Economic Integration
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1. Three levels of economic integration
•
The econ integration has been a predominant feature of the
contemporary global economy. The econ integration brings together
countries based on collaboration, flexibility, risk and cost, shared
interest and objectives. The econ integration has led to a relocation
of resources across sectors and space.
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Global: trade liberalization by GATT or WTO
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Regional: preferential treatment of member countries in the group
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The General Agreement on Tariffs and Trade (GATT) was first signed in
1947. This agreement was designed to provide an international forum that
encouraged free trade between member states by regulating and reducing
tariffs on traded goods and by providing a common mechanism for resolving
trade disputes.
The World Trade Organization (WTO) came into being in 1995. It is the
successor to the GATT. Now it is the only global international organization
dealing with the rules of trade between nations. At its heart are the WTO
agreements, negotiated and signed by the bulk of the world’s trading nations
and ratified in their parliaments. The goal is to help producers of goods and
services, exporters, and importers conduct their business.
Location-Geneva, Switzerland
Members—153 countries
NAFTA
Bilateral: preferential treatment between two countries
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2. Four types of economic integration
Groups or countries are coming together all over the world with the idea of defending
themselves economically against the incursions of other blocks in the area.
a) FTA (free trade area)—free and open trade among members
•
no internal tariffs among members, but each country imposes its own external
tariffs to the third country.
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NAFTA (North America Free Trade Agreement)
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AFTA (ASEAN Free Trade Area)
•
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1994; free trade area among the US, Canada and Mexico.
Signed in 1992 Singapore; originally 6 countries
EFTA (European Free Trade Area)
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1960, Austria, Denmark, Norway, Sweden, Portugal, Switzerland and UK
b) Customs union
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no internal tariffs and common external tariffs
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Mercosur (Southern Common Market)
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CACM (Central American Common Market)
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Formed in 1991 by Brazil, Argentina, Paraguay and Uruguay
1960, Guatemala, El Salvador, Honduras, Nicaragua
CARICOM (Caribbean Community and Common Market)
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1973, 15 members
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c) Common market:
• free movement of products and factors (resources), which is customs union
plus factor mobility
• EU (European Union – previously Euro Econ Community)
d) Economic union
• common market plus common currency
• coordination of fiscal and monetary policy
– EMU (Economic and Monetary Union)
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3. Economic effects of economic integration
Econ integration brings significant benefits, more efficient allocation
of resources
• Static effects: Short-term effects
– Better use of existing resources
– Trade creation: production shifts to more efficient member
countries from inefficient domestic or outside countries.
• Specialization, comparative advantage
• Dynamic effects: Long-term effects
– Cost reduction due to economies of scale
– Cost reduction due to increased competition.
– Both producers and consumers benefit from more efficient
allocation of resources as a result of integration
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History of European Union
The legal base of the EU is a sequence of treaties between its member states. These
have been much amended over the years, with each new treaty amending and
supplementing earlier ones.
a) The first such treaty was the Treaty of Paris (1951) which established the European
coal and steel community between the original group of 6 European countries
(France, West Germany, Italy, Belgium, Luxembourg, Netherlands) to pool the
steel and coal resources of its member-states, thus preventing another European
war.
b) Treaty of Rome (1957)
– Still in effect, though much amended since then, most notably by the
Maastricht treaty of 1992, which first established the EU under that name.
– Formation of EEC (European Economic Community), initially free trade area,
becoming a customs union in 1967 (no internal tariffs and common external
tariffs).
– The Stockholm convention in 1960 created EFTA by 7countries to counteract
EEC (Austria, Denmark, Norway, Sweden, Portugal, Switzerland and UK)
c) Single European Act of 1987
– Creation of single market (Common market) effective on 1/1/ 1993 (free
movement of products and factor resources (goods, people, capital)
– Rename EEC by EU (15 members) Austria, Belgium, Denmark, Finland,
France, Germany, Greece, Ireland, Italy, Luxemburg, Netherlands, Portugal,
Spain, Sweden and UK.
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d) Treaty of Maastricht (1992)
– Creation of the Economic and Monetary Union EMU (12 members)
• UK, Denmark and Sweden opted out
– Establishment of European Central Bank on July 1998
• Main task is to maintain the euro’s purchasing power and the price stability in the
euro area.
– Introduction of a common currency, euro on Jan. 1, 1999
– Circulation of euro on Jan 1, 2002
e) The Treaty of Accession 2003
– 10 more countries became members of the EU 5/1/2004
• Cyprus, the Czech Republic, Estonia, Hungary, Latvia, Lithuania, Malta, Poland,
Slovakia, and Slovenia
f) On October 29, 2004 European heads of state signed a treaty establishing the first
constitution for the European Union in Rome requires approval in national
referenda.
– defeat in France and Dutch referenda in 2005 caused suspension of the ratification
process
g) 2007 Bulgaria and Romania became members of the EU.
h) The Lisbon Treaty (2007) which after the rejection of the Constitution (the
constitution attempted to replace all earlier EU treaties) for Europe modified the
existing treaties, enhancing the efficiency of the decision making process and
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democratic participation in a Union of 27 Member States.
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2007
Population
Territory
Density
EU
USA
494 mln
303 mln
4.3 mln sq km 9.6 mln sq.km
1.7 mln sq mi
3.7 mln sq mi
114/sq km
31/sq km
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Organization of European Union
a) European Council (European summit)
– Is a meting of the heads of state and the president of the European Commission,
Brussels, 4 times a year.
b) European Commission is the executive body of the EU.
– Located in Brussels
– administrative body of 27 members (4-year terms)
• Each commissioner takes responsibility for a particular area of policy
• The commission is headed by a president Jose Manuel Barroso of Portugal in 2009
reelected for 5 more years.
• Unlike the Council of the EU, the Commission is intended to be a body independent
of member states. Commissioners are not permitted to take instructions from the
government of the country that appointed them, but are suppose to represent the
interests of the citizens of the EU as a whole.
– Primary role is to propose and enact legislation, and to act as “guardian of the
treaties” which provide the legal basis for the EU; and implementing policies
c) European Parliament—Strasbourg, France
– 785 members elected according to population distribution
– Legislative body
• able to accept, amend or reject proposals for regulation, directives, decisions,
recommendations, but final decision by Council of Ministers.
– Control over budget (adopting the final budget of the EU) and supervision of the
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Commission
d) Council of Ministers/“Council of the EU”
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Located in Strasbourg
Along with the European parliament is the legislative arm of the EU
Unlike the European commission, the ministers can defend their national interests
27 different councils (agriculture, transport, etc.)
The council does not have a single president but the role is rotated every 6 months.
(Belgium since 7/1/2010)
e) Others
– Court of Justice
• 27 members for 6 years.
• It ensures that the treaties are interpreted and applied correctly by other EU institutions and
member states
– Court of Auditors
• Examining the legality and regularity of receipts and expenditures
• Management of EU budget
– sub-committees
• Committee of the regions
– Advice on regional issues
f) Policy Initiation, Analysis, Preparation, Approval, Implementation:
– EU Council of Ministers, representing national interests, holds strongest hand.
– Proposals from the Commission and amendments from the Parliament require assent of
the Council.
– Proposals rejected or amended by the Parliament can still be approved by unanimous
assent of the Council.
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EMU (Economic & Monetary Union)
By joining the EU, the countries become members of the EMU
– They are committed to adopting the euro eventually and taking appropriate steps
in that direction. But EU accession does not necessarily mean adoption of the
euro.
– The new member states must pursue price stability and also fulfill the same
convergence criteria that were required of the existing members.
– There is no predefined timetable for adopting the euro by the new member
states, it will depend on the level of convergence required.
a) Common currency (Euro) area for 12 members
– European Monetary System (EMS), arrangements by which most nations of
the EU linked their currencies to prevent large fluctuations relative to one
another.
• It was organized in 1979 to stabilize foreign exchange and counter inflation among
members
– In 1994 the European Monetary Institute (EMI) was created as transitional
step in establishing the European Central Bank (ECB) and a common
currency.
– ECB (established July 1, 1998) is located in Frankfurt, Germany; the central
bank for Europe’s single currency, the euro
• Main task is to maintain the price stability in the euro area, (to keep inflation low,
present target is to keep inflation below but close to 2%)
• The ECB with the National Central banks, composes the European System of Central
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banks
• The ECB is one of the world’s largest central banks, being in charge of monetary
policy for the EU’s official currency, the euro, which is used by over 300 million
people in 12 EU countries. The ECB is governed by a board of directors, headed by a
president, and a board of governors, consisting of the members of the board of
directors and representatives of the local central banks
– Euro became the official currency unit on Jan. 1, 1999.
– Euro is in circulation since Jan. 1, 2002
– U.K, Denmark and Sweden opted out.
b) Convergence criteria—the member countries must coordinate their
econ policies in order to achieve some objectives
– A high degree of price stability
• Reduction of inflation
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A stable exchange rate
Control on budget deficit: no more than 3% of GDP
Control on public debt: no more than 60% of GDP
Convergence in long term interest rates
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Remaining Issues of EU
a) Further elimination of barriers to common market
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Compatible standards and specifications
No barriers to market access
Coordination of VAT and other taxes
b) Expansion
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European Economic Area: extension of customs union (no internal tariffs
and common external tariffs) privileges to the European Free Trade
Association EFTA member countries (Norway, Iceland and Liechtenstein
accepted. Switzerland voted not to join), in force since 1/1/2004.
Special agreements with Turkey and others (Croatia, Macedonia)
Questions:
1) Why will admitting the poorer nations of eastern Europe be a challenge to
EU?
2) For what reasons do existing members of the EU favor the admission of new
nations from the former Soviet block?
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The European Model
I. Foundations
• Based on mercantilism-strong state is necessary to regulate and control the
domestic and international operations of a national economy.
• Influence of Marx
– indirectly thru his warnings about the inherent stability of capitalism.
• Schmoller
– the teachings of the German economist Schmoller argued that there are no universal
principle of economics. Instead we can understand the workings of the econ activity only
by long observation of facts, rather than by trying to identify general principles via
theoretical abstractions;
– antitheoretical approach; strong state is necessary to correct social injustices and to
regulate the economy.
• ideas of the social mkt economy
– After the WWII, the European model was influenced by the ideas of the social mkt
economy, where the combination of state intervention and mkt forces to achieve desired
social goals
– Philosophy of social democracy, which reflected the view that the state is a necessary
force for good and must intervene actively the econ affairs.
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II. Legal Foundations: Civil Law
• The EM has its legal foundations in Civil law
– a code based legal system operated by professional judges interpreting a detailed set of
written rules and regulations.
III. Features of the European Model
1. Corporate Governance
a) managerial capitalism replaces shareholder capitalism
– Managerial Capitalism-is a system of corporate governance that places the
interests of stakeholders above those of shareholders
• Whereas shareholder capitalism requires managers to focus on profitability,
managerial capitalism focuses on other objectives, such as providing a stable work
environment for managers and employees
– More emphasis on the interests of all "stakeholders": efficient management vs
employee loyalty
– Advantages
• provides more stable employment; create a more equal distribution of income within
company; stakeholder corporations may take a longer view of technological
improvements than shareholder corporations which may be more interested in shortterm profits.
– Disadvantage
• lower efficiency (not profit max).
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b) Shareholdings
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–
Corporations typically controlled by small number of investors and banks
often have substantial interests; whereas shareholder corporations in the US
tend to be broadly owned by a large number of investors
stakeholder corporations in Europe tend to be held by a smaller number of
investors many of whom hold a significant stakes
•
The largest German bank Deutsche bank and Germany’s insurance company
Allianz hold 5% and larger shares in most major German corporations.
c) Insider Trading
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–
–
Insiders (managers, board members, etc) have more info about corporation’s
performance than do public shareholders.
In Anglo-Saxon countries, stock exchanges &security commissions have
more strict laws against insider trading than those in Europe.
In Germany there were no insider trading law until January 1995, when the
security trading law was adopted.
d) Transparency
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–
The transparency requirement is less vital in a stakeholder company
The French accounting standards do not require the disclosure of transactions
with related parties or disclosure of changes in equity (the value of the
corporation). Such disclosures are essential in US stock exchange, the
19 in
collapse of Enron in 2002 was associated with the non disclosure of change
equity.
e) Less active mkt for corporate control
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In European corporations large owners tend to be stakeholders as well and are
less inclined to sell the stock if profit declines.
The Anglo-Saxon model focused on corporate takeovers, including hostile
takeovers, as a disciplining device for management. If the current
management is not max shareholders value, the mkt for corporate control will
install a new and more profit oriented management team.
European firms tend to be closely held rather than widely publicly traded.
When management changes occur through mergers and acquisition they tend
to be friendly takeovers approved by the current management team
f) Codetermination—firms with 2000 or more employees fall under the
codetermination legislation
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allowing worker representatives on management boards
workers have a say in management decisions
used widely in Germany, France and Italy, e.g. German law requires that
shareholders and workers have equal numbers on boards of directors and are
represented by enterprise councils.
Codetermination is one of the most distinctive features of the EM because it
formally gives non owners of companies (employee) the same rights as
owners to make decisions on how property will be used
Supporters
•
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codetermination has maintained peaceful labor relations; low turnover, loyalty
Critics
•
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May interfere with laws protecting private property; may prevent management
2. Capital Markets
• In the Anglo-Saxon model financing primarily through issue of equity and debt;
start-up capital provided by private venture capitalists. In the EM:
a) Companies finance primarily through bank lending as opposed to
stock markets
– bank provides start-up capital.
– Much greater reliance on bank finances
– bank holds shares and is represented on board of directors
b) Universal banks
– European banks perform not only traditional banking but also stock brokerage and
merchant banking, such as stock sales, risk-sharing. The financial system is not divided
into investment banks, commercial banks, and stockbrokers.
– Advantages of bank financing:
• Banks examine business risks carefully; if they back poorly run companies their loans will not
be paid.
• Banks diversify their risks, therefore, a downturn of one sector will be offset by upturn
– Problems—limits the degree of competition and innovation in the financial sector.
c) Dynamism
– the capital mkt and its corporate governance do not allow capital to be allocated from
declining to rising industry.
– When a new industry develops old established German companies must change their
profile to produce these new goods
• Siemens started to produce PCs
21 is
– Ranking of the top 20 firms changes in the US over relatively short period, the reverse
true for Germany
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3. The Labor Market
a) Labor unions
– higher share of workers are unionized than the US; strong political
role (e.g. England, through the Labor Party)
b) Much more highly regulated than that of the US
– EU directives set regulations:
• equal pay, minimum annual paid holidays, hours of work, portability of
pensions, health and safety, maternity and paternity leave, gender equality
– Member countries can offer even more generous provisions such
as:
• two-yr maternity leave in Germany and provision in Sweden for parents to
take 480 days off for each child at 80% pay;
• 35-hour work in France;
• Germany-unemployed workers qualify for unemployment insurance for 32
months and are not required to take open jobs that necessitate their moving
or that offer lower wages than they had earned before.
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c) Employers cannot easily fire of lay off workers
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elaborate procedures and approval of works councils required for significant
layoffs
•
German law, 30 days before any termination, firms must inform the state
employment office and the works council.
d) EU Works Council directive (enacted in 1994) requires employers to
consult and inform employees about decisions that could directly
or indirectly affect their jobs and to keep them informed about the
financial health of businesses
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“social dumping“ (social policy advocates call the move to lower cost):
transfer of production to lower cost jurisdiction
•
Renault case, Renault was sued by the Renault European Work Council for
failure to fulfill its info and consultations before closing the plant in Belgium and
moving it to lower labor cost in Portugal.
e) Hours worked per employed person much lower than in the US
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in 2003-US-1,792 hours per year; Italy 1,600; France-1,430; Germany1,446; Korea-2,390
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f) Results of regulation:
– High Costs of Regulation
• The costs of labor mkt is not simply cost of compliance but the paid vocations,
maternity leaves, and unemployment benefits
• the costs of maintaining the highly regulated EU labor mkt as measured by income
tax and social security contributions; Tax burden added to labor costs.
– High priced and inflexible labor
• Costs of labor inflexibility are not included in the monetary cost of labor; employers
unable to lay off workers in bad times.
– strong disincentives to growth and job creation
– High unemployment -8-11%, in US-5-7%
• 2009 august EU-3-18%, US-9.7%
• Virtually no increase in private sector jobs over past 20 years
• High long-term unemployment
– More than 40% of the unemployed have been out of work for more than a year (US-11%)
• High youth unemployment
– In Spain half of age less 24 out of work
• High unemployment among unskilled
– wages too high relative to skilled
• Unemployment geographically concentrated
– low mobility of labor; concentrated in particular regions or towns so it is hard to escape.
In the US people move to get jobs, but Europeans without jobs cannot move or see25
no
point in doing so.
Annual hours worked per employed person, 1996 and 2006
In both years, Koreans worked the most hours annually.
The Republic of Korea and Ireland experienced the largest reductions in annual hours .
Source: US Dept of Labor; Report: A Chartbook Of International Labor Comparisons: The Americas, Asia-Pacific, Europe —
January 2008; http://www.dol.gov/asp/media/reports/chartbook/2008-01/index.htm
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Unemployment rates, 2006
Most of the European countries had higher unemployment rates than the US.
The Republic of Korea, Norway, and Mexico had the lowest unemployment rates.
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Unemployment rates for youth, 2006
Italian teenagers had the highest unemployment rate, followed by their counterparts in
Sweden and France.
Unemployment rates for teenagers were higher than those for 20- 24
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Persons unemployed one year or longer, 2006 as a % of total unemployment
Long-duration unemployment was least prevalent in the Republic of Korea and Mexico.
The EU-15 countries combined had a relatively high percentage of persons unemployed one year
or longer. More than half of the unemployed were without work for at least one year in Germany,
Italy, and Portugal.
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• Different European countries deal with the problem of unemployment
differently:
France and England
• Incentive to substitute part time jobs and temporary workers
Germany
• “job centers" to help unemployed find work
• Agency to employ jobless people and hire them out to private
companies as temporary workers; lose benefits if refuse offer
• unemployed required taking pay cut
– Decrease in benefits during the 1 year of unemployment, the workers will
receive 60% of what they earned, after 1 year unemployed they receive flat
payment 345 euro per month and payments for kids and costs for housing and
heating, free healthcare.
• young singles may have to travel to another part of the country; must
justify refusal to take job offered
• Reduction in maximum period of unemployment benefits
• Tax incentives to encourage people to set themselves up as self30
employed
“Intricate workings”--Jun 15th 2006, The Economist
• Tackling unemployment requires a careful mixture of policies.
• OECD 2006 Jobs Strategy (mainly in Europe) to reduce high
and persistent unemployment rates.--“There is no single road to
better labor markets.”
– France, Germany and southern & central Europe, too few people work.
– People aged 55 or over--70% of Swedes and 61% of Americans aged 55
to 64 work; only 32% of Austrians, Belgians and Italians
– Too many countries have allowed or even encouraged older workers to
drop out early.
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Reasons for unemployment:
•
•
•
•
Highly regulated labor markets
No job creation
Generous unemployment benefits
High minimum wages and tight job-protection laws can make employers
unwilling to take on new employees, especially young ones who are untrained and
untried.
• A thick wedge of taxes between what workers take home and what it costs to
employ them can both discourage people from working and make firms reluctant
to hire them.
– The tax wedge is the difference between workers take home pay and what it costs to
employ them (consists of income tax and the social security contributions of employers
and employees)
– In Germany, Belgium, Sweden, employment taxes exceed the take home pay
• People without jobs may lack the education/ skills that employers require.
Policies to raise employment
• Deregulating the labor markets—flexible labor mkt with weaker job protection
• Job creation
– Depends on deregulation of labor mkt, and introduction of more competition
• Trimming marginal tax rates
• Making benefits less generous.
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A tale of two Frances--Mar 30th 2006 The Economist
New labor rule --to encourage employers to create jobs, particularly for illqualified youngsters by giving them a two-year trial period, after which full job
protection comes in, i.e. to loosen the firing rules for the young.
Young French people:
• Face a high unemployment rate
• They also find it difficult to break out of a cycle of back-to-back
short-term contracts.
• Over 64% of French 15-24-year-olds in work are on temporary
contracts one year after leaving education.
• The reason that these jobs are the best on offer is that permanent
jobs are so protected that employers hesitate to hire.
• The potential trade-off—between less security and more jobs—is
not the way the students see it.
“Today's protests are based on the defensive, the fear of insecurity
and of change.”
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IV. Nationalization, Privatization, Deregulation
The A-S model—limited role of the government and protection of
property rights, the EM is characterized by a greater amount of public
enterprise, although in recent years European countries have begun to
initiate privatization and deregulation. The regulated mkts were
largely in transportation, utilities and banking; deregulation started
with opening of European gas and electricity mkt to competition.
1) Public ownership
• In early post war years the choice of gov’t affected the extent of
public enterprise. Social democratic and trade union gov’t favored
nationalization and conservative gov’ts opposed it. Hence,
nationalization were followed by privatizations of major industries.
• Reasons for nationalization—ideology, national security, maintain
employment, regulate natural monopolies, provide for external
benefits in industries such as health care.
– F. Mitterrand (socialist): extensive nationalization in France in early 1980s in
industry (iron and steal, metals, chemicals), transportation and largest remaining
private banks.
• Problems—many of the nationalized industries fail to turn a profit and
require subsidies. However, they were often nationalized to pursue
goals other than profit maximization.
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2.) Nationalizations were followed by privatizations of major industries.
• in mid 1980s when the conservatives returned to power, policy then
reversed: privatization of several large companies
• Privatization pursued in Britain under Margaret Thatcher (several
industries sold to stockholders):
– the first privatization of large company British Telecom, British Gas, British
Airways, Rolls-Royce, British Steel, British Coal, and British Rail.
– Some have become profitable. Raised revenue for budget and created new group
of stockholders.
• Benefits of privatization
– performance improvement (sales, profitability), sustained employment- British
airways became more innovative and profitable after privatization.
• Critics say that the government sold the assets too cheaply, that profits
are excessive, and that firms should not be allowed to exercise
monopoly power.
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Recent trends
• European countries have begun to initiate privatization& deregulation.
• UK: companies in public ownership-1979: 12% of GDP; 1997: 2%;
• France: partial privatization of France Telecom, Air France, Renault,
Thales (defense & electronics)
• Germany: privatization of Deutsche Telecom, Deutsche Post
• Recently momentum has stalled; sales have declined from peak in
1998; weak stock markets
• "strategic" industrial holdings - govt. maintains some shares, controlling
interest in some cases
– e.g. France
France Telecom 55.5%
Air France
56%
Thales
33%
Renault
25%
EDF (French electricity supplier) – One of the world’s largest producers of
electricity; 2003-22% of the EU electricity; monopoly in France but has taken over
suppliers in other European countries till 1999 when the first EU directive to
harmonize regulation of electricity mkts was implemented. Until 2004 was a
government corporation, but it is now a limited liability corporation under private
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law. Retain 70% government ownership.
3) Deregulation
• Privatization and regulation are related. The deregulation process
in the US strengthened the US economy.
• Pursued by Thatcher in Britain in 1980 and also strengthened the
economy.
• has been promoted by EU as part of the single market: gas and
electricity and air travel were open to competition
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V. French Indicative Planning
1) Features:
Planning initiated after WW II to rebuild the capital stock. Planning was never
meant to replace the market, but to improve its operation. Headed by General
Planning Commissariat, much work is performed by Modernization Commissions,
with labor, management, and government representatives. The Economic and
Social Council reviews plan documents as they are formulated and Regional
Development Commissions sponsor regional economic needs.
–
–
–
–
No compulsory targets are prepared for enterprises.
• Decision making can be improved if a planning agency disseminate info to decision makers;
such indicative planning is nonauthoritarian-no directive targets are issued.
Planners project probable trends in the economy.
Compliance with the plan is purely voluntary.
The plan should indicate to enterprises the planners’ best estimate of the course of the economy.
•
–
Broad sectoral growth targets related to input, output, investment and productivity
Mechanisms for plan implementation
• budget and public ownership.
– With public ownership in key sectors such as banking, coal, gas and electricity,
transportation, the state could influence econ activity through its control of credit,
electricity and tax incentives
• The government urges compliance through influence over nationalized industries and banks,
monetary and fiscal policies.
•
After 1970 the French planning was of limited importance
•
Econ institutions are judged by their durability. Institutions that work persists,
those that fail are abandoned. The disappearance of indicative planning is probably
the best indicator of its limited ability and utility to society.
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VI. Income Security:
1) Important similarity among the European countries is the importance
of safety nets to provide income and employment security
2) Econ security is provided by the state, w/ greater generosity than in
the Anglo-Saxon M with its emphasis on individual reliance.
– One of the principle activities of governments in modern mkr economies
involves modifying the income distribution. This involves the use of transfer
payments, the public provision of goods that might otherwise be supplied
privately and the finance of both these expenditures out of taxation. We
generally refer to this activity as the operation of “welfare state”
– In Sweden the state guarantees the entire population with access to a wide range
of services—free education, free health care, etc.
3) Sweden conducted the most ambitious experiment in transferring income and
benefits from one group to another in 1960’s and 1970’s.
Swedish Model
• The Swedish model aimed at providing econ security, including full
employment, and egalitarianism, which included both reducing
income differences and eliminating poverty.
• It is an example of market efficiency with socialist equity
– in terms of the mechanisms used to allocate resources, Sweden is a market
economy.
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Features of the Swedish Model:
• Mostly private ownership of the means of production
• Large public sector financed by high and progressive tax rates
– Tax rates were raised gradually, culminating in 1971 tax reform that left workers
with a marginal take home pay rate less than 30% (if worker earns an extra 1000
SEK, it keeps 300kr. at 30%) and executives with a marginal take home pay rate
of some 10-15% (now 33-60%)
– High level of taxes are required to finance redistribution policies
• Centralized wage bargaining to even out wages
– developed after WW II. Employers wanted more orderly bargaining. Unions
wanted wage solidarity (largest wage increases to the lowest-paid workers).
Wage negotiations take place at the national level. During 1945-1970, central
bargaining worked well. In 1970 departures from the central agreement became
common and inflation rose above the average of other industrial countries.
Disagreements over wage solidarity have weakened the system.
– The most heavily unionized society in the world-85-90% of the workers are
covered by collective bargaining agreements. The objectives of collective
bargaining agreement is the eliminations of strikes and labor disputes.
– “Wage solidarity”—to keep the earnings of the workers more closely grouped,
in order to eliminate class conflict
– Problems of centralized bargaining
• No work incentives
• Inefficiently allocated labor between occupations and industries
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• Active labor market intervention
– programs to increase the demand for labor, programs to prepare labor to new job
openings, and to match supply and demand through job information and
placement services.
• Welfare system
– universal coverage
• Unemployment benefit of 90% of gross wage
• Generous retirement and disability pensions-state pension of 65% of
previous income
• Income support provided to parents who stayed home to care for
children;
– family allowances for children (about $135/month/child until age 16)
• National health insurance
• free public education through graduate school.
• Sweden very successful in reducing inequality
– the most even distribution of after-tax income in the West.
• Welfare state successful in 70's & 80's
42
Although, Swedish firms are capitalist in terms of ownership, the
strength of unions, powerful labor laws and other government
redistributions place constraints on Swedish managers’ ability to
operate. (Ericsson, IKEA, Saab, Volvo, Electrolux)
Problems
• High cost
– social spending represented 29% of national income in 2002, compared to 21%
OECD average (but down from 37% in Sweden in 1993). Total taxation was
51% of GDP in 2001, compared to 37% OECD average or 29% in USA.
• High taxes have driven a significant part of income and production
underground in the form of do-it-yourself home improvements and
barter activities.
• High unemployment
– 8% in 1995
• High debt (90% of GDP) & deficits (10%)
• Slow growth (1-2%) - further reform needed?
• Disincentives
43
– e.g. unemployed person not obliged to take job unrelated to previous occupation
By the 1990’s output faltered and debt soared and unemployment increased. The
Scandinavian countries started reforms such as reduced taxes and benefits.
VII. Reforms
“Remodeling Scandinavia” (The Economist, 8/23/97)
1. Reduced taxes and benefits
•
•
Sweden has cut benefits and marginal rates of income tax
Denmark has cut top tax rates.
2. Unemployment benefits have become less generous.
•
•
Denmark -unemployed youths must join vocational-training programs
Norway has cut the duration of unemployment benefits (to a still-generous 3 years).
3. Pension costs
•
•
Norway is salting away a big chunk of its oil income in a State Petroleum Fund to help pay
the pensions of its ageing population when oil and gas production tails off
Finland raised the retirement age (from 65 to 67).
4. Wages and working conditions are still largely set by centralized agreements among
powerful trade unions, employers and the state (keep minimum wages high and, in the name
of equality; narrow the variation between low- and high-wage jobs and industries. Unskilled
workers cost too much and the talented have too little incentive to invest in their education,
or to switch from lackluster industries to booming ones.
44
5. Job-creation programs
•
Sweden's 4year job-creation program relies heavily on getting adults into higher
education, upgrading infrastructure and early retirement.
Germany:
•
Reform process begun by Christian Democrats under Helmut Kohl (became
Chancellor in 1982): tax reductions, deregulation of labor markets, and
privatization (Volkswagen, Deutsche Telecom)
•
continued by Social Democrats under Gerhard Schroder - reduced expenditure
including state pensions and other welfare benefits; commitment to reduce
public debt
•
Tax reforms (July 2000) - cut in top rate of corporate tax and income tax
France
•
Tax Cuts:
–
Lower income tax rates in all brackets; remove disincentive at bottom end
for seeking work
–
Lower social security contributions from the low-paid
–
cut in corporate profits tax
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Health Care
France: "Under a financial anaesthetic" [Economist, 01/12/02]
• French health care system rated first among 191 countries by WHO
• spends under 10% of GDP (US: almost 13% and ranked 37th)
• Most of doctors' fees paid by state insurance; poor and unemployed get free
cover
• Problem of overuse; share of GDP has risen by more than a quarter over 20
years
• Future rise in proportion of older people in population
Germany: "Is it enough?" [Economist, 6/7/03]
• Highest spending as % of GDP (11%) of all European countries in the world.
• Services are free: problem of overuse
– Germans stay longer in hospitals than anyone else, have more x-rays, ultrasounds,
swallow more pills and visit the doctor more often.
• Demographic shift as in France
• Proposed Reforms
– eliminate coverage for glasses, artificial insemination, over-the-counter drugs
– Larger payments for prescription drugs
– Increase in cost of hospital stays (e12 instead of e9)
46
Source: BBC news In Graphics: Comparing welfare states
http://news.bbc.co.uk/2/shared/spl/hi/pop_ups/05/business_comparing_welfare_states/html/1.stm
The welfare states of continental
Europe and social democratic
Sweden seem better at tackling
poverty than either the UK or the
USA.
47
The effectiveness of welfare
states in combating poverty is
closely related to how its
citizens are prepared to spend.
Sweden, where total state
spending makes up 60% of the
economy, also spends twice as
much on social welfare as the
United States.
Britain falls between the lowspending USA and the highspending continental European
countries.
48
The US stands out as the only
industrial country which only
provides limited government health
care benefits -mainly to the elderly.
Other people must buy private
health insurance through their
employer.
Britain's NHS provides a universal
service, although not the bestfunded one, with particularly
generous prescription drug
coverage.
49
The most dramatic differences
in welfare provision occur in
regard to unemployment.
Liberal welfare states like the
USA and the UK provide a sharp
cut-off in benefits to discourage
dependency and force people
back to work.
Germany and France provide
generous benefits, and some
argue this leads to high
unemployment and inflexible
labor markets.
50
“Admire the best, forget the rest”—Sept 7, 2006, The Economist
• The Scandinavian countries have the world’s highest taxes and the most generous
welfare benefits
• Sweden, Finland and Denmark have a strong growth and low unemployment
• Sweden’s big companies such as Ericsson, Volvo are breaking export records 2005
– Well-managed, export-driven, high-tech companies and its well-educated workforce.
– Female participation is the highest
• Weaknesses:
–
–
–
–
–
High unemployment rate
No new jobs, especially in the private sector
Labor market is heavily regulated
Powerful unions (enforcing min wage)
Public sector—30% of employment in the public sector
There is never a single economic model for other countries to follow. Neither
membership of the EU nor adoption of the euro seems necessary: Sweden is in
the EU, but not the euro, Finland is in both, Norway is neither. Different
countries have different strengths:
Finland—education; Denmark—labor mkt; Sweden’s management of big companies,
Norway’s oil.
The right conclusion is that it is wisest not to look for a single
country model at all, but just to take best practice wherever you
find it
51