When growth and social protections clash

Oct 28th 2005
From The Economist Global Agenda

Tony Blair wants Europe’s leaders to back reforms that would make the region’s economies more dynamic. But there is still deep disagreement over how best to balance growth and social cohesion

“A COMMITTEE”, said science-fiction writer Robert Heinlein, “is an organism with six or more legs and no brain.” Pity Tony Blair, who on Thursday October 27th was trying to herd a committee with 50 legs towards a conclusion, as the leaders of the European Union’s 25 member states convened for a one-day summit at Hampton Court, near London. Though the meeting was an informal one, the British prime minister was hoping to hammer out solutions to some of the contentious issues that have bedevilled the cause of “ever closer union” in recent years.

Mr Blair assumed the six-month presidency of the EU in July with great hopes, as fate conspired to hand him the leadership of Europe and the Group of Eight rich countries at the same time. The G8 summit held at Gleneagles in early July produced substantial progress on his push for African debt relief. So far, however, his EU presidency has been disappointing. In part this is because he assumed it at an inauspicious time, just as voters in France and the Netherlands were giving the European project a big thumbs-down by rejecting the EU’s proposed constitution—and just as Europe’s bureaucrats were heading off for their traditional long summer holidays.

Moreover, the EU still has not even come to agreement on its next budget, thanks to a row between Britain and others, particularly France, over the partial rebate Britain receives on its contributions. This was negotiated by Margaret Thatcher to mitigate the effects of Europe’s Common Agricultural Policy, which had left Britain, with its relatively modest agricultural sector, making disproportionately large contributions to the EU’s budget. At a summit in Brussels in June, Mr Blair linked negotiation of the rebate to reform of the CAP. This went down badly on the continent and the summit ended with no agreement.

Nor have Europe’s leaders resolved their long-running disagreements over how to balance economic growth and the social safety net. Five years ago, the EU launched the “Lisbon Agenda”, which was supposed to turn the Union’s economy into the world’s most advanced by 2010. So far, however, there has been little reform, and the European economy is falling behind those of its peers. Growth has consistently lagged behind America’s in recent years, particularly in continental Europe, where unemployment rates often hover near double digits (well above 10% in the cases of Germany and Belgium). Joblessness is above average among the young—the very people whose dynamism is sorely needed to support the EU’s rapidly ageing population.

But the generous safety nets that ease the economic pain of Europe’s citizens are also exacerbating it. Heavy government interference in the labour market to protect workers has made employers reluctant to create jobs, for fear of hiring incompetents who cannot then be fired. Generous employment benefits encourage laid-off workers to continue seeking jobs in dying industries rather than train for something new. Lavish pension systems allow them to step out of the labour force long before old age would force them to retire, leaving a heavy burden on the workers that remain. And social-security systems may even be contributing to the coming demographic crunch. Recent research suggests that generous retirement benefits may result in fewer babies being born, since people no longer need children to insure against an impoverished old age.

This has led to a clash between those, like Mr Blair, who believe that Europe’s problems are a clarion call to free up markets and liberalise trade, and those who believe that the answer is for European governments to band together to stamp out competition from wayward members. “Harmful tax competition” has been a recurrent theme of such arguments, with a particularly baleful eye cast towards Ireland and its 10% corporate-tax rate. Such concerns were also behind the stalling earlier this year of a directive that was supposed to open markets for services to the same free flow enjoyed in markets for goods. This would help advance the Lisbon Agenda and foster the deeper economic integration necessary to make the euro zone a sustainable currency area. But it has foundered on fears of a flood of Polish plumbers and Hungarian hairdressers flowing west, undercutting high domestic wages. Mr Blair tried to revive the directive at the summit, but getting an agreement on it will be tough going.

France has led opposition to the “Anglo-Saxon” economic model, fighting tooth and nail to prevent any further competitive encroachment on its markets. French manoeuvring in recent weeks blocked Peter Mandelson, the EU trade commissioner, from making sufficient concessions on agricultural protections to satisfy his counterparts in the current Doha round of world-trade negotiations. Given that the outlines of a deal must be settled by the Hong Kong ministerial meeting coming up in December for there to be any hope of a substantial agreement, there was a real risk that Doha might be derailed by French intransigence. France has also blocked attempts within the EU to reform the CAP, which was glossed over at the summit to allow discussion of other issues.

Nonetheless, the summit did bring some signs of rapprochement between Jacques Chirac, the French president, and Mr Blair. The British leader backed plans dear to his French counterpart's heart, such as substantial new retraining funds for displaced workers. Mr Chirac, in turn, resisted the temptation to broadcast his grievances about the effects of proposed trade liberalisation on French farmers. On Friday, after the summit ended, the European Commission announced that it would make a new offer in the Doha round on agricultural protections. The deal outlined is a substantial improvement on its earlier negotiating stance, with an average 47% cut in EU farm tariffs. This is much closer to the demands of America and developing nations, and may be enough to get Doha back on track. But it does not constitute the radical reform of agricultural policy that Britain is looking for in exchange for surrendering its rebate. So the budget battle still promises to be a long slog.

Is R&D the answer?

Writing in the Financial Times before the summit, Mr Chirac suggested another plan to revitalise the EU’s flagging fortunes: increased investment in research and development (R&D). His essay made it clear that he believes the recent rejection of the constitution was a cri de coeur from Europe’s voters to protect their precious subsidies from more competition, inside or outside the EU. Rather than radical liberalisation, Mr Chirac proposed a new investment fund to mobilise €30 billion ($36 billion) in public and private capital over the next eight years for new research and innovation projects.

Europe could certainly do with more R&D. A report released this week by Britain’s Department of Trade and Industry showed that Europe’s companies have fallen behind their American and Asian counterparts when it comes to research. According to the DTI’s figures, the top eight countries—America, Japan, Germany, France, Britain, Switzerland, Sweden and Taiwan—account for over 86% of total R&D (as measured by number of companies in the R&D Global 1000 index). But the European members of that group contributed only around a quarter of that figure. In part this is due to the sector mix—the British economy is heavy in low-R&D finance, while America dominates the development-intensive software industry. But this itself could be a sign of a problem: Europe’s more rigid labour markets may be keeping workers, and capital, from flowing to the rising new industries that invest large sums in R&D.

But are state funds really the solution? Governments have a good track record on funding basic research, but a much less glorious history when it comes to bringing products to market. And the billions in seed capital that Mr Chirac wants the public sector to inject into his proposed research initiative will run into the same reluctance on the part of big budget contributors, such as Germany, that greeted calls for funds for big new training programmes. With so many of the EU's legs running in different directions, it will remain hard for the group to get very far.

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