Must Europe become more liberal?

[Originally published on a weblog called “What Is Liberalism?”]

André Sapir argues that continental Europe must become more liberal (more like the English speaking countries) if it is to do well economically:

First, the global economy of the twenty-first century is characterised by rapid changes which create both threats and opportunities. The biggest challenge for the European economy is to become sufficiently flexible so as to avail of the opportunities and surmount the threats. This requires, above all, reforming labour market and social policies. Failing to do so would not only prevent Europe from the opportunity of globalisation but could even jeopardise two of its crucial policies – the Single Market and monetary union – which could in fact facilitate Europe’s ability to meet the challenge of globalisation, but only if labour market and social policies are adequately reformed.

Second, the notion of “European social model” is misleading. There are in reality different European social models, with different features and different performance in terms of efficiency and equity. Models that are not efficient are not sustainable and must be reformed. The combined GDP of countries with inefficient models accounts for two-thirds of the entire EU and 90 per cent of the eurozone.

Third, in the EU system of economic governance, certain policies are decided at the national level, others at the EU level. Labour market and social policy reforms are a matter for the Member States alone, not for the European Union. Nonetheless, there are some benefits in coordinating these reforms with other necessary reforms, especially for the countries in the eurozone which share a common currency. A two-handed strategy combining reforms at EU and national levels would be best. The Lisbon Agenda tried this but is rapidly failing. All EU efforts should now be geared towards completing the Single Market among the 27+ members of the EU. For their parts Member States should concentrate on reforming labour market and social policies.

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The emergence of developing countries as major suppliers of products, both manufactures and services, which compete with European producers, has only just started. Over the coming decades, the trend is bound to accelerate as new suppliers join the fray. In particular, developing Asia (including China and India), which accounts for more than 50 per cent of world population but 25 per cent of world GDP (at PPP), is expected to continue growing steadily at more than 6 per cent per annum for at least one generation, drawing on vast resources of labour combined with increasingly sophisticated technological capability. Such a prospect is not only inevitable, but also desirable given the current distribution of world income, where the G-7 accounts for nearly 45 per cent of world GDP (at PPP) with barely 11 per cent of world population [the respective figures are 21 and 7 for the EU-25 and 21 and 5 for the US]. But emerging economies are not only producers and exporters; they are also consumers and importers. Indeed, the same six emerging economies which currently rank among the world’s top ten exporters (China, Hong Kong, Korea, Mexico, Chinese Taipei and Singapore) are also among the top ten importers.

In Europe, the needed economic and social reforms concern above all labour market and social policies which were established in the 1950s and 1960s, when the economic environment was relatively stable and predictable. These policies have become increasingly dysfunctional in the more variable economic environment of the late twentieth and early twenty-first centuries. Instead of fostering the necessary adaptation and flexible responses to increasingly rapid changes, modern European welfare states, which had helped fuel economic and social progress during the ‘trente glorieuses’ (the 30 years between 1945 and 1975 when Europe witnessed an unprecedented period of growth, stability and social cohesion), now often protect the status quo. And as James Heckman (the Nobel Prize winner) rightly states in his insightful analysis of Europe, “The opportunity cost of security and preservation of the status quo – whether it is the status quo technology, the status quo trading partner, or the status quo job – has risen greatly in recent times.” (Heckman, 2002).

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[Some important changes have been attempted, such as the introduction of the Euro] yet these important institutional achievements seem to have failed to generate greater economic dynamism. On the contrary, Europe’s economic performance has steadily declined, its potential growth falling by nearly one full percentage point during the past 25 years. According to most estimates, the EU’s potential growth is now only 2 per cent a year, compared with almost 3.5 per cent in the United States and more than 4 per cent for the entire world.

One reason for Europe’s poor performance is clearly that the speed and intensity of its institutional achievements have been insufficient in comparison with the speed and intensity of globalisation and technological change. The completion of the Single Market is progressing too slowly; the EU budget remains a relic of the past, allocating far too much resources to agriculture and far too little to research and innovation; and the fiscal framework of the monetary union has not yet succeeded in raising sufficiently the quality of national public finances in terms of growth and stabilisation.

But probably the main reason for this poor performance is that changes at the EU level have not been accompanied by necessary changes at the national level. Outdated labour market and social policies simply do not allow the Single Market, public spending on R&D and the currency union to unleash their full potential in meeting the challenges of globalisation and technological change.