A few weeks ago, on April 1st, my book, Dagbok från USA, came out in Sweden. It will also, sometime coming summer, be published in English (as an e-book for Kindle and for other readers with the title: “Diary from the United States – Notes on a society in crisis“). As an appetizer for English speaking readers, I will the coming week publish three essays, excerpts from the book (chapter 4).

This is the first essay. It  deals with  the American model of society, which I in the following will call “the small-government strategy”. It may have reached its limits. By that I mean that this political strategy may have lost its ability to create a society that simultaneously can achieve both high relative GDP growth, and provide all its citizens welfare at the same level as the citizens of other highly developed Western countries. I will show that the northern European welfare state, so often disparaged by Americans, compares quite favorably with the small-government strategy.

Essay 1: Small-government strategy in a dead end (or the renaissance of the European welfare state)

What is a welfare state? The definition I will use here is based on two criteria. The first is that all citizens should have basic social and economical protection of their welfare in case of sickness, accidents, old age, unemployment etc. This can be achieved in different ways. As in Sweden, Norway and Denmark, it can be done by making the public responsible for both the financing and production of welfare. For example, the county councils in Sweden fund and provide the greatest part of the health care system. Gosta Esping-Andersen, Danish sociology professor well known for his typology of welfare models, calls the Nordic model “the social democratic regime”. Or it can be done as on the European continent (“the conservative regime”) with more limited state and local responsibility, supplemented by private efforts, in particular for the provision of health care, and with private insurance.

Whatever the model, the public has two tasks. State and local governments are to assist in different ways so that even the weakest in society get the help they need when confronted with sickness, accidents, unemployment, and old age. This can be done through various types of social security systems, and through for example subsidized medical and social care. The state can also influence the relative income differences through grant schemes, tax deductions or progressive taxation.

The second criteria veer from the typical course of these debates because it isn’t usually discussed in literature about the welfare state. However, I argue that for us to talk about a welfare state, income disparities in the country should be moderate in comparison to other developed countries because research has shown that in Western countries, there is a close correlation between relative income inequality and social conditions. The larger the income disparity, the greater the social problems. Therefore, relative income distribution is a relevant welfare measure. In fact, it’s an indication of whether the welfare model that politicians have chosen (following a social democratic, conservative or liberal model) works for the citizens of the country in question.

According to these two yardsticks, Belgium, France, Holland, Germany, Austria, and the Nordic countries, Denmark, Finland, Norway and Sweden, are European welfare states. Two countries that usually are categorized as welfare states have been left out. The UK because the distribution of income criteria was not met. Income inequality in the UK is, compared to other Western countries, extremely large, almost the same as in the U.S.  Switzerland has also been left out for the simple reason that its successful welfare model is unique. There is no other Western country that has the same characteristics. For example, all the countries I have defined as welfare states here currently have government expenditures taking up around 50% of the GDP (58% in Denmark in 2009 being the highest with Germany as the lowest at 48%). The Swiss public sector in terms of government expenditures was the same year at 34% of the GDP.

A misunderstanding

In the U.S. debates in recent decades, especially after 1980 and the presidency of Ronald Reagan, the European welfare system has been considered an outdated and costly social model. It’s associated with political interference in the market, with income distribution policy, and with economic inertia and lackluster performance, in short, with, in U.S. parlance, “socialist” politics, the most antiquated political system of all. The welfare state has also been a costly social system as its relative growth is weak. Welfare states, it’s argued, have a lower GDP growth than the U.S..

I would argue that today this approach – with an emphasis on today – is wrong. My hypothesis is that it’s in fact the American model that is outdated. It’s my prediction that the European welfare state will have to be relabeled from politically outdated to up-to-date. As it turns out, if one lets markets work freely, over the long term it results in instabilities and misallocations. The financial sector especially is at risk of spiraling out of control. This was the case during the financial crisis of 2008-2009, for example. If the political goal is always to keep taxes low, and thus puts the public sector on a starvation diet, the risk is that one will eventually end up with a society that does not work effectively. The poorly maintained U.S. roads, bridges, and other infrastructure can serve as a prime example.

It’s the purpose of this essay to try to prove this hypothesis. I will systematically compare the European welfare state model with the American model of society (from now on referred to as the small-government strategy). Some may say that such a comparison is impossible because it’s like comparing apples and oranges. However, the U.S. and Europe are culturally, politically and economically part of the same world; the differences are moderate to say the least. The countries are invariably liberal states, democracies, and capitalist economies at a similar level of development. Even the differences in size are moderate. The entire EU-Europe and the U.S. are nearly equivalent measured in terms of GDP. The nine European welfare states as defined above together account for an economy that equals two-thirds of the U.S. economy.

There are three strong reasons why the European welfare state model is likely to undergo a renaissance.

The small-government strategy at the end of the road

The first reason is the most obvious. Judging by the global economy as it looks like today, the small-government strategy will probably turn out to be a political and economic dead end. There are many indications of this.

* Insufficient investment in the public sector, most notably in infrastructure. For a long time the U.S. investment in infrastructure has remained at about half the European level. In Europe, we annually invest roughly 5% of GDP in infrastructure compared to 2.5% in the U.S. The American Society of Civil Engineers (ASCE) regularly publishes a “report card” on the state of American infrastructure – roads, bridges, dams, schools, energy systems, water supply etc. In the latest report, from 2009, the state of the infrastructure did not get a pass.

* Over-investment in some parts of the private sector, especially concerning those having to do with private consumption. One does not need to spend much time in the U.S. to understand that there are, albeit unevenly divided, tremendous resources available for private consumption and for making increased private consumption possible. Corporate spending to facilitate final consumption has been huge in recent decades. This can be seen in everything from new shopping malls to more and more new product showrooms. Seventy-one percent of U.S. GDP in 2009 went to private consumption. In Germany the figure in the same year was 55%. High private consumption may suggest that private and public investment in the U.S. economy is too low compared to other developed countries, and this could eventually affect America’s relative competitiveness.

* The weaker groups in society have very poor protection against sickness, accidents, and unemployment. The U.S. uses just under 10% of GDP for tax-funded social safety nets. Germany and Sweden use more than twice as much. The protection of the economically weak is bad in other ways too. Illness has been the leading cause of personal bankruptcies in the U.S..

* Big income inequities. In practice, the small-government strategy is very stingy regarding measures aimed at mitigating the large income differences.

* Less effective solutions. The small-government strategy has an ideological background that sometimes leads to more costly solutions than is necessary. Politicians, and this goes for both Republicans and Democrats, simply choose a socially and economically more costly approach because they cannot, simply put, imagine that the government should take on greater responsibility. One of the most obvious examples is the private financing of health care.

* An increasingly speculative financial sector contributes to greater instability. Significant deregulation and a generous, almost libertarian, monetary policy, in line with the economic policy paradigm that was introduced at the beginning of the 1980s, has led the U.S. financial sector over the past 10-15 years to increasingly taking on a life of its own, more and more disconnected from the real sector. Historically, growth of the banking sector has followed GDP growth. Logically, one can say that the financial and real sectors should grow at about the same rate. This connection was nevertheless broken during the late 1990s. No matter how one measures it – in credit volume, profits, employee compensation, etc. – the U.S. banks, and shadow banks, have lost the connection to the real sector. This indicates more risk-taking and increased speculation, which will have disastrous consequences if the risks materialize in serious difficulties. This was the case in the crisis of 2008-2009. There is no doubt that there is a close connection between the small-government strategy and increased degrees of freedom for banks and other financial institutions to speculate.

*The  national debt problem. That a government borrows is one thing. All countries with the possible exception of Norway and other states with extraordinary resources or windfall gains do it. But with the small-government strategy, government borrowing tends to function as a substitute for tax increases. There is an imbalance between the demand for public goods on the one hand and the ability to fund it with limited tax revenues on the other hand. It leads to a budget deficit, and increased national dept. The national debt can become a serious problem if and when the financial markets lose confidence, as recently has been the case in Greece and the other heavily indebted countries in Europe. Economic historian Niall Ferguson, and Kenneth Rogoff and Carmen Reinhart in their book This Time is Different, argue that problems will increase when the national debt of a country approaches 100% of the GDP. Rogoff and Reinhart demonstrate that a Western country with a national debt exceeding 90% grows significantly slower in comparison to countries with a lower debt. This insight is part of the background of the intense debate in recent times on the U.S. national debt, which is approaching 100% of GDP.

These seven problem areas can be misleading. It’s not that the market-friendly economic policy paradigm launched by Ronald Reagan and Margaret Thatcher in the early 1980s – which has been so influential in the West and has become the small-government strategy in the U.S. – has been a failure. On the contrary, it has been a success. It was a necessary change. The previous economic policy model in the Western world, the outsized Keynesianism in which the state would actively participate and interfere in the markets, had outlived its usefulness. It was the model found in many European countries during the 1970s. Sweden is a primary example. It was an ossified, social democratic society that was no longer competitive, of which citizens gradually during the 1970s and 1980s became more critical. Sweden’s GDP per capita relative to other Western countries, especially compared to the U.S., declined for 15-20 years until the mid-1990s. From having had virtually the world’s highest GDP per capita in terms of purchasing power in 1970, Sweden fell to place 25-30 in the mid-1990s. There is an explanation for that. Sweden had gone further than almost all other Western countries with its ambitious, and for a time very successful, economic policy. The country paid a high price for it.

History repeats itself. So I would argue that the American version of the new paradigm, the small-government strategy, which can also be seen as an extreme form of economic policy, has reached its limits.

European welfare states hold up well in the face of competition

The second reason the European welfare state will most likely go through a renaissance is that the economy in terms of growth is as strong as the U.S. economy, and thus, the main political argument for the small government- strategy no longer applies. The main argument has been, and still is, that the relative growth in the United States is better compared to other Western social models, perhaps especially compared to the northern European welfare state countries. Many Americans believe that “big government” inhibits growth. This argument should, I think, no longer be upheld. Growth in the European welfare states is clearly currently not lower than in the U.S.. The dynamics are not worse, and the competitiveness, generally speaking, is the same as for the United States. I will be examining these three claims a little more systematically.

First, concerning growth, it’s correct to say that if we look at the entire period from 1980 until today, the U.S. economy has grown faster than the economy of the welfare states in Europe. While there are no major differences, the U.S. GDP growth, or GDP per capita growth, has been decidedly better during the past three decades. This is a fact whether we measure in current or constant prices. One explanation for this could be that the number of hours worked per year per capita is significantly higher in U.S. than in Europe; all else being equal, this raises the relative growth. Another explanation could be that the public sector is comparatively larger in Europe. The method used to calculate the productivity in the national accounts means that a country with a bigger private sector will gain. A third explanation, and this is definitely the case for Sweden, is that the transition from the old paradigm, the outsized Keynesianism, to a new, more market-oriented economic policy, took longer in Europe than in the U.S. Whatever the explanation, it’s unequivocal that U.S. growth has been better than Europe’s in the period 1980-2010.

It looks slightly different with a shorter time perspective. The GDP growth of the welfare states in Europe over the past fifteen years, 1995-2010, does not differ greatly compared to the U.S. If we measure growth in real terms and after purchasing power, the percentage increase for the entire period for Sweden was 45% against the U.S. growth of 46%. Norway and Belgium developed even better yet. Especially Germany breaks the pattern. During the past 15 years, the country has had significantly slower growth (20%) than the U.S. One explanation might be that the integration of the East German economy slowed growth of the reunited country. Germany has also had to deal with some macroeconomic problems during this period.

The overall picture is that the U.S. is still growing well in line with Europe’s welfare states. But the gap in growth rates has tended to shrink over time. Between 2005 and 2010 the nine welfare states grew by 5.2%, and the U.S. grew by 4.8%. The difference is negligible.

There’s another aspect to this question. Political scientist Uwe Reinhardt, a professor at Princeton, has shown that because households with the highest incomes are taking such a large share of the pie in the U.S. economy, the comparison is misleading. It turns out that if one removes the percentage of households with the highest income, the top percentile, the picture changes dramatically. This is how Reinhardt illustrates the problem (referring to: Atkinson et al, 2011):

Average real income per family in the United States grew by 32.2 percent from 1975 to 2006, while they grew only by 27.1 percent in France during the same period, showing that the macroeconomic performance in the United States was better than the French one during this period. Excluding the top percentile, average United States real incomes grew by only 17.9 percent during the period while average French real incomes – excluding the top percentile – still grew at much the same rate (26.4 percent) as for the whole French population. Therefore, the better macroeconomic performance of the United States and France is reversed when excluding the top 1 percent.

The second claim relates to the dynamics of each model of society. We know that a country with a relatively large influx of new businesses and a high degree of entrepreneurship will manage the jobs and growth better than other countries. Against this background, it would be interesting, not least for politicians, to measure the degree of entrepreneurship in different countries. One of the best and most publicized attempts of this is the Global Entrepreneurship Monitor (GEM). The problem with GEM is that it measures the degree of entrepreneurship indiscriminately. The simplest “enterprise for a living” is mixed up with Facebook, Google, and other corporate gazelles. Now Professors Zoltan Acs and Laszlo Szerb have developed a new index, the Global Entrepreneurship and Development Index (GEDI), which focuses more on measuring the quality part of entrepreneurship, the new “value added heavy” businesses. One could say that GEDI provides an indication of which countries have created favorable conditions for new businesses based on high technology, that is, the kind of company that creates high value added and thus contributes significantly to GDP growth.

Zoltan Acs and Laszlo Szerb analyzed and ranked 71 countries. All European welfare states are found close to the top of the list. Of the welfare states, Austria ranks the lowest, coming in 22nd. Most thought-provoking is that the Nordic countries end up very high: Denmark tops the list, Finland is in thirteenth place, and in between come Sweden and Norway, with Sweden in fourth place. This is interesting because it suggests that the economic policy model that we adhere to in the Nordic countries today is also competitive with regard to entrepreneurship. One can no longer argue that relatively high taxes and a rather generous welfare state are in opposition to growth through new businesses. The United States is also found at the top of the list at number three. This is not unexpected. Everyone knows that the conditions for high-tech growth are better in America than in most other countries.

The third claim concerns the big picture and raises the question, to what extent can the European welfare states compete with the U.S. when the perspective is broadened? The World Economic Forum’s competitiveness study from 2010, The Global Competitiveness Report, which I wrote about earlier, can be used to answer this question.

The following graph (click for bigger picture) from the study shows how U.S. competitiveness holds up when compared to the average of other highly developed countries (“Innovation-driven economies”), which in practice are dominated by the European welfare states. What one sees is what one expects. The U.S. is particularly good at innovation, highly sophisticated in business, with a relatively well-functioning labor market. In addition, the country has a distinct advantage due to the size of its domestic market. The United States has by far the largest and most sophisticated market.

In the ranking showing the best countries, Switzerland comes in first. After Switzerland we find – taking the top ten competitors in the ranking – Sweden, Singapore, the U.S., Germany, Japan, Finland, the Netherlands, Denmark, and Canada. Between positions 11 to 20 we find the rest of the European welfare states, with Belgium coming in last at number 19. It’s no exaggeration to say that the European welfare states truly equal the U.S. when it comes to global competitiveness, at least according to the World Economic Forum’s report.

When these three conditions – the capacity for economic growth, the conditions for entrepreneurship, and overall competitiveness – are put together into a complete picture, the differences between the two social models are not great. The European welfare state model and the U.S. small-government model seem relatively economically comparable.

There is a third factor. By all accounts, people, I would argue, feel better in the European welfare state than in the U.S. small-government society.

People in the welfare state

In their book, The Spirit Level, epidemiologists Richard Wilkinson and Kate Pickett argue that at any given time there is a correlation between income inequality and the social conditions of a country. The wider the income inequity, the more social problems there are when comparisons are made between countries. Infant mortality, life expectancy, obesity, the status of women, mental illness, drug use, people in prison, school performance, the school dropout rate, and teenage pregnancy. For all these factors, the larger the income disparity in a country, the greater the problems.

In the book there are many graphs in which they show the income inequality in different countries along the x-axis and the social parameters along the y-axis. In other words, far to the right of the chart below, click for bigger picture, (Source: Wilkinson & Pickett, 2009, p 20) are the countries that have a high relative income discrimination, high income inequality, and in the upper part of the graph are the countries with major social problems. The U.S. is situated high up in the right corner in all the graphs, that is, for all the social parameters that I just mentioned and a few more. In other words, it’s a position that says that compared to other highly developed countries, the U.S. has greater income inequality and hence greater social problems. The European welfare states (often along with Japan) are without exception positioned in the opposite corner, on the positive side of the graphs so to speak, the side with a relatively low income inequality and low social problems. When I argue that the people of the European welfare states in general “feel better” than people in the American small-government society, it’s this systematic difference in the degree of social problems I’m referring to.

I am not uncritical of The Spirit Level. To be sure, the authors have persuaded me that large income disparities in a country are not good for the people of the country, but they do not show how the relationship operates. What underlying mechanisms, for example, cause infant mortality to be higher in U.S. than in Sweden? Wilkinson and Pickett only assume that there is a causal relationship. Other researchers have also criticized the methodology used, and, of course, there exists a furious criticism of the book from the political right. Still, I think the main message of The Spirit Level, that countries with large income differences on average have more social problems than those with less income inequality, stands up to scrutiny.

A few additional observations in the book are also worth a comment when discussing the United States. In a study of conditions in a number of Western countries including the U.S., researchers at the London School of Economics have demonstrated that there is a correlation between income inequality and social mobility. Social mobility is a term that refers to how easy or difficult it’s for an individual to break free from the income level of his or her parents. The data isn’t extensive, and the results must therefore be handled with care, but what can be seen is astounding. Social mobility in the United States (and Britain) is significantly lower in than the other countries in the survey – Norway, Finland, Sweden, Germany, and Canada. The European vision of the United States, since Alexis de Tocqueville wrote Democracy in America about his visit to the U.S. the 1830s, has been rooted in the myth of the land of opportunity, a place where anyone through hard work and perseverance can achieve anything, the very model of high social mobility. This study drives a wedge into that story. Contrary to what de Tocqueville observed in the 1800s, it seems that it’s more difficult to climb the social ladder in the U.S. today than it’s in Europe.

This second comment is about the relationship between work time and income inequality. It’s well known, and I have touched on these facts earlier, that Americans on average work more hours per year, and take less vacation time than the average Western European. Wilkinson and Pickett discuss the question in their book, and find even here a clear correlation. The wider the income gap between rich and poor in the country, the more hours people tend to work per year when compared to other countries. Hence, one could say that one reason, and perhaps a major reason why Americans work so much, is that they live in a country with relatively large income differences.

The countries with small income gaps in Wilkinson and Pickett’s studies are all European welfare states – with one exception. That exception is Japan. Since Japan’s public sector is one of the smallest among OECD countries if measured as a share of GDP, less than the U.S.’s., this should encourage those American politicians who want to do something about income inequality in their country. It appears that one can achieve a more fair income distribution even without a welfare state of the European type. However, the Japanese model is built on the assumption that there should be small differences in income between all different groups in society, and one can assume that the general public backs this. In other words, it’s the farthest one in the advanced capitalist world can come from the American wage and bonus culture.

If we accept Wilkinson and Pickett’s analysis, and not all do, there is no doubt that the people of the European welfare states on average live a healthier, better life than people in the United States.

Time is on the side of the welfare state model

The first argument in favor of the renaissance of the welfare state model is that the small-government model has serious problems, ranging from shoddy infrastructure to over-investment in the private sector. Further, which I have not discussed here, the political deadlock between Republicans and Democrats in the U.S. has lead such political scientists and commentators as Fareed Zakaria and Francis Fukuyama to be pessimistic about Americans’ ability to address the major issues that urgently need to be addressed in the U.S. society. Some may say that Europe has plenty of its own problems. A bankrupt Greece, difficulties for the other PIIGS countries to affordably finance their public debt, and a high risk that the monetary union, the euro, will collapse all lead one to say that they do have a point. Of course, they are right. But these problems have nothing to do with the welfare state as a social model. The problems only indirectly affect the nine welfare states involved in this discussion.

The second argument is that the European welfare states are no longer economically inferior to the U.S. For a long time it was an unquestioned truth that the welfare states of Europe were if not economically less developed, then at least less dynamic than the U.S. It’s difficult to argue that this is the case now. Although the U.S. remains one of the world’s most competitive countries, and even if no other country in the foreseeable future can compare to the U.S. in terms of domestic market size, on closer inspection it’s proved that the European welfare states are holding up well in everything that determines future economic development.

The third, and decisive, argument has been that people in the welfare states in general live a better life with less social problems.

There is also a fourth point. Time is on the side of the welfare state model. Income inequalities will keep pace with globalization and technological progress, and this will require political measures to mitigate the effects of these developments. Compared to the U.S. small-government strategy, the European welfare state is, I would argue, better equipped to handle them.

Literature:

“2009 Report Card for American Infrastructure”, American Society of Civil Engineers, March 2009;

“The Global Competitiveness Report, 2010-2011”, 2010, World Economic Forum, Genève;

Acs, Z. J. & Szerb, L., 2010, “The Global Entrepreneurship and Development Index”, paper presented at the DRUID Conference, Imperial College Business School, June 2010, London;

Atkinson, A. B. et al , 2011, “Top Incomes in the Long Run of History”, Journal of Economic Literature 2011, 49:1;

Snowdon, C., 2010, The Spirit Level Delusion: Fact-checking the Left’s New Theory of Everything, Democracy Institute;

Ferguson, N., 2008, The ascent of money: a financial history of the world, Penguin Press, New York ;

Reinhart, C. M. & Rogoff, K. S., 2009, This Time is Different, Princeton University Press, Princeton;

Wilkinson, R. & Pickett, K., 2009, The Spirit Level, Penguin Books, London;

Woolhandler, S. et al, 2003, “Costs of Health Care Administration in the United States and Canada”, The New England Journal of Medicine, Vol. 349, No. 8, August 21, 2003, s 768 ff;

Reinhardt, U. E., 2011, “What Does ’Economic Growth’ Mean for Americans?”, Economix, The New York Times, September 2nd, 2011;