January 23, 2007
European corporatism needs to embrace market-led change
Why did the economies of continental Europe fail to converge on the US after their brilliant post-second world war resurgence and then, more recently, start falling behind again? Why are they mired in high unemployment? What do these facts tell us about their economic model? Last year’s Nobel laureate, Edmund (Ned) Phelps of Columbia University responds by arguing that continentals have chosen the wrong system: corporatism. As Prof Phelps noted in his Nobel lecture, he starts from a rejection of orthodox neoclassical economics. This, he insists, abstracted from the “distinctive character of the modern economy – the endemic uncertainty, ambiguity, diversity of belief, specialisation of knowledge and problem solving”. A central distinction, argues Prof Phelps, is between capitalism and corporatism. By capitalism, he means a system of free enterprise that embraces and motivates entrepreneurship. By corporatism, he means a system in which businesses have to negotiate change with the government and “social partners”. The remainder of Martin Wolf’s column can be read here (FT.com subscribers only). Discussion from our guest economists is free.
Willem Buiter: I would like to raise two issues, both motivated by Martin’s discussion of Ned Phelps’s Nobel critique of European corporatism - the system under which businesses have to negotiate change with the government and “social partners” and other stake holders. I broadly share Phelps’s analysis of the strength of corporatism as a socio-economic institutional arrangement that was historically adequate for catching up with the post-World War II economic leader (the US) and the failure of corporatism as a mechanism for moving the frontier through innovation.
There is, however, a key problem with corporatism that should be brought out more clearly. The social partners and stake holders that are part of the negotiation process are the insiders – those who have power and influence – established firms, organised labour and, increasingly, some privileged NGO and other civil society elites. The arrangement encourages the further marginalisation and weakening of those outside the charmed circle of the insiders, unless the government somehow speaks and acts for them. In some key instances, governments in continental Western and Eastern Europe have failed to do so. This applies with special force to the unemployed, and specifically the young new labour force entrants and the long-term unemployed (racial and ethnic minorities are another example). Rather than providing these outsiders with the means to compete effectively with the insiders, by removing artificial obstacles to their capacity to challenge and undercut the insiders, governments have bought their acquiescence through relatively generous unemployment benefits and other bribes. The culture of dependency thus created destroyed the human and social capital of the unemployed and other marginalised groups and turned them into quasi-permanent outsiders. In the labour market, continental European corporatism, in practice, has been the triumph of the incumbents – the strong, the organised and the well-connected – over the outsiders – the would-be challengers, that is, the weak, unorganised and socially isolated.
The second issue I wish to raise concerns the (correct) statement in Martin’s article that in the early 1990s, only 75 per cent of those of working age in France and Italy were in employment, against 87 per cent in the US. Taken in context, I take the clear implication of this observation to be that a higher labour market activity rate means greater economic dynamism and is a good thing. I am worried about the widespread shift in policy emphasis from minimising involuntary unemployment (undoubtedly a good thing) to maximising employment. I oppose, on broader efficiency grounds, this new Stakhanovite ethic that makes maximisation of labour supply an objective of economic policy. The length of the working week, the labour force participation ratio, the active/inactive ratio are viewed as indices of economic health, and fewer vacation days are considered evidence of virtue and industry.
People should, of course, be able to work any number of hours they want to work, as long as they can find a willing taker for their services, unconstrained by crude quantitative constraints like the Working Time Directive and other administrative and regulatory encumbrances. It is, however, clear that the socially competitive nature of much of our consumption of market goods means that in the rich, developed world, people will tend to work too much and to spend too little time with family and friends (if they have any). As Richard Layard has pointed out, when well-being depends on your relative consumption of market goods and services (that is, your own consumption relative to the average in your reference group), taxing labour income may well be (up to a point) an efficient way to correct the externality associated with excessive labour supply and excessive consumption of market goods and services.
Another example of the overvaluation of market activity relative to non-market activity (such as looking after your own children) is the flood of incentives driving single parents of even very young children into the labour market, with too little regard for the value of the services they could provide at home. Just as societies are unlike to get rich when people take in each other’s laundry, they are unlikely to become more productive by opening crèches to mind each other’s children.
Posted by: Willem Buiter, London School of Economics | January 29th, 2007 at 2:24 pm | Report this commentProf Edmund S. Phelps: My recent thesis on the economic symptoms in continental Europe, reviewed by Martin Wolf in his article “European corporatism needs to embrace market-led change”, says that elements of its economic institutions and its economic culture make the Continent less productive in innovating and less receptive to innovation than are the US, Canada and possibly the UK. Further, this defect in the Continent’s economic model, more than the side-effects of its welfare spending, helps to account for the generally lower marks in productivity, labour force participation, unemployment, employee engagement and job satisfaction. Demurring on the latest chapter in this story, Lance Taylor writes (FT Letters, January 26) that the big European economies failed to participate in the information and communications revolution because the requisite computer and transistor technologies, which the US public sector spearheaded, were less well understood on the Continent than in the US, not because of its corporatist institutions and culture.
Even if the US had a jump start on the Continent owing to earlier state support for new technologies, the larger thesis would be untouched by this added observation. It remains true that productivity was increasing at a blistering rate in the 1930s - despite the Great Depression - while the newly corporatist German and Italian economies, no longer encouraging and relying on private entrepreneurs for new directions, fell more and more behind (as Hitler famously observed); that it was only in the mid-1950s when the big continental economies began their 20-year and some catch-up; and that when in the early 1990s they came close, thanks to the long US slowdown, their productivity levels still lagged behind the US, which remained the main source of innovation, and their employment levels had fallen back.
Even with regard to the continental slowdown and resurgence of unemployment in the 1990s, to which Mr Taylor offers his explanation, I believe that the relative difficulty that the private sector on the Continent has in hitting upon, funding and developing new commercial ideas, and the relative unreadiness of continental consumers and managers to embrace new products and services, go far towards explaining how the US came to get such a large jump on the Continent in the IT revolution. It was one thing for the Continent in the 1960s to copy US innovations that had been around for two or three decades, another to play a cutting-edge role in the 1990s revolution.
Finally, it would be hard to deny that the readiness of US consumers and managers to embrace the new and, consequently, the profitability for US companies of developing the new technologies had a lot to do with the success of the US in creating the required computer and transistor technologies.
Posted by: FT Economist Forum | January 31st, 2007 at 10:00 am | Report this commentMartin Wolf: Willem Buiter has raised two very different, but important, points on my column on Ned Phelps’ ideas. I hope Ned will himself respond. My response to the first - that corporatism has favoured insiders over outsiders - is one of whole-hearted agreement. It is one reason why European countries have found it relatively difficult to integrate immigrants.
My response to the second point is also one broad agreement. I certainly do not believe that employment is an end in itself. People should be allowed to make their own choices, as Willem argues. But the regulatory and tax structures of Europe prevent people from making those choices freely. This needs to be changed. Moreover, if we agree with Richard Layard (personally, I am unpersuaded), we are already penalising the “bad behaviour” of competitive workaholics through progressive taxation. I do not believe we need to do any more to discourage excess labour supply.
Posted by: FT Forum - Martin Wolf | February 4th, 2007 at 10:31 pm | Report this comment