European social protections are not just morally wrong, but also economically nonsensical.
One of the reasons Continental governments resist letting go of the “European model” is that some intellectuals keep telling them that it’s economically viable. A school of thought maintains for example that the existing intricate network of social protection is not only morally good because it levels off sharp inequalities, but can be efficient too. This is an important argument to hang on to when the rest of the world seems to be going in the opposite direction. With free trade and a single European currency making protectionism and competitive devaluations more difficult, the “European model” is coming under threat. What better salve than to tell yourself that it’s good economics?
An example of this type of intellectual succor for the European model came recently from the influential National Bureau of Economic Research. Richard Freeman has argued that the “European model” has nothing much to fear, for the effect of social protection on economic efficiency is, broadly speaking, neutral. If this is a correct view, it is vastly important. If it is not correct, it is important to say so and to find the source of the error. Let’s explore the issue.
Mr. Freeman’s main claim is that productivity growth is on the whole no higher in countries with flexible labor markets than in those with regulations that gum up the system. His explanation is ingenious, and goes to the heart of our social system. I also believe that it is seriously wrong.
‘Owning’ One’s Job
Invoking a famous theorem enunciated by the British Nobel laureate economist Ronald Coase, Mr. Freeman reminds us that, with freedom of contract and low transaction costs, an asset will end up in its most productive use regardless of who happens to own it initially. Now, a job protected by administrative controls over hiring and firing, by a closed shop or other union restrictions, or by “lifetime employment” traditions, can with some exaggeration be regarded as “owned” by the employee. A job unprotected by such “workers’ rights” devices is “owned” by the employer. He can freely dismiss his employee, close down the job or fill it with someone else.
Suppose the employer wants to “close down” one job because, by reorganizing the shop or the office, he can get the work done by one fewer employee. If he “owns” the job, the marginal employee is fired and the employer pockets the productivity gain. If the worker “owns” his job, he cannot be dismissed.
However, in Mr. Freeman’s scenario, the employee will agree to be “bought out,” for he will not value his lifetime job any more than the sum the employer can save by getting rid of him. Consequently, he will go, the productivity gain will take place, and it is the departing worker who will pocket it in the form of a lump-sum severance payment. Under this version of the script, the distribution of income will be tipped in favor of the employee, but the progress of productivity will be exactly the same. The economy benefits equally.
Except that it is hard to see why a worker should never value the chance of preserving his job more highly than the productivity gain his employer could obtain by firing him. If he does not give up “his” job, the script will not play well. Numbers of unproductive workers are liable to stay in their jobs. Productivity gains will be forgone due to the “ownership” of jobs being vested in the workers. This is labor market inflexibility.
Yet this is not even the major source of error in the thesis that the “European model” is neutral in its effect upon economic efficiency. Let’s say that the unproductive employee does always agree to depart, taking with him a capital sum representing the present value of some or all of the productivity gain his departure generates. Let us suspend judgment about what such a shift might do to efficiency, not to speak of entrepreneurial incentive. We’re still left with the irreducible hard core of the error in the whole neutrality argument.
If every employee has two prospects – keeping his job until he retires, or leaving it early with full compensation – this means that everyone starts their jobs with an insurance policy providing either an annuity or a capital sum. The policy is paid up by the enterprise. It makes no difference to the outcome whether the premiums are paid to a government body, a private insurer or if they’re accounted for as a reserve on the enterprise’s own balance sheet. They are payable whether productivity gains are forthcoming or not. They are obviously a cost that tan be avoided by not hiring labor.
Offering job-loss insurance as part of a worker’s compensation is no different from offering any of the other guarantees that make up the arsenal of social protection under the welfare state, guarantees that today in Europe are not freely negotiated between labor and capital in employment contracts, but are imposed upon them by law. Job security is but one part of the far wider and more general range of protective measures that make up what interested parties like to call the “European model.”
Who Pays the Insurance?
Who “really” pays the premium on the various kinds of social insurance that the welfare stale has decreed to be an obligation to provide as part of a worker’s entitlement? Ostensibly, in addition to his cash wage, his employer pays the insurance. But could the employee demand instead to have the cash rather than see it paid over as premium on voluntary social insurance polices? If he had the option to take the cash instead but did not, the employee would in effect be a consenting, voluntary buyer of social protection, willingly paying its cost.
Clearly, however, the employee is given no choice in the matter. The cost the employer incurs is of some benefit to the worker. But if the worker must be denied the option of giving up the insurance, something is surely getting cost somewhere. The employer provides social protection at a cost he can’t escape, but the worker who would rather take the money can’t – legislators have wished on him a benefit that is worth less to him than it cost his employer to provide.
Though there are some minor differences, in its sheer wastefulness and value-destroying capacity, this is nothing but the old “truck” system of forcing workers to accept wages in kind rather than cash. Truck was repeatedly outlawed as oppressive to workers, while social protection is on the contrary imposed by politicians who say they want the best for the workers.
This deadweight of social overhead, owing to the cost of protection being higher than it is worth to the intended beneficiaries, is hard to assess. A fair guess would put it somewhere between “significant” and “colossal.”
There is no call to be upset about the sacrifice of some efficiency for the sake of something more worthwhile. But when the main fruit of the sacrifice is chronic unemployment with all its corrupting consequences, it is urgent to reconsider the merits of the “European model.” At all events, the illusion that it is neutral and innocent must not be indulged.