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PDF FormatThe government’s increasing difficulty in implementing economic reforms is largely attributable to the dramatic rise of political parties such as Shas and Gesher, and to the newfound confidence of extraparliamentary groups like Keshet and the Histadrut. Increasingly, these groups are discovering the appeal of the vision offered by Shlomo Ben-Ami and the new Left, who are pushing the only real alternative to market reform which has any likelihood of being adopted by the mainstream political parties: The European model, the idea of a “social democracy” which purports to maintain cultural cohesion and economic vitality through taxation and social programs.
The vision of European-style social democracy has great instinctive appeal, so great that many neglect to ask the most important question about it: Does it work? To understand just what is wrong with the vision of Israel’s social democrats, one need only take a sober look at what is taking place in Europe—and has not taken place in the countries that offer the chief alternative to the European model, the market-oriented economies of the United States and Great Britain.
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The last twenty years have served as an important experiment in economic theory. While Continental economies have maintained a fairly consistent loyalty to their “mixed” economic traditions, the United States and Great Britain have adhered to market-based policies through successive changes of government.33 The results are now open for the world to see: Whether you are rich or poor, it is better to live in a free, market economy.
European economies today are in a state of more or less permanent crisis. Unemployment rates throughout continental Europe are consistently high: Eleven to twelve percent in Germany, France and Italy, and over eight percent in Sweden, which was once thought the acme of a working social-democratic polity.34 Figure 1, which shows unemployment trends in various developed countries, begins with the year 1980, which was the year after the second major oil shock, and therefore a good starting point for examining how different industrialized economies adjusted to the oil shock and, over the long term, to an increasingly integrated and competitive world economy. Unemployment rates in most European countries have risen slowly but surely, going up during recessions, declining during periods of economic expansion, but never quite making up for lost ground.
Many of those not working are the long-term, hard-core unemployed who have fallen out of the working lifestyle and probably will never work again. In 1991, these constituted less than one-third of the unemployed in Britain, but close to half in France, Germany and Spain and over two-thirds in Italy. Moreover, their proportion tends to rise over time, even as the total number of unemployed rises.35 Unemployment among youth in these countries is about twice as high as national averages. GDP growth per capita has been acceptable since 1985, averaging 1.5–2 percent per year, but the benefit of this growth has redounded largely to those who have jobs. France, Italy, Spain, Belgium and other countries have large and growing excluded populations.
The consistent rise of unemployment during the last twenty years has caused much concern among European policymakers, and has generated much research. The causes of European unemployment are now thought to be well understood. Unemployment is largely due to high taxes on labor, including social-security taxes to pay for pensions and other benefits, which make labor more expensive for employers; regulatory constraints on hiring and firing, whether imposed by legislation or union rules, which effectively prevent employers from implementing rational workforce decisions; and minimum-wage legislation, which contributes directly to youth unemployment and indirectly places a “floor” under the entire wage scale, raising the cost of labor and thereby reducing employment. In addition, generous unemployment benefits are found to encourage long-term unemployment.36 In other words, welfare policies meant to help poorer workers, or to provide security for workers in danger of losing their jobs, do exactly the opposite, by preventing would-be workers from getting jobs and leaving many of them in the desert of long-term unemployment. And, the more public funds are spent on pensions, unemployment benefits and subsidies to preserve jobs in failing industries, the less there is for truly important things such as employment retraining—investment in creating advanced skills among the unemployed—which is the key to reducing both unemployment and poverty.
The contrast with Britain and the United States is striking. In 1979, the year Margaret Thatcher came to power, British unemployment was about mid-range among European countries37—though to the British it was high enough to be considered unprecedented (Thatcher and the Tories campaigned successfully on the slogan “Labor Isn’t Working”). Thatcher ended thirty-five years of restrictive union power, and made the economy and the labor market much more efficient. The immediate effect of the adjustment was a rise in unemployment which lasted through the early 1980s, with another significant rise in the early 1990s. Since then, however, unemployment in Britain has dropped considerably, and by 1998 stood at around 6.5 percent—as opposed to 11.2 percent in Germany, 11.8 percent in France and 12.2 percent in Italy.38
In the United States, where the economy is even less subject to government controls than in the United Kingdom, the picture is that much clearer. The U.S. was not immune to the second oil shock in 1979, which raised production costs and prompted a recession throughout the Western world, costing many workers their jobs. In 1980, U.S. unemployment was high relative to most European economies; it would peak in 1982 at 9.7 percent. The 1980s and early 1990s were years of downsizing and restructuring; hundreds of American companies fired millions of blue- and white-collar workers. During the same period, however, the economy also created millions more new jobs than were lost. The market, especially the labor market, worked exactly as economic theory predicted it should: The economy as a whole became more efficient and productive, as resources released by some companies were taken up by others, new and old, which produced more goods and services. This has created a more inclusive economy: In the U.S., someone who wants to work is likely to find work in short order.39 Far more than in Europe, a worker in America can be confident of attaining the security and dignity inherent in having a job.
Yet unemployment is only one factor in judging an economy’s health; another is the government’s financial soundness. The commitments implied by welfare programs are gradually undermining the finances of European social democracies. Europe’s population is aging, leading to ever increasing health and pension costs. Since 1980, government expenditure in most European economies has grown considerably, Britain being a refreshing exception. As illustrated in Figure 2, spending by European governments today stands at fifty to sixty percent or more of annual Gross Domestic Product—very much like the pre-1985 levels of Israeli government spending.40 (Compare this with Britain, where government spending stayed just under 39.9 percent in 1998, and the U.S., where spending in 1998 was as low as 30.9 percent of GDP.)41 Even these monumental amounts have been insufficient to finance the welfare commitments of European countries, so they have borrowed heavily: Public debt in Europe’s social democracies now amounts to anywhere from two-thirds of annual GDP to well over one hundred percent in some countries—119.4 percent in Italy and 117.3 percent in Belgium in 1998 (as opposed to 57.2 percent in Britain and 57.4 percent in the United States).42
Yet these “official” figures of public debt tell only part of the story. Future receipts of most state pension systems are inadequate to fund future pension obligations. Governments will have to make up the difference from other sources, by imposing additional taxes on top of ordinary social security taxes. This implicit obligation ought to be counted as government debt, but it usually is not. An authoritative study by the International Monetary Fund, based on data from 1994, attempted to calculate the burden of public debt including pension fund liabilities for a number of developed economies. The results were ominous: In France, for example, the projected total was 156 percent of GDP, in Germany, 163.2 percent, and in Italy, 188.4 percent.43 Compare these with 89 percent in the United States, and only 42.3 percent in Britain. It seems governments can neither tax nor borrow enough to meet pension commitments of this magnitude, since borrowing means increasing the interest payments on the public debt, interest payments that also must be funded by taxation.
Unemployment and fiscal insecurity in the European welfare state constitute a vicious cycle, as most pensions and many other public social services are funded by payroll taxes. The unemployed make no contribution to these taxes; as their numbers increase, the burden of paying for the welfare state falls upon a smaller and smaller base. This causes tax rates to rise, which deters employers from hiring workers, increasing the ranks of the unemployed further still. The result is that more people become poorer, and more become permanently alienated from society due to unemployment. In other words, the policies social democrats have pursued for the sake of “social solidarity” end up having just the opposite effect.
