Monday, September 04, 2006

Munkhammar's European Dawn: A Powerful Indictment of Euro-Socialism

I just finished reading Johnny Munkhammar's book on the European welfare state, European Dawn-After the Social Model . While , as we shall see, there were parts of the book which could have been improved further, it is nevertheless the most powerful indictment of the Euro-socialist welfare state that I have read so far.

Although there are several books which better argue for sound economic principles, European Dawn does a better job than any other book I've read in applying these principles to modern Europe and using them to analyze the abundance of interesting statistics the book presents.

The book discusses the economic crisis that most of Western Europe faces . Western Europe have for years lost ground to most other parts of the world, including America, East Asia and Eastern Europe. Meanwhile, mass unemployment have become a seemingly permanent reality.

Munkhammar shows that this is clearly the result of first, the weakening incentives for productive activities created by high taxes and government hand-outs using both theoretical arguments and empirical studies. Also contributing to Europe's weak growth are over-regulated labor and product markets.

Here a distinction can be made. Labor market regulations and high taxes and government hand-outs weaken growth mainly (but not exclusively) by reducing employment levels and increasing unemployment (including various forms of hidden unemployment, like government financed early retirement)whereas product market regulations mainly lower growth by reducing productivity growth.

Munkhammar ties the problem of increasing unemployment among people in the working age population with the demographic trend of increasing number of old people which is expected to be provided for by the state. Further aggravating this problem is that the fewer number of young people are entering the work force later and later, as more and more are studying at university for a longer and longer time. All of this means that the dependency ratio for workers are steadily rising.

This problem is often discussed in the public debate, and Munkhammar shows in this book better than most people how the only way to solve this problem is to improve incentives for work, both among young, middle-aged and old people.

One really great thing about this book is how it in addition to the widely discussed problem of insufficent employment also deals with the all too often ignored problems created by government financing of certain services, like health care and education.

In this context, Munkhammar discusses the implications of what is known as Baumol's cost disease. That is, the fact that while productivity is rapidly rising in certain sectors, particularly manufacturing other sectors are because of the nature of theirb sector unable to improve productivity. For example, while it takes fewer and fewer workers to produce a car, nurses changes bandages no faster now than in the 1960s.

But if the relatively higher productivity in manufacturing where to result in higher wages there, no one would want to work in the sectors where productivity is rising. Because of this, wages must increase at more or less the same rate in both sectors. Nor can the higher productivity result in permanently higher profitability in those sectors for similar reasons, that is since that would attract investment capital that would eventually restore equilibrium and bring down returns on investment to the same level as in sectors with stagnating productivity.

Instead, the result will be that the prices of manufactured products must fall compared to prices in those service sectors where productivity is stagnating. That in turn implies that sectors with stagnating productivity will, ironically, increase its share of the economy.

And since government funded sectors like health care, education and care for the elderly are sectors with stagnating productivity, whereas manufacturing is private, this implies that the burden of the private sector in providing for the government sector will steadily rise, further aggravating the previously discussed problem of the increased burden of providing for those who do not work.

The fact that services like health care and education is publicly funded creates special problem since unlike in other services with stagnating productivity, it implies higher taxes . Because tax increases, particularly from today's elevated Western European levels, there is a limit to how much it can be raised. A limit which for many taxes (particularly corporate income taxes) is steadily lowered as increased tax competition lowers the so-called Laffer point (the point where further tax rate increases weakens the tax base so much that actual tax revenues will in fact fall).

The solution is instead to increase the degree of private financing, whether through direct user fees or private insurances and with regards to the poor some element of private charity. This have the advantage of reducing demand for the public services and thus in itself limit costs and unlike tax increases it do not harm other sectors.

Munkhammar also emphasizes that higher productivity growth, while being good for other reasons, cannot help solve this problem. The reason for this is the previously mentioned fact that higher private sector pay will only help bid up government sector pay. He notes however that higher private sector employment growth can help solve this problem since this will raise tax revenues at any given tax rate without bidding up government sector pay.

To this it could be added a point not mentioned by Munkhammar, that the high tax society have hit particularly hard on the private service sector compared to private goods production. This is for two reasons. First because goods production is more capital intensive and since capital is more lightly taxed the total taxation of services is higher. And secondly, and perhaps even more importantly, it is usually a lot easier to substitute legal private service production with "black market" activities or to do it yourself. You can't produce a car by yourself, but you can cut your own hair with a hair cutting machine and you can clean your own house instead of hiring someone else to do it.

This disproportionate negative effect on private service sector activity is particularly relevant given the fact that they too often also have stagnating productivity and could thus be particularly helpful in lessening the burden of financing for government services.

Munkhammar also makes many other interesting points. He for example points to how "welfare" is a word which have been hijacked and stolen by socialists, just like the word "liberal" have similarly been taken over by socialists. "Welfare" originally meant "well being" but has now been twisted into essentially meaning government spending outside the "night watch man" (police, legal system, military) part of the state. Munkhammar makes numerous examples as to how welfare in its original meaning would be better provided for by the private sector.

Also, in the section on labor market regulations he makes the interesting point that while laws limiting the ability of employers to fire employees may reduce the risk for those who already have a job of losing it, they will make unemployment a lot more dreadful prospect because these laws will make employers a lot more reluctant to hire them again.

The one disagreement I have with Munkhammar is his optimistic view that as society becomes more heterogenous, the support for the welfare state will decrease. This according to Munkhammar is because people are more inclined to feel solidarity with people of their own ethnic group, and in a ethnically heterogenous society, people will thus not support the welfare state. As "empirical evidence" for this is offered how America with a more limited welfare state have been more diverse than for example Sweden or Denmark.

But this is in fact not based on the issue of homogenity versus diversity, but on America's more anti-statist, individualist traditions compared to Europe. And there are countless counterexamples which could be offered. Japan and South Korea are among the world's most homogenous societies , yet Japan's welfare state are no more extensive than America's and South Korea have in fact a much less extensive welfare state than America. Meanwhile, two examples of quite bloated welfare states include Belgium and Israel, two highly diverse countries. Belgium's Flemish and Walloon inhabitants certainly identify themselves as different ethnic groups. And the example of Israel is perhaps even more telling as Israel have a bloated welfare state despite having a large (20% of the population) Arab population and despite the well known mutually hostile feelings between Jews and Arabs in Israel and despite the fact that Arabs recieve a lot more in transfer payments and government services than what they pay in taxes(Despite the frequent accusations of Israel being "a racist state", Arab citizens of Israel have full access to the Israeli welfare state).

The reason why the empirical evidence contradict this hypothesis is because it is based on the faulty premise that support for the welfare state is somehow based on "solidarity". While this is what socialists often claim in their official propaganda, I have sufficent personal experience with socialist relatives and friends to know that they do not support the welfare state because they want to give away their money to the poor, but because they want to receive money taken from the rich. While there are a few socialist idealists who wishes to share their wealth (Warren Buffet is a good example of that), they are a small minority and they are at any rate usually just as willing to give to foreigners. The welfare state is not based on the desire to give but on the desire to take.

The reason why government payments to families with children is a lot more accepted than government payments to immigrants, despite the fact that the former cost a lot more is simply because the vast majority of people expect that they themselves will be on the receiving end of subsidies to families with children sometime, whereas they will obviously not be on the receiving end of payments to immigrants.

While the emergency of immigrants who are net receivers of money from the state may lessen somewhat support for the welfare state among the native born, this will be compensated by the support for the welfare state from the immigrants themselves.

I am also generally a bit less optimistic than Munkhammar that the European social model is doomed. In part because I do not share his view that increased ethnic diversity will lower support for the welfare state, but also because the strong popular support for the welfare state will make politicians more inclined to resort to ad hoc solutions that do not mean a significant lowering of the burden of government.

Sweden's centre-right opposition is a perfect example of this, as they pledge they will not make any significant spending cuts (and indeed increase spending on some areas, such as government services and foreign aid) and that most of the tax cuts they offer will be financed by other tax increases. These ad hoc solutions , such as the lowering of payroll taxes in a few targeted service sectors are designed to deal with the above mentioned problem of the greater impact of taxation on the service sector.
But these ad hoc solutions, apart from creating other distortions will of course mean that the social model is preserved.

While the economic pressures discussed above is likely to mean that a few modest free market reforms and ad hoc solutions will be put into place, the basic social model is unlikely to disappear until we either suffer a really serious economic downturn (which however could also result in a move to even more collectivist solutions) or advocates of liberty are better at reaching out and changing the general mentality of a significant number of people. While Munkhammar's book is again not perfect, it is still the best book so far published on the issue of Euro-socialism and for that reason one which could contribute to the needed change in mentality.


Anonymous Anonymous said...


A great post indeed. I have never commented here before and actually not seen anyone else do it either, but I keep coming back to read the blog. The blog is highly recommended reading. Keep up the good work! :)

Anyway, about the doom of the welfare state, do you not think that tax competition within the EU might doom the welfare state in due time?

If not outright doom, then at least reduce it significantly to a level where it can be competitive.

This assumes of course tax competition will not be limited within the EU, tendencies we have seen recently.

One last question, do you not think that tax competition between states in the USA is part of the reason why taxes are kept low or is it really all a question of mentality?

12:55 AM  
Anonymous Tom said...

A couple of comments:

First, the existence of an informal market for services appears to contradict Baumol's disease, since it means lower prices for equivalent services. But perhaps I'm misunderstanding the concept. Also, somewhat reluctantly, I might ask if moving services to the private sector will alleviate the problem of poor improvements to productivity? (It seems a more direct cause is the lack of accountability, and thus parsimony, that stems from public funding. But also, in some cases, rising demand or requirements.)

However, one should note that services can be, will be, and are outsourced/offshored today, up to and including health care. This is another way to reduce their costs. Privatization would hasten this process, which is one argument in its favour.

Second, to what extent do you think competition with our neighbours will change the game? Extrapolating growth rates, it seems for instance that Estonia will catch up with Sweden on a per-capita basis (PPP adjusted) in a decade or so. They will, of course, catch up with our one-million strong non-working lumpenproletariat some time before that. The external pressure of the EU, as sclerotic as it is, may provide a desirable impetus for reform in this respect.

11:12 AM  

Post a Comment

<< Home