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Symposium 2008

Proposal - Globalisation and Europe's social model: Challenges and policy responses

The Challenge

What are the implications for welfare state eform? What constellation of welfare state policies enables us to compensate the losers from globalization without harming incentives to work and acquire ...

What are the implications for welfare state eform? What constellation of welfare state policies enables us to compensate the losers from globalization without harming incentives to work and acquire skills? What are the appropriate roles of the state, firms, housholds and civic organizations in the provision of welfare services?

Introduction

The integration of emerging Asian economies, such as China, India, and others, and of the former communist countries in Central and Eastern Europe into the world economy has added roughly 1.5 billion workers to the global workforce, putting pressure on the remuneration and employment perspectives of workers in the developed world, particularly the low-skilled. The mobility of capital and, increasingly, skilled workers has led to fears that redistributive policies are becoming increasingly restricted. These developments have raised questions about whether the European “social model” with its high levels of equity, insurance and social protection paid for by high tax burdens, can and should be maintained. I will argue that the answer to both questions is “yes”, provided appropriate policies are put in place.

The opportunities of globalisation

Globalisation entails an increasing international division of labour. Countries specialise in what they can do best, and the principle of comparative advantage indicates that this is mutually beneficial. Increased economic integration also implies increased competition, a faster pace of innovation and technology adoption, and the realisation of economies of scale. Consumers profit from a larger variety of products and lower prices of goods and services. The increased international flow of capital and labour improves the allocation of resources and results in faster technology diffusion. In the developing world, in particular in China, India and other emerging Asian economies, globalisation has enabled a reduction of extreme poverty at an astonishing rate. Never before have so many in such short time escaped from poverty as in the last 2 decades.

The challenges of globalisation for European social models

Accelerating globalisation poses policy challenges to our European social model. This model is based on a broad consensus amongst Europeans that there should be a relatively high degree of equity in our societies, that major risks should be insured, that poverty should be avoided and the risk of falling into poverty minimised. This consensus holds even though Member States differ substantially regarding the extent of state intervention in the market, the institutional framework of their pension systems, their health and long term care systems, the set of labour market institutions and the nature of the social dialogue, the design of family policies and so forth.

Challenges to the European social model stemming from globalisation may be roughly grouped into three. First, globalisation implies an accelerated reallocation of labour between sectors and firms. Second, globalisation, along with skill-biased technological change, puts pressure on the distribution of income, adversely affecting low-skilled workers in particular. Third, and finally, European governments need to secure adequate financing for social spending. With increasingly mobile tax bases, tax competition can undermine the ability of a tax system to be used to tackle the adjustment costs arising from globalisation. In addition, and quite apart from the challenges posed by globalisation, the European social model will come under immense pressure in future years as a result of population ageing. European pension and healthcare system, many of which were designed 50 years ago, are no longer viable in view of current demographic trends and unless they undergo reform, will not be sustainable to support future generations.

Policy responses to the three groups of challenges

Let me start by the first challenge linked to globalisation, the need to accelerate the reallocation of labour between sectors and firms. If Europe is to reap the benefits from the increased international specialisation and technological innovation offered by globalisation, flexible product, capital and labour markets are essential for it to easily move into new and more competitive activities. The problem is that, by moving into new activities and away from traditional ones, Europe's economies may leave some European citizens, especially its least-skilled citizens, with inappropriate skill sets to be able to get the new jobs available. In this environment, the first thing policy should aim to do is minimise the need for workers to change jobs. Tax reductions for low-skilled workers may be necessary to that end. But if workers must change jobs, then welfare states need to provide smarter social safety nets. Hiring vouchers, for example, could be envisaged whereby part of an individual's unemployment benefits are used as a temporary wage subsidy, eliminating disincentives to work by decreasing the cost of employment facing employers and thus encouraging them to employ more. Efforts should also be made to facilitate the training and reallocation of workers across sectors. Policies that foster human capital formation are of the utmost importance. The provision of good quality education will enable people to better seize new job opportunities in a changing economic environment. Furthermore, poverty risks, long-term unemployment and social inclusion are closely tied to individual education and acquired skills, which makes the argument for more comprehensive and systematic training all the more compelling.

What about the second challenge facing Europe in the context of globalisation – the pressure on the distribution of income? The risk posed by globalisation of rising income inequality and low-skilled unemployment deserves an adequate policy response because it is contrary to the nature of Europe's social model, but also because it risks acting as a deterrent to further progress in the reform agenda for growth, adjustment and fiscal sustainability. Appropriate policies need to compensate globalisation's losers or, preferably, enable those citizens to share in the benefits of globalisation. An effective approach could be to ensure that workers' incomes are substantially protected whilst they are in transition from one job to another. The focus needs to change from providing job protection to the provision of security in the market place (with appropriate unemployment benefits and activation policies). However, such policies have to be undertaken whilst recognising that it is no longer affordable to continue the old policies of subsidising inactivity, which involved little or no requirement to actively seek and accept jobs. One operational way that such policies could be implemented is via so-called personal accounts giving individuals much more ownership or say about the way and the extent that they would like to be protected from substantial risks of life. However, market failure may undermine personal accounts, so their introduction could actually aggravate the potential adverse consequences of globalisation on inequality; care should therefore be taken about introducing personal accounts, and should only follow very careful analysis of their social consequences. In any case, however it is achieved, greater income security must be combined with policies that intensify job-seeking efforts. In addition, structural policies to improve the functioning of product markets would complement direct social policies by resulting in lower prices that benefit low wage earners in particular. Similarly, reforming and deepening financial markets improves access to credit, in particular for low wage earners. This reduces the need for government intervention and can help facilitate labour market reforms.

As for the third and final group of challenges, the problem of tax competition and mobile tax bases, Europe clearly needs tax systems that are appropriate in a globalised world. Such systems should rely more on tax bases that are less mobile. However, while labour is a less mobile tax base, it is already highly taxed and higher rates may create disincentives to work and increase unemployment. Consumption and environmental taxes are other possible tax bases that are not so mobile, but they may raise equity and inflation considerations in the short run which could arouse sensitivities in the current economic slowdown; nonetheless, they remain important long term options. Taxes on property and on bequests are additional alternatives that could be considered. But beside such adjustments to their tax structures, Member States need to improve mutual information exchange and increase their cooperation to avoid tax evasion and tax fraud. In addition, governments need to encourage people to work longer and be more active. High participation rates are key to the sustainability of our social protection systems. This requires a coherent set of policy measures providing appropriate financial incentives for people to work beyond current actual retirement ages in most Member States. Such measures would need to be complemented by policies that improve the employability of workers as they age, via lifelong learning, promotion of occupational health, and other activities of maintaining work ability.

The policies outlined above that are necessary to cope with globalisation are policies that Europe has already been pursuing in other contexts. Most notably, the Lisbon Strategy for Growth and Jobs, with its core of product, capital and labour market reforms, is the EU's comprehensive strategy to tackle the challenges set out in this paper. This important European policy framework was relaunched in spring 2005, and one of the reasons for that relaunch was precisely to enhance interaction between Europe's policies on social protection and social inclusion on the one hand and its policies for employment and growth on the other. In respect of labour markets, the Strategy integrates the Community's flexicurity approach; that is, it advocates policies that target the use of unemployment benefits and employment protection legislation in a way that makes labour markets more flexible by giving workers more security in return. Under the Strategy, Member States have received policy recommendations for reforms in labour, product and service markets deliberately aimed at facilitating adjustment capacity.

Microeconomic reforms require a stable economic framework, which is why sound macroeconomic policies also form a key pillar of the Lisbon Strategy. Fiscal and monetary policies that anchor stability have a direct bearing on lowering unemployment, mainly by reducing risk premiums on interest rates and the servicing of debt, thereby improving the conditions for investment and growth. Macroeconomic policies should be geared to promoting low inflation, particularly during today's difficult economic climate. For example, fiscal consolidation reduces the pressure on monetary policy and creates room for adjustment, without the need to restrict welfare spending. Sound budgetary policies are also a vital means to improve the long term sustainability of public finances in view of population ageing.

Another Community policy framework helping to cope with globalisation and its challenges for our social model is the Economic and Monetary Union. As laid out in the Commission's EMU@10 report, EMU has proved to be a great success and a cornerstone of dynamic economic development in Europe; EMU's stable macroeconomic framework and international currency has helped shield and absorb shocks coming from the global economy. Nevertheless, several challenges remain to further improve its functioning. In particular, the report stresses that European labour markets need to become more flexible to increase Europe's ability to cope with economic shocks. To that end, the report argues that reforming unemployment benefits could play an important role in enhancing the flexibility of Europe's labour markets by upgrading the role of the tax and benefit system to act as a shock absorbing instrument in EMU's institutional arrangements. Thus, policy requirements for EMU and sound social and labour market policies in a globalised world run largely in parallel and are mutually reinforcing.

Conclusion

"Europe must modernise to ensure continued high quality education and health care, satisfactory jobs for all and adequate pensions. Modernisation will give the confidence to reap the benefits of globalisation"

As the experience in a number of EU countries shows, provided the right incentive structures are in place, it is possible to ensure economic dynamism while maintaining comprehensive social protection systems. The trade-off between efficiency and long-term financial sustainability of welfare systems and equality is not inevitable. However, reconciling these objectives requires decisive political decisions and resolute action for implementing proactive and forward-looking reforms that contribute to employment and growth and lay the foundations for the long run viability of social protection models in the era of globalisation.

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