling to bear the expense of this training.
The evidence on employment security is mixed. Some countries have combined high levels of
employment security with low overall levels of unemployment. But in much of Europe, the
average duration of unemployment is much greater than in the United States. In countries
with employment security laws, fewer people may become unemployed. But those who are
unemployed are unemployed for a long time. And in general, the countries with high levels of
employment security have experienced lower amount of job creation. Often, this employment
security is considered a policy to benefit “insiders” at the expense of “outsiders”!
An interesting counter example is the case of Denmark. Despite being a social market
capitalist economy, Denmark has very little job protection. Workers can be dismissed relatively
easily. In its place, Denmark has one of the world’s most extensive systems for worker retraining
and aid in finding a new job. This is called and an active labor market policy. In Denmark, the
phrase “flexicurity” has been used. In this portmanteau, the “flexi” comes from flexibility – the
ability of companies to flexibly adjust their work forces. The “curity” comes from security – the
security of being able to get a new job or to get training. This is “employment security”, not “job
security”. (See the next section)
(D) Active Labor Market Policies
While most social market capitalist economies have some sort of “active labor market policy”,
the Scandinavian countries are most associated with this. “Active Labor Market Policy” might be
better said to focus on employment security (rather than “job security”). One part of this
employment security is a very generous unemployment compensation system to protect
against income losses associated with unemployment. In Denmark, for example,
unemployment benefits replaced up to 80% of income and last for 4 years. The replacement rate
for Sweden and the Netherlands was even higher. (In the United States, unemployment benefits
replace about 58% of income on average and last for 180 days.) But more significantly, Active
Labor Market Policy entails an extensive system of government programs designed to help
workers find better-paying jobs. Besides job training, Active Labor Market Policies include
government employment services (to help workers find jobs and better market themselves) and
relocation subsidies. To contrast the two models of market capitalism, Denmark spends 1.7% of
its GDP on such Active Labor Market Policies (and Sweden spends 1.5%) while the United States
spends only 0.2% of its GDP on such policies.
The goal here is to make workers secure in the knowledge that, no matter what happens with
their current jobs, they will be able to be employed. In doing so, some of the insecurity inherent
in a liberal market capitalist economy is overcome. Active Labor Market Policies act to make
labor markets more efficient. Indeed, one study did find that greater government spending on
Active Labor Market Policies acted to lower unemployment rates and also to shorten the
duration of unemployment.
(E) Skill Formation
There are basically two kinds of skills: general skills and specific skills. General skills are
those that can be transferred between employers. Specific skills are those that are specific to
one employer or one industry and cannot be transferred. If one leaves a job and goes to
another job, the general skills are still useful on the new job. So the ability to read is a general
skill. Some specific skills might be useful if one moved to another company in the same industry
but would not be of much value in a different industry. These are industry-specific skills. Other
specific skills are useful only to one employer and would not be useful if one moved to a different
job even within the same industry. These are job-specific skills. (These job specific skills might
12
include knowing the procedures of the company, knowing the details of the company’s product,
getting on with the specific workers in the company, etc.) Workers “invest” in skills that are very
general by attending and doing well in high schools and colleges. (The “investment” is the cost of
this education plus the value of the time given up.) Workers “invest” in industry specific skills
through vocational or apprenticeship programs. (The cost of this “investment” is of the same type
as for general skills.) Workers “invest” in job-specific skills through experience with one
employer. (This “investment” arises because while workers learn through experience in one
company, the value of other skills that might be marketable could decline.)
For the general skills, the worker acquires them by attending and doing well in school. The
worker pays for this by paying the cost of the schooling and by sacrificing the income that
otherwise could have been earned. Employers will not pay for the acquisition of general skills
because of the likelihood that the workers will move to other companies. For the specific skills,
the worker also makes an investment. In making this “investment”, the worker must consider
the cost of acquiring these skills, the extra wages that are likely to result as a result of
having these skills, and the risks of losing the job and therefore losing the benefit of having
acquired the specific skills. (The analogy is to an investment in a bank. Here one considers the
amount of the investment, the return that can be gained, and the risk of loss.) With job-specific
skills, their skills will be worth little if the workers are forced to change jobs; therefore workers
need considerable job security in order to provide incentives for them to “invest” in job-specific
skills. With industry-specific skills, workers can move between jobs within the same industry.
The skills earned them higher wages. In order to invest” in these skills, workers need to know that
these higher wages are protected; they will not lose the benefit of these higher wages either by
changing jobs or by experiencing periods of unemployment.
From this description, we can surmise that there is a relationship between the types of products
produced in a country and the amount of job security and wage protection. Liberal market
capitalist economies like the United States and Britain have weak job security (or, as they are
called, flexible labor markets). Workers forced to change jobs often experience a period of
unemployment, with unemployment benefits replacing barely more than half of their previous
incomes and doing so for only a short while. When these workers find new jobs, the pay is
commonly 10% to 15% below their previous pay. Given these circumstances, it is not too
surprising that workers in these countries “invest” mainly in general skills. Because workers
have the general skills, it makes sense for the companies to produce products that rely heavily on
these types of general skills. So in these countries, manufacturing has been mainly of the
“Fordist” type described in Chapter 2 – low cost, mass produced goods and services. Companies
also produce high technology products that rely on workers with general skills. Professionals also
are trained so that they can move freely between different types of employment, as we also saw in
Chapter 2. There is a great advantage to this type of approach. Having an abundance of general
skills (especially those that require a university education) generates an advantage in radical
product innovation. It is not too surprising that the United States and Britain are two of the most
innovative countries and that these two countries have most of the world’s top 100 universities.
But there is also a major disadvantage of this type of approach. Since the most important general
skills are provided in colleges and universities, there is an incentive to strive to be able to attend
one. But not all people can do this. For those not able to attend college or university, this type of
system does not provide many good opportunities to improve one’s labor market value. Studies
have shown that American companies invest significantly less in worker training than do
the European companies. This is one reason that liberal market capitalist economies that rely on
general skills tend to be more unequal than others. (See below)
The importance of industry specific skills explains the importance of the Active Labor
Market Policies in Scandinavia mentioned in the last section. One characteristic of this is a high
replacement ratio (unemployed workers get perhaps 80% or more of previous wages). Therefore,
13
the worker does not lose as much from the experience of unemployment and is therefore more
likely to make the “investment” necessary to obtain the higher wages. A second characteristic is
that the period for unemployment benefits is long – often 4 years or more, compared to 6 months
in America. Therefore, the worker’s wages are again protected and the worker has sufficient time
to find another job that matches his or her skills. And a third characteristic mentioned above is the
large amount of effort devoted to job retraining and employment counseling so that skills can be
replaced. A fourth characteristic, noted earlier, is coordinated wage bargaining. This assures that
the wages for workers of a given skill are similar at all companies and therefore a worker will not
take a wage decrease by moving to another company in the same industry. It should be no
surprise that these countries specialize in products that require a workforce highly trained
in industry-specific skills. These are likely to be high quality, niche products (furniture,
glass, specialty electronics, etc.). And partly because those who are not bound for colleges and
universities still have good opportunities to develop their ability to earn a decent living, average
literacy test scores are higher in the Scandinavian countries than in the United States. But
more importantly, the dispersion of scores around the average is less in the Scandinavian
countries. Those whose scores are near the bottom are closer to those who scores are near the top
in the Scandinavian countries than in the United States. Based on this, one can surmise that
unskilled workers have greater literacy abilities in the Scandinavian countries. If literacy
approximately measures skill development, then the Scandinavian countries have relatively fewer
low-skilled workers than does the United States.
Germany is a country that relies on a combination of job-specific skills and industry-specific
skills. It does so by producing high quality products, but producing them in factories rather than
small shops. In order to achieve this, Germany has large-scale training in governmentfinanced vocational schools combined with apprenticeships paid for by all of the employers
within a given industry. The labor unions are involved to assure that the apprentices actually
receive the training they are supposed to receive. Besides learning the requisite skills, studies
have found that workers who have completed a vocational training and apprenticeship program
need less supervision than do other workers. This allows the companies to operate with fewer
supervisors, lowering their labor costs. But as labor markets for older workers are virtually nonexistent in Germany, it is important to the workers to have the job security and wage protection
that they have.
France is a country with a high level of job security. France is not considered here. Japan is a
country that relies heavily on job-specific skills and has a very high level of job security. Japan
will be considered in detail in a later chapter.
In conclusion, there seems to be a connection between the types of products mainly
produced in a country, the skill development of the workers, and the labor market
institutions. This could be considered as a form of market failure (see Chapter 2). Where
specific skills are important to production, they are likely to be under-supplied unless the
government provides the labor market institutions of either job security or active labor market
policy. However, it has been argued that the technological changes of recent years have reduced
the significance of specific skills. If true, we would expect to see more flexible labor markets,
tighter restrictions on obtaining social welfare benefits, and greater investment in general
education in European economies. To some degree we are indeed seeing that. Perhaps the best
example of this shift is found in Britain as it changed from a social market capitalist economy to a
liberal market capitalist economy. Britain is the subject of Chapter 5.
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(F) Final Aspects of Labor Market Differences
Before concluding the labor market, there are a few points to mention. In most European
countries, the workweek is shorter than it is in the United States. In addition, European
workers have more paid holidays and longer paid vacations. France is the most famous for
this. Most of the workers in France have a paid holiday for the entire month of August. In much
of Europe, workers are entitled to five weeks of vacation beginning in the first year of
employment. In 2003, the average German and French worker worked 400 fewer hours than the
average American worker. In addition, the retirement age is lower in most European
countries. Combined with low birth rates, this could present some serious problems for the
European economies in the years ahead. Most European countries are facing the problem of
having a greater proportion of their populations being retired.
(G) Recent Problems
While some of the smaller European countries have done well economically in recent years
(especially the Netherlands, Denmark, and Sweden), the larger ones have been having economic
problems. In Germany, France, and Italy, the unemployment rate was around 10% in 2004. All
three countries experienced very slow rates of economic growth of Real GDP between 1993 and
2003 --- averaging 1.4% a year in Germany, 2% a year in France, and 1.5% a year in Italy. This
poor economic performance over such a long period has been blamed partially on the labor
market institutions and has led to calls for reform. Indeed, at a meeting in Lisbon in 2000, the
leaders of the European Union countries committed themselves to significant labor market
reforms. These have yet to fully develop.
6. The Welfare State
The other main difference between the social market capitalist economies and the liberal
market capitalist economies concerns what has been called “the welfare state”. The prime
minister of Serbia summed it up in this way: “Modern societies are defined by three elements:
political democracy, market economy, and social identity. It’s in this third aspect – their attitude
to social solidarity – that Europeans seem to have an identity that is distinct from either Asia or
America.” The Welfare State is a response to two main criticisms of liberal market capitalism
mentioned earlier. First, supporters of social market capitalist economies believe that liberal
market capitalist economies generate considerable and unacceptable inequality. One rationale
for the Welfare State is to redistribute income to provide greater equality. Second,
supporters of social market capitalist economies believe that liberal market capitalist economies
generate considerable and unacceptable economic insecurity. Another rationale for the Welfare
State is to provide greater economic security. As we just saw, this greater economic security is
seen as a necessary condition to provide incentives for workers to invest in specific skills. In
addition, supporters of the social market capitalist economy see Welfare State programs as a
means to foster and enhance a sense of community and citizenship. These programs are
available to all. They are rights of citizenship. These are not programs that are simply targeted
for poor people (called “means tested”)
(A) Welfare State Programs
Some Welfare State programs are found in both Europe and the United States. The most
famous American and European Welfare State program is Social Security. This guarantees a
certain pension for all workers and therefore protects all workers against the insecurity that comes
from aging. In 1995, the United States spent 3.27% of its GDP on public pensions compared to
15
7.71% of GDP for Germany. In addition, the United States has Medicare (medical care for
people age 65 and up) and Medicaid (medical care for people with low income). These programs
provide protection against the insecurity that comes with illness. Like Europe, the United States
also has programs of unemployment compensation (providing some protection against the
insecurity that comes from unemployment) and disability insurance (providing some protection
against the insecurity that comes with disability). Unemployment benefits replace about 58% of
the average income in the United States, as noted earlier, compared to 86% in France, 74% in
Germany, and 90% in Denmark, Sweden, and the Netherlands. Disability payments replace 43%
of the average income in the United States compared to 80% in Sweden. Finally, the United
States’ Welfare State has means-tested programs such as Temporary Assistance to Needy
Families (TANF), Public Housing, Food Stamps, and so forth. These provide redistribution to
people with low income.
European Welfare States are much more extensive than those found in the United States.
Some of the functions they undertake are provided in the United States by employers or others,
not by the government. So, for example, many European Welfare States have parental leave.
Upon becoming a parent, each parent can take paid leave. The payment comes from the
government, not the employer. The most extensive of these plans is in Sweden. There a worker
who becomes a parent can take up to 18 months leave at 90% of the previous wage. In the United
States, parental leave must be granted but the worker is not paid. European governments also pay
for pregnancy leave and sick leave. The head of Norway’s Christian Democratic Party put it
this way: “We have decided that raising a child is real work. And that this work provides value
for the whole society. And that the society as a whole should pay for this valuable work.” In the
United States, sick days are common. They are usually paid (up to a certain number per year) by
the employer. But public sickness benefits are available in only 5 states (and not from the federal
government). In Europe, the person’s wage while sick is paid by the government, not the
employer. They replace 70% to 80% of the person’s wages and, in Sweden, last indefinitely.
Even funeral costs are paid by the government in European countries, unlike the United States.
Hence the term “cradle to grave security”. A program found in all European countries, but not in
the United States, is family allowances. Every family there receives a certain amount of money
per month ($136 in Germany and $87 in Sweden) for every child in the family living at home.
Undoubtedly, one of the best known of the European Welfare State programs is National
Health. Sometimes, this is called “socialized medicine”. But this is a misnomer. In most
European countries, the health care itself is not socialized. Doctors, nurses, and other
providers work for themselves (although most hospitals are government owned). It is the
payment for the health care that is socialized. In many of the European countries, health
care is paid from taxes. The rest of the program is different from country to country. Let us use
Britain as the classic example. Here, each person can choose a primary care doctor. At regular
times throughout the year, the person can choose a different doctor. So there is a choice of
doctors. The primary care doctor is responsible for primary care and also for sending patients to
specialists. A person cannot go to a specialist without the referral from his or her primary care
doctor. Only specialists are allowed to practice in a hospital. The primary care doctor is paid by
the government --- so much money for every person on the doctor’s list of patients. The payment
per person (called the capitation fee) is negotiated between the doctors’ organization and the
government. The specialist is also paid by the government – so much money per patient. Hospital
costs are paid by the government at rates negotiated between the government and the hospitals.
The only cost to the patient is a small co-payment. Prescription drugs are also paid by the
government. They are bought by the government from the pharmaceutical companies. The
government uses its power as the only buyer to get particularly low prices from these
pharmaceutical companies. People familiar with American health care will recognize that this
description is similar to a Health Maintenance Organization (HMO) in the United States. Indeed,
16
starting with Kaiser, American HMOs were modeled on the European system. The main
difference is that payment to an American HMO comes either from a person’s employer or from
the person himself or herself. The payment does not come from the government as it does in
Europe.
There are several advantages to the European system of health care. One important
advantage is that everyone is covered by the system. In the United States, some 15% of the
population (about 47 million people) has no health insurance coverage at all. Another
important advantage is that the European system is cheaper. Spending on health care as a
percent of GDP is much lower in Europe than in the United States. For example, health care
costs are about 16% of GDP in the United States compared to 8.5% in the Netherlands, 8% in
Sweden, and 6.7% in Britain. Yet, by most health measures, overall health is as good or better in
Europe. Life expectancy is slightly longer in most European countries than in the United States.
Infant mortality is lower in Europe. Incidence of disease is the same or lower in Europe. The
European rate for obesity is half that of the United States. And there are more doctors per 100,000
people in Europe than in the United States. The fact that the doctor is paid the same capitation fee
(whether the patient needs service or not) provides an incentive for the doctor to keep the patient
healthy. Another cited advantage is that the monetary connection between doctor and
patient is removed. The doctor gets paid a fixed amount per patient. No patient needs to wonder
if the doctor is just “running up the bill”. Finally, since the British style of health care is paid
for by general taxes, it reduces the health care costs paid by employers. This reduced cost
allows the companies to be competitive in international markets. (In some European countries,
such as Sweden --- see below --- the tax is indeed on the employer.)
But there are some disadvantages to the European system as well. Waiting times can be very
long for non-emergency procedures. One needing a non-emergency procedure in a hospital
may wait several months. Then, one will have the procedure when the hospital schedules it, not
when it fits best into the patient’s schedule. It is very difficult to have procedures considered nonessential, such as face lifts and so forth. And many hospitals in Europe are significantly
under-funded. They are old and lack some modern technology.
(B) Extent of Welfare State Spending
To get some perspective on the difference in the amount of Welfare State provision in the two
types of economies, in the United States in 2001, 14.6% of GDP was spent on what are called
“Social Programs”. No social market capitalist economy spent less than 20% of GDP on
these programs. The average for the social market capitalist economies was just about 25%
of GDP. The top spenders were Sweden (27.5% of GDP), Denmark (27.7% of GDP), and
France (27.2% of GDP). These countries spent almost double the percent of GDP on Welfare
State programs than did the United States.
There is an important theory that Welfare States are larger in countries that are more
exposed to international trade. European countries have been heavily exposed to international
trade for a long time. The United States had very little exposure to international trade until the
1980s. Even though this exposure has grown, it is still much less than that found in Europe.
There are two hypotheses given to support this argument. First, international trade creates
greater economic instability. There are many winners from international trade but also many
losers. The need for workers to shift jobs is greater if there is more international trade. So there is
a need for a Welfare State to cushion the impact of the economic instability. However, it turns out
that, measured by the change in Real GDP, the United States has experienced more instability
than has Europe. So this hypothesis may not hold. The second hypothesis follows from the first:
there are many losers from international trade. They see the effects on themselves strongly
and therefore will oppose all efforts to expand international trade. The winners do not see
the effects as strongly and therefore do not advocate for measures that would expand trade.
17
In such a political system, measures to increase international trade will be defeated. In this
hypothesis, the Welfare State is necessary to mollify the losers so that they will be less likely to
oppose measures that would expand international trade.
There is another theory that says that Welfare States are likely to be larger in countries
with proportional representation than in countries with majoritarian governments. This is
discussed below.
(C) Redistribution
As noted earlier, one major purpose of the Welfare State is to redistribute wealth so as to make
people more equal. Inequality is measured by calculating Gini Indexes. The Gini Index is a
number between zero and one; the lower the number, the more equal is the distribution. This
index has been calculated for market income and then for disposable income. Disposable income
is income minus taxes plus transfers. So, disposable income takes into consideration the effect
of taxes and cash transfers. For the United States in the year 2000, the Index was .436 for market
income and .363 for disposable income. Therefore, taxes and transfers did make people more
equal in the United States. For the social market capitalist economies in the same year, the
Index for market income was about .35. So you can see that the social market capitalist
economies have a more equal distribution of market income than does the United States even
before considering the Welfare State. Much of this difference reflects the process of setting
wages described earlier. As just one example, in 2000, an American in the 90th percentile of the
earnings distribution earned about five times as much as a person in the 10th percentile. For
Norway, the most egalitarian of the social market capitalist economies, a person in the 90th
percentile earned only twice as much as a person in the 10th percentile. For disposable income
(income plus transfer minus taxes), the Index for the social market capitalist economies averaged
about .246. Again, the social market economies are more equal than the United States. But notice
also that taxes and transfers in the social market capitalist economies had a greater equalizing
effect than they did in the United States.
A related goal of the Welfare State is to alleviate poverty. In international comparisons, one is
considered “poor” if one’s income is less than 40% of the median household income in that
country. In 1991, 21% of Americans were poor by this definition if we measure only by their
market income. After taxes and transfers are considered, 11.7% of Americans were poor. So 44%
of the poor people were taken out of poverty as a result of the tax and transfer system of the
United States. In approximately the same year, taxes and transfers reduced the poverty rate
in Denmark from 24% to 3.5%, in Sweden from 20% to 3.8%, in Belgium from 24% to
2.2%, and so forth. Several points emerge from these data. First, before considering taxes and
transfers, poverty rates are very similar in the social market capitalist economies and the
United States. Second, the social market capitalist economies are much more successful at
using Welfare States programs to remove people from poverty. And third, by this measure, the
poverty rates in the social market capitalist economies are approaching zero. This is especially
so for children. In the year 2000, some 14% of American children were considered poor. This
compares to 3% in Belgium, 6% in Germany, 6% in the Netherlands, and 2% in the Scandinavian
countries.
(D) Taxes
The Welfare State, of course, must be paid for. The corollary to the Welfare State is high
taxes. As a percent of GDP, Americans pay about 1/3 of their national income in taxes (counting
all federal, state, and local taxes). In most Continental social market economies, people pay 40%
to 45% of the national income in taxes. In the Scandinavian countries, people pay over 50% of
the national income in taxes. As an illustration, let us briefly look at the tax system of the highest
18
taxed social market capitalist economy – Sweden (where total taxes took 54% of the GDP in
2001). First, people pay municipal income taxes of 29% to 34% of their incomes, depending on
the municipality. Few deductions from income are allowed. Those with incomes above a certain
amount (about 17% of all income earners) pay an additional 20% of their incomes to the national
government. The corporate profits tax rate was 52% until 1990. However, it has been lowered
and is now 28% of profits. (This rate is 35% in the United States.) The capital gains tax rate is
30% (compared to 15% in the United States). For health insurance, old-age pensions, and other
social benefits, the tax is completely on the employer. (In the United States, the tax is split
between employer and employee.) For every dollar paid in wages, a Swedish employer must pay
32.82% of that dollar for these social benefits. (In the United States, for every dollar paid in
wages, the employer and employee share comes to 15.3% of that dollar for Social Security and
Medicare. But employers also pay health insurance premiums for most employees.) In addition,
in Sweden, there is a Value Added Tax (VAT), similar to a sales tax. The tax rate in Sweden is
25% with a reduced rate of 12% for food and so forth. In the other European countries, the VAT
rates vary from a low of 16% (Spain) to a high of 25% (Denmark and Sweden). Finally in
Sweden, there are a variety of other taxes: a tobacco tax, an alcohol tax, an energy tax, a property
tax (1% of assessed value), and so forth. As might be guessed, the income tax is more
progressive in Europe than in the United States. This means that income taxes take a higher
percent of higher incomes and a lower percent of lower incomes in Europe. The tax wedge is
defined as the difference between the amount a worker is paid in total and the amount the worker
actually receives. In the United States in 2003, this was 29% on average. In Germany, France,
and Italy, it averaged close to 50% -- workers take home slightly more than ½ of the amount they
earn.
Taxes this high have some serious negative effects on economic performance. A major one is
tax avoidance. Tax avoidance means finding legal ways to get out of paying the taxes. It has
been estimated that perhaps 25% of the Swedish GDP may escape taxation through a
variety of means. (Some of this is commonly called the “underground economy”.) Another
negative effect is the effect on work effort. Knowing that the government will take away a
sizable part of any income one earns may remove the incentive to earn that income. It was
estimated for Sweden prior to 1991 (when the tax rates were lowered) that the high tax rates may
have reduced the labor supply by 6% to 10%. If people are not working, they are not producing
and total production suffers.
(E) Effects of the Welfare State
The evidence on the other effects of the Welfare State is mixed. In the 1960s and 1970s, the
social market capitalist economies (with the larger Welfare States) grew faster than the liberal
market capitalist economies. Although most social market capitalist economies are still rich
and industrial, economic growth rates in most of the social market capitalist economies
slowed greatly in the 1980s and 1990s and were quite low compared to the liberal market
capitalist economies. (The rapid growth in Britain and Ireland is considered in the next two
chapters.) As mentioned above, besides slower economic growth, Europe has suffered higher
rates of unemployment than has the United States. Especially, Europe has suffered higher rates
of long-term unemployment than has the United States. (In 2006, the European Union
unemployment rate was 7.6% compared to 4.7% for the United States.) Some people have
blamed the labor market institutions and welfare state policies for this poor economic
performance. Reforms of the labor market were considered earlier. There have also been some
reforms of the Welfare State.
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(F) Reforms of the Welfare State
Before considering reforms, it needs to be noted that the main parts of the Welfare State have
remained. In 2001, most countries were spending approximately the same share of their
GDP (or even a greater share of their GDP) on social programs as they had spent in 1980.
As just a few illustrations, the following table shows the percent of GDP spent on social
programs.
Table 5: Percent of GDP Spent on Social Programs
Denmark
Sweden
Germany
Austria
Netherlands
1980
28.7%
27.6
23.0
22.5
26.3
2001
27.7%
27.5
26.3
25.5
20.3
Even Britain, despite the so-called “dismantling” of the Welfare State under Margaret Thatcher
discussed in the next chapter, was spending a higher percent of GDP on social programs in 2001
(21.5%) than it had spent in 1980 (17.3%). To provide contrast, in 1998 the United States spent
14.6% of its GDP on social programs. Clearly, the Welfare State in Europe is not dead!
But there have been some major changes to the European Welfare States in recent years. First,
virtually all European countries experienced deceleration in the rate of growth of social
spending per capita. This means that, while social spending grew, it grew at a slower rate than
previously. For example, in the Scandinavian countries, social spending per capita grew at 5.8%
per year in the 1970s, grew at 3.7% per year in the 1980s, and grew at only 1.5% per year in the
1990s. The same trend can be found in most of the other European countries. Only in the
Netherlands in the 1990s did social spending per capita actually decline. This deceleration came
at a time that the elderly were becoming a larger share of the population and at a time of
relatively high unemployment (that is it came at a time that one would think that social spending
would be rising considerably). Second, there has been some “privatization” of health care in
most of the countries. This “privatization” usually has come in the form of greater co-payments.
This means that patients have had to pay more of the cost of their health care out-of-pocket. But
in a few countries, there has been an increase in private health insurance as well. In some cases,
health care activities that used to be provided by government-owned entities have been contracted
out to private entities. The number of public employees working in the health care system has
declined considerably (for example a 12% decline in the 1990s in Sweden). Third, in virtually
all European countries, the percent of income that is replaced by unemployment benefits
(called the “replacement rate”) has fallen. The duration of unemployment benefits has been
shortened. The same is true for sick pay benefits. And eligibility for sick pay and disability
pay has been made harder. These changes have been especially focused on young people.
However the replacement rates are not low. For unemployment compensation, the replacement
rates in some illustrative countries fell as shown below:
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Table 6: Replacement Rate of Unemployment Benefits
Denmark
Sweden
Germany
Netherlands
1985
79%
83
67
88
1999
64%
73
66
76
Even in 1999, these replacement rates were significantly higher than the American rate of 58%.
Finally, in some countries, the proportion of social programs that are means-tested (aimed
specifically to lower income people) has increased.
7. Why Is There No Social Market Economy in the United States?
Let us digress a moment to examine an interesting historical question. Throughout American
history, the philosophy of the social market capitalist economy has had very little support in the
United States. There are not many other countries that have had this history. Political parties
advocating the principles of the social market capitalist economy have been on the left fringes of
American politics. The main party of the left in the United States, the Democratic Party, would be
considered a conservative party in most of the northern European countries. Many people have
wondered why the social market capitalist economy has had such little success in the United
States but has had greater success in other countries colonized by Britain, such as Australia and
Canada. This has been called “American exceptionalism”. Several hypotheses have been
suggested.
First, Europe inherited a rigid class structure from its feudal past. People identify
themselves as “working class” or “capitalist class” or “landed gentry” or “royalty”. The United
States has never had a rigid class structure. People believe they can move up and down the social
scale within one lifetime and also between generations. In the United States, people do not envy
the rich or hate the rich. They want to be rich and think they can achieve that.
Second, for much of its history, the United States had the western frontier. This served as
a safety valve for discontent. A worker unhappy with his lot did not have to advocate for political
change. That worker could simply pick up, move west, and start over.
Third, there is the American political system. (1) The American Electoral College has
made it very hard for third parties to succeed. In the United States, a third party must win a
whole state to get any votes in the Electoral College. It must win many states to get the 270
electoral votes to elect a President. The history of third parties in the United States has been one
of dismal failure. And it is such parties that would have might the Welfare State to the United
States. As a contrast, the Labour Party (the political party supporting the Welfare State) started as
a third party in Britain. Under their parliamentary system, (with relatively small districts,
geographic concentration of working people, and no countervailing power in the executive
branch) the Labour Party could gain seats in Parliament. As it grew, it eventually squeezed the
Liberal Party. Today, Labour and the Conservatives are the two main British parties, although
the Liberal Democrats are also significant. The story of Social Democratic parties in other
European countries is similar.
(2) Also, the American system has single districts with majority winners. This is called a
majoritarian political system/ In contrast, many of the European countries have
proportional representation and no single districts. In the United States, a third party must win
a whole state to elect a Senator and a whole district to elect a Representative. Theoretically, a
21
political party could win 49% of the vote everywhere in the United States and still have no
representation at all. But small political parties do much better on the continent of Europe where
most countries have proportional representation (a party getting 10% of the vote would have 10%
of the representatives). Studies show that proportional representation combined with no specific
districts lead to an increase in transfers -- that is, an increase in redistribution. (On the other
hand, the same studies show that a majority winner, single district system, as we have in the
United States, leads to what is called “pork barrel” spending but resists transfers.)
(3) The American Senate over-represents the non-industrial areas of the country and
therefore acts as a check on workers’ political demands. Wyoming, with less than 500,000
people, has the same number of Senators as California. (4) The American President acts an as
independent check on the legislature, unlike the parliamentary systems of Europe. Getting
control of the parliament was sufficient to have political power to put into effect the Welfare State
in Europe. But in the United States, a party must have control of both houses of Congress and
also the presidency. (5) Finally, the courts in the United States have more independent power
than is found anywhere else. The courts have often used their power to stop redistributive
proposals.
Fourth, as mentioned earlier, Americans have a perception of greater social mobility than
do Europeans. (The data seem to show that social mobility in the United States is actually not
much greater than in Europe.) If people believe that they will someday be rich, they are more
likely to oppose policies that redistribute from rich to poor. Also, Americans are more
geographically mobile than Europeans. When unemployment hits, Americans are more likely
to move to new locations to get a new job. Europeans tend to stay in the same place and therefore
demand more protection from the government.
Fifth, there is the racial and ethnic division of the American working class. American
workers have never been able to come together to form an effective political and economic force,
as did workers in Europe. Indeed, management could use the racial division to its advantage, such
as by hiring African-American workers as strikebreakers. The first American political party to
advocate redistribution, the Populists, was defeated in the south by opponents playing to racial
hatred. People who supported the working classes politically were often branded as “foreigners”.
The labor movement in the United States has traditionally been weak in comparison to that of
Europe. And America has not seen a political party specifically representing labor.
Sixth, in the United States, support for the social market capitalist economy has been
labeled “socialism”. Unlike Europe, “socialism” has been a pejorative word in the United States.
Americans have been taught to associate the word “socialism” with treason.
Some of the ideas of the social market economy, such as social security, have indeed come to
the United States. When they did, they came from within the two dominant political parties. And
many of them came during the decade of crisis of the 1930s. For us, it is important to know that
the United States is quite different from other countries of the world and that there are historical
reasons for the differences.
8. Conclusions
This chapter has highlighted some of the differences between liberal market capitalist
economies and social market capitalist economies. But we should also note the important
similarities. Both are basically capitalist economies in that most of the capital goods are
privately owned. And in both systems, markets are of the greatest importance in allocating
society’s scarce resources. So the similarities among these types of economies are much greater
22
than the differences. Two aspects of social market economies that were the most different from
liberal market capitalist economies --- nationalization and economic planning --- seem to be
insignificant now. One main difference still existing involves the functioning of the labor
market. The differences were described in Section 5 above. The other main difference
involves the importance of government in the economy. The differences, known as the
Welfare State, were described in Section 6 above. Government spending as a percent of GDP is
much greater in European countries than in the United States; this difference is totally due to
spending on Welfare State programs. In this concluding section, let us go back to the goals on
which an economy is to be judged (from Chapter 1) and use these to evaluate the performance of
social market capitalist economies. From what we have said in this chapter, we cannot evaluate
all of the goals. But we can evaluate some.
In Chapter 1, we said that we can evaluate economies by economic growth rates. Many
economists have chastised the European social market capitalist economies for their slow rates of
economic growth. Indeed, as mentioned earlier, the slow rates of economic growth have been
responsible for some of the changes described in this chapter. But if we look at the data, we get a
somewhat different picture.
Table 7: Annual Real GDP Per Capita Growth Rate
1960 to 1980
1980 to 2000
Austria
3.7%
2.0%
Belgium
3.6
2.0
Denmark
2.7
1.7
Germany
3.1
1.6
Netherlands
2.9
1.9
Norway
3.7
2.5
Sweden
2.7
1.6
United States
2.1
United Kingdom 2.0
Canada
3.2
2.1
2.0
1.5
The countries above the space are social market capitalist economies. The countries below the
space are liberal market capitalist economies. Notice that the social market capitalist economies
experienced a significant slowdown in the rate of economic growth. But notice that the social
market capitalist economies had grown much faster from 1960 to 1980. Finally, notice that the
rates of economic growth in the two types of economies were about the same (low) after 1980.
To some extent, one can manipulate these data by the choice of year. After 1995, productivity in
the United States grew rapidly. It stopped growing rapidly in 2000 but then began growing
rapidly by 2003 (before slowing in 2007). On the other hand, the growth of productivity in
Europe has stayed low. This is now seen as a problem for the social market capitalist economies.
A second goal was the level of the standard of living. The data below show the GDP per
capita in 2007 (at what is called “purchasing power parity” or PPP)
23
Table 8: GDP Per Capita (PPP) in 2007
Austria
Belgium
Denmark
Germany
Netherlands
Norway
Sweden
$33,600
31,800
37,000
31,400
31,700
47,800
31,600
United States
Ireland
United Kingdom
Canada
43,500
43,600
31,400
35,200
Notice that all of these are rich, industrial countries. The United States is the richest country,
except for Norway (which has a large amount of oil) and Ireland (which has many American
companies). But the differences are not great. Standards of living are high in both systems.
Despite its high taxes, the European Union actually has more millionaires than does the United
States (2.6 million vs. 2.2 million in 2000). And 32% of all billionaires live in Europe.
The third and fourth goals relate to efficiency. We have no data that relate specifically to
efficiency. But considering the restrictions on employers described in Section 5 and the Welfare
State programs and high tax rates described in Section 6, one might guess that the social market
capitalist economies are not as efficient as the liberal market capitalist economies. However, the
following data on GDP per hour worked (productivity) for 2002 does not bear out this conclusion.
The American workers are more productive than workers in some countries and less productive
than workers in other. In 1995, Germany, France, and Italy had greater productivity than the
United States. As you can see, by 2002, the United States had passed Germany. But the
differences are not great. France (not listed here) also has higher productivity per hour than does
the United States. Relating to productivity, the average European has one more year of schooling
than does the average American.
Table 9: GDP Per Hour Worked (PPP) in 2002
Belgium $41.11
Denmark 36.77
Germany 37.33
Netherlands $32.18
Norway
50.51
Sweden
34.37
United States $39.17
United Kingdom 32.38
Canada
31.97
There is another way to look at efficiency. In 2000, the then 15 members of the European
Union, with a combined population of 375 million people and a GDP of $10.4 trillion, used 63.3
quadrillion British Thermal Units (BTUs) of energy. The United States, with a smaller
population of 280 million people and a similar GDP of $10.2 trillion, used 98.8 quadrillion BTUs.
So Europe is more energy efficient than the United States.
The fifth goal was equity. It should be no surprise that equality is greater in the social
market capitalist economies. After all, generating greater equality is a major reason for the types
of Welfare State programs they have. The data below show the Gini Indexes for household
income from a 2004 study. Remember that the Gini Index is a number between zero and one; the
lower the number, the greater equality there is. The greater equality existing in the social
market capitalist economies is apparent.
24
Table 10: Gini Index in 2004
Austria
Belgium
Denmark
Germany
Netherlands
Norway
Sweden
.266
.250
.236
.264
.248
.251
.252
United States
United Kingdom
Canada
.368
.345
.302
A result of the greater equality is a lower crime rate in Europe. For example, in the late
1990s, the European Union has 1.7 homicides per 100,000 people compared to 6.26 per 100,000
people in the United States. The European Union averages 87 prisoners per 100,000 people
compared to 685 per 100,000 people in the United States.
A sixth goal was full employment. Indeed, several (but not all) European countries have
had relatively high rates of unemployment in recent years. Of particular importance has
been the percent of unemployed people that have been unemployed for a long time. The data
below show the unemployment rates and the growth of employment in the various countries.
(Other years might give a different impression.) In some of the social market capitalist
economies, the unemployment rates have not been particularly high. The countries experiencing
high unemployment rates have been Germany and Belgium. Italy and France have also had high
rates of unemployment. There is a problem in the social market capitalist economies with the
creation of new jobs. The United States has done better than most social market capitalist
economies in creating new jobs. So have Canada and Ireland. The reasons for the problems of
job growth in the social market capitalist economies may be found in some of the aspects of
the labor markets described in Section 5.
Table 11: Unemployment Rates and Employment Growth
Unemployment Rate 2000-2003 Annual Employment Growth 1990-2002
Austria
4.0%
0.9%
Belgium
7.3
0.5
Denmark
4.8
0.2
Germany
8.4
-0.2
Netherlands
3.0
2.0
Norway
3.9
1.1
Sweden
5.3
0.5
United States
United Kingdom
Canada
5.1
5.1
7.3
1.2
0.5
1.4
A seventh goal was economic security. Again, we have no specific data on this. But given
the programs available in the social market capitalist economies and not available in the liberal
market capitalist economies, one would have to surmise that economic security is greater in
the social market economies. That should not be surprising. Creating greater economic security
is a major reason for the types of programs found in the social market capitalist economies.
An eighth goal is price stability. The following table shows average annual inflation rates
from 1991 to 2001 for the social market capitalist economies alone.
25
Table 12: Inflation Rate 1991 to 2001
Austria
Belgium
Denmark
2.1%
2.1
2.4
Netherlands
Sweden
Germany
2.4
2.8
2.0
With the exception of Greece, no member of the European Union experienced inflation rates
much above 4% in this period. So inflation rates have been low. While not shown, the inflation
rates in Europe have been about the same as those found in the United States. Therefore, the
social market capitalist economy seems no more prone to inflation at this time than does the
liberal market capitalist economy.
The final goals were military power, environmental quality, and freedom. There are no
specific data on these. Clearly, the United States is the strongest military in the world. But the
other countries all seem to be able to afford a military that is adequate for their defense. One finds
the same environmental issues and most of the same laws relating to the environment in both
types of economies. Europe is more efficient in using energy, as shown above. And all of the
countries discussed in this chapter are political democracies. So there is no reason to assume that
there are significant differences on these goals among the two types of capitalist systems. Finally,
it has been argued that a large Welfare States affects social norms and attitudes toward
work and may create a culture of dependency. If true, the long-run effects of the Welfare
State would be more serious than can be measured here. Whether this assertion is true or not is
beyond the scope of this chapter.
As can be seen from the above discussion, there are some goals that give an advantage to the
liberal market capitalist economies. And there are other goals that give an advantage to the social
market capitalist economies. But over the past 20 or 25 years, the differences in economic
performance between the two types of economies are not large as many people would have
guessed. Which system you prefer would seem to depend on the value to place on each of the
various goals. In particular, it would depend on how much you value equality and economic
security.
It has been said that it is possible to convert a social market capitalist economy into a liberal
market capitalist economy but that the opposite conversion is not feasible. Such conversions took
place in Britain and in Ireland beginning in the 1980s. These conversions are the subject of the
next two chapters.
Assignment
4. We have discussed the Social Market Capitalist Economic System as practiced in Europe.
A. In what ways has the Social Market Capitalist Economic System, as practiced in Europe,
been influenced by the ideas of liberal market capitalism developed in Chapter 2? Support your
answer with as many examples from Europe as you can, naming some ways by which the
European Social Market Economic System is similar to the American economy.
B. In what ways is the Social Market Economic System, as practiced in Europe, been
influenced by the views of Marxism developed in Chapter 3? Provide as many examples from
Europe as you can.
C. Over the past twenty years, the European countries have evolved somewhat in the direction of
free market capitalism. Provide some examples to illustrate this change. Then, explain why you
believe this change has taken-place? Give as many possible reasons as you can. (See the
discussion of technological change in Chapter 2.)
26
Practice Quiz
1. Which of the following countries best exemplifies liberal market capitalism?
a. Sweden b. Austria c. Germany d. the United States
2. Which of the following words would NOT be characteristic of social market capitalism?
a. democratic b. moralistic c. egalitarian d. libertarian
3. Which of the following is an argument for equality in the distribution of income?
a. The gains to the poor are greater than the losses to the rich if there is redistribution
b. People would choose equality if they did not already know their own place in the
distribution of income
c. Equality fosters social cohesion and reduces divisiveness
d. All of the above
4. Social market capitalist economies are characterized by all of the following except
a. tightly organized business communities
b. weak or non-existent labor unions
c. large government provision of social welfare
d. nationalized industries
5. European businesses are more likely than American businesses to be financed by
a. bank loans
c. management
b. outside stockholders
d. governments
6. Which of the following does NOT characterize labor markets in social market economies?
a. low rates of union density
c. a high degree of employment security
b. employee participation in management d. active labor market policies
7. In countries such as Sweden, collective bargaining is conducted by which level of union?
a. the local union
c. the federation of labor unions
b. the national union
d. the individual worker
8. The phrase “active labor market policy” includes which of the following:
a. a solidaristic wage policy
c. co-determination
b. government job training programs d. laws guaranteeing employment security
9. Which of the following is considered a “Welfare State” program?
a. Social Security for retirement
c. Parental leave
b. Government provided medical care d. All of the above
10. Which of the following does NOT characterize the National Health Service in Britain?
a. All citizens are covered
b. The system is paid for mainly out of general taxes
c. Doctors are paid on a fee-for-service basis
d. Health care spending as a percent of GDP is lower than in the United States
Answers: 1. D 2. D 3. D 4. B 5. A 6. A 7. C 8. B 9. D 10. C