The Online Library of Liberty

A project of Liberty Fund, Inc.

• Introduction
• Part 1: Rights, Property, and Markets
• Property Or “property Rights”? *
• “design Faults” In Locke’s Theory of Property Taint Ownership With Guilt *
• Is Ownership a Myth? *
• How to Get a Free Lunch? Just Apply For It *
• The Problem of Contract Enforcement *
• The Public Goods Dilemma *
• Trying the Free Market *
• The Statist Legacy *
• Part 2: The Common Sense of Non-economics
• The Yakoubovich Syndrome, Or Lies, Damn Lies, and Economic Policy *
• Winning Policy Battles But Losing the War Against Economic Realities *
• Paying Ourselves More of Their Money *
• The Doctrine of “unequal Exchange” the Last Refuge of Modern Socialism? *
• Corporate Managers Are They Going to Kill Capitalism? *
• When the Economy Needs Morals *
• The Political Economy of Force-feeding *
• Hostile to Whom? *
• Mannesmann’s Courtesy Could Prove Rare *
• Part 3: French and Russian Tragicomedies
• Can Putin Build a Real Economy From Oil and Rigor? *
• Russia and the New Europe Growing Apart *
• Russia Hopping Along On Clay Feet *
• The French Tragicomedy *
• How the French “social Model” Could Self-destruct *
• A Little Bit of History Repeating *
• There Is No French Exception *
• The Hobbling of Private France *
• Part 4: The Capitalism They Hate
• The Capitalism They Hate *
• Striving to Get Richer and Poorer *
• “bread and Circuses” In the Modern Welfare State *
• Who Minds the Gap? *
• Float Or Sink? the Millstone of the “social Market” In Germany *
• How Germany and France, the Sick Men of Europe, Torture Themselves *
• Shall We Borrow From the Children? *
• Low Pay *
• Freedom to Strike Or Right to Strike? *
• Part 5: Creating Unemployment
• Stamp Your Feet and Demand a Fair Deal *
• Paternalism and Employment *
• The Things Labor Unions Are Up to *
• The Instability of the Welfare State *
• Some Bad News Could Be Good News *
• Built-in Unemployment Social Protection Costs More Than It Is Worth *
• Let ’s Throw This Model Away *
• How to Stifle Employment By “social Protection” *
• Workable Alternatives *
• A Tale of Two Models *
• A Vicious Circle of Social Kindness *
• Part 6: The Future of Europe
• The Economic Consequences of a United States of Europe *
• A Giant Free-trade Area Or a Political Counterweight to America? *
• European Crosscurrents and the Federalist Drift *
• How Confederacy Could Turn Into a Federal Superstate *
• Majority Rule By Any Other Name *
• What Now For “europe”? Why the People Failed Their Masters *
• Free-riding On the Euro *
• Some Democratic Economics *
• The Soviet Legacy *
• A War of Attrition Between Economic Reality and Political Dreams *
• A Brightening of the Economic Skies Over Brussels? *
• Turkey Knocking On Europe’s Door *
• Turkey and the Eu Club *
• Europe More Secular and More Islamist *
• A Bill of Rights Europe Did Not Need *
• Europe’s Social-democratic “government” *
• Power Corrupts, So Let ’s Make It Less Absolute *
• Part 7: Economics, True and False
• On the Economics of Protecting Employment *
• The Costly Mistake of Ignoring Opportunity Costs *
• “globalization” and Its Critics Mutual Gain Vs. Cloud-cuckoo Land *
• Are High Oil Prices a Form of Exploitation? *
• Immigration What Is the Liberal Stand? *
• More Nonsense On Stilts Mr. Bentham Is At It Again *
• Risk, Value, and Externality *

PART 5

Creating Unemployment

STAMP YOUR FEET AND DEMAND A FAIR DEAL*

Last November’s riots in the outskirts of Paris and other major cities have not yet been forgotten, but the French are at it again. The country is living up to its sorry reputation of lawlessness and violence as the accepted means for any interest group to defend itself against the facts of life. When truckers find that freight rates do not pay, they block the highways and blockade the refineries. When fruit and vegetables are too cheap, growers overturn supermarket shelves and spill cargoes of Spanish fruit into the ditch. Imports of Italian bulk wine are treated with no greater respect. When the tobacco tax goes up faster than usual and cigarette sales dwindle, tobacconists threaten the government with revenge, and receive compensation. Schoolchildren respond to poor marks or words of blame with beating up the teacher; real little revolutionaries stab her. Hardly a week passes without a futile demonstration or factory occupation where layoffs menace. Such resorts to violence are routine and pass almost unnoticed.

Many observers, including President Chirac, are convinced that the French are ferocious by temperament and must be treated with kid gloves, for if their violence is met by violence, mayhem and civil war will break out and blood will flow in the gutters. France has one of the world’s largest, and very efficient, riot police, the CRS that, however, is hardly ever used in politically sensitive conflicts for fear that worse might ensue. In his eleven years as president, Mr. Chirac has never faced down street crowds and has been especially quick to capitulate when all too necessary school and university reforms were met, as they always were, with protests by students and their teachers.

The obvious result is that street crowds have in fact become ferocious and the young self-willed and intractable because they have never been resisted or punished. Every interest group has learned the lesson that it always pays to stamp their feet and shout “boo!” for the government to cut and run.

Currently, the young are at it again, with over fifty out of eighty-four universities paralyzed by small groups of militants who shut out the bulk of the student body. High schools are joining in the fun. Eager commentators are promising that it will be the May 1968 youth “revolt” all over again.

French unemployment for the under-twenty-five age group is 23 percent compared with an average of under 10 percent. French labor law is among the most elaborate in the world. As I write this, it is 2,632 pages long and is growing longer almost by the hour. It is aimed at ever tighter job protection. Laying off employees has become very difficult. It can be prohibitively expensive and may involve batteries of labor lawyers litigating endlessly while the employees in question draw their salaries. The obvious result is that business fears the risk of getting caught with labor it no longer wants. Firms are reluctant to hire anyone, let alone the untried and untrained young. To get round this, the government has just amended the labor law, which permits employers to dismiss under-twenty-five-year-old workers (who have not been previously employed) without specific justification during a two-year period, though with normal notice and fairly generous compensation. Not unreasonably, the government argues that even if the young employee is not retained beyond two years, she will have gained work experience, learned the habit of getting up in the morning, and become more employable. In any event, two years in an insecure job is better than the mortal boredom of idleness. It is against this relaxation of the labor code that French youth is now stamping their feet and shouting “boo!”

As the Latin dictum has it, poeta non fit sed nascitur—“One is not made, but born a poet.” We owe another version of this truth to Milton Friedman. When he was asked whether the study of economics was a good thing, he allegedly replied: Yes, it can be useful, but you have to be an economist to start with.

Some nations have economics in their basic culture and indeed in the way their mind works. They instinctively understand opportunity cost, scarcity, they know that you cannot have it both ways, that you do not create more jobs by making labor more expensive, that the state can give to Peter only what it takes away from Paul, and that there is no free lunch. English-speaking nations, the Scandinavians, the Dutch, and to some extent the Germans are economists in this instinctive way. It has just been proved that 68 percent of the French are, at no little cost to themselves, not economists. The proof lies in a recent nationwide poll, which showed that 68 percent of the French wish the new legislation for promoting youth employment to be revoked without further ado.

It stands to reason why. You only have to ask the right questions. They might go something like this:

Are secure, permanent jobs not better than insecure temporary ones? (Yes, they are much better.)

Is it fair to allow an employer to give his employee notice without sufficient grounds? (No, it is grossly unfair.)

Does a business need two years to decide whether a young worker is worth being made permanent? (Of course it does not, a month or two should do it.)

Can you expect the young to respect the law and behave responsibly when it is treated without due respect? (No, it is only normal that the young cut up a little rough and one cannot blame them.) And so forth. Small wonder that 68 percent agree with answers of this kind.

Public choice, a study that combines economics and politics, teaches that what is happening in France is perfectly rational and intelligent. Ninety percent of the working population is in more or less safe jobs, and within that vast majority there are public service employees (notably in the state railways and in Électricité de France) and union officials who are doubly safe and enjoy privileges. They fight tooth and nail for the most restrictive labor laws and “worker rights” in an ever more elaborate welfare state, cynically sacrificing the 10 percent unemployed and the 23 percent young unemployed whom these policies condemn to joblessness. The privileged keep up a hypocritical rhetoric lamenting the fate of the jobless and the hopeless young, but this is only a fake alibi.

It would be almost comforting to believe that public choice has got it right, for rational calculation, however selfish and cynical, is not quite so frightening as sheer stupidity. Looking around him, however, this writer strongly feels that what has brought France to her present pass and what is stirring up the current minirevolt of the young is not rational calculation, but, well, the other thing.

PATERNALISM AND EMPLOYMENT*

Reading “Stamp Your Feet and Demand a Fair Deal,” the Nobel laureate economist Milton Friedman remarked in a letter to the author that he was not surprised that 10 percent of the French labor force and 23 percent of the young had no jobs, but wondered how 90 percent did have one.

Why do they? It is a good question and we do not really know the answer. In moments of despair and disgust, as one surveys all that has been done in this rich and talented country to pervert the normal functioning of the economy, combat reality, foster illusions, and make water flow uphill, one is tempted to say that the worst has become plausible and anything better is a surprise. Perhaps we should not think it absurd that all jobs should just disappear. In any case, the question now is to explain any level of employment between 0 and 100 percent, rather than minor shortfalls from the 100 percent norm.

In a centrally planned and commanded economy, the state in practice owns the workers and employs such proportion of them as it wishes. It pays them with what they manage to produce. Even if all are employed, they cannot produce much, the system is hardly workable, and too many of the potential workers have to be employed as policemen of one kind or another to keep down the rest. This “model” is now confined to the museum, though some intellectuals still hanker after it and would dust it off if they had their way.

Employment in competitive economies based on individual ownership and freedom of contract is explained in terms of equilibria in which producers and consumers are each doing the best that is feasible for themselves, provided that all or most others do the best that is feasible for themselves as well. The neoclassical model of explanation runs in terms of such equalities as the one between the marginal product of labor and the wage, between the (risk-adjusted) return on capital and the rate of interest, between the quantity of money divided by the price level and the demand for real money balances, and between consumption and abstinence rewarded by the rate of interest. Under not too implausible conditions, excess demand or excess supply is corrected, the necessary equalities are satisfied, and the standard solution in general equilibrium is 100 percent employment subject only to frictional losses.

The “Austrian model” runs mostly in different terms (though the difference is often only one of semantics) and makes less use of the concept of equilibrium, but it produces a solution that resembles the neoclassical one. In a normally functioning free economy, employment will tend to be full. In the Keynesian scheme, full employment is a special case that may or may not be achieved according to certain variables. Two of these, the level of wages and the minimum achievable rate of interest (caught in the “liquidity trap”) are inflexible and this permits equilibrium to be maintained at some low level of activity and employment. Each of these explanatory models can be, and has been, refined almost out of recognition by generations of economists as they climbed the ladders of academic preferment, but the main outlines subsist.

Enter the modern welfare state in the particular version that it took on in the main countries of continental Europe, notably in Germany, France, and Italy. With the welfare state enters a paternalistic economy that operates to shred, grind, and send down the drain some of the value it creates. A kind of paternalistic economic model might help to explain how it works and why it destroys jobs.

The ancestry of the value-grinding machine goes back to the custom in the English weaving and metalworking trades of the seventeenth century to pay workers not in cash, but in kind, usually in the very product—e.g., cloth or nails—they were making. Despite repeated Truck Acts prohibiting the practice, it survived into the mid-nineteenth century. In America, it persisted into the twentieth century in the form of the company store where workers had to spend the vouchers they were given in lieu of wages. Even if the worker was not cheated on the rate at which his nominal wage was converted into cloth, nails, or groceries, the payment of his wage in kind instead of cash deprived him of the choice of spending the wage as he saw fit, hence reducing its value to him.

The modern version of the ancient truck system, practiced on a gigantic scale, is compulsory social insurance which the worker is legally obliged to accept in lieu of part of his wage.

A schematic illustration will make it clear what is going on. If in Germany or France the cost to the employer of employing a worker for a given length of time is $100, the employer pays $20 of that sum into publicly administered health, unemployment, disability, and pension schemes on behalf of the worker. This is misleadingly called the “employer’s contribution” though it is in fact part of the employee’s wage compulsorily deducted rather than paid out to him. Of the remainder, a further $20 is deducted and paid into the same insurance schemes on behalf of the worker. This is called the employee’s contribution. Though the fact is masked by a fraudulent vocabulary, the employee in reality contributes not $20 but $40, for both contributions come out of his wages. However, what he receives in cash is only $60.

The worker is told that his wage is $80, of which $60 is in cash and $20 is in kind, namely insurance against various contingencies. He is pleased to know that on top of this, his employer is also paying $20 to make his insurance cover fuller. However, basic value theory tells us that cash of $100 is worth more to the recipient than a basket of goods—including a basket of insurance policies—that would cost him $100 to buy and that he has not himself chosen but that was chosen for him. Between the $100 cost of the insurance basket that he is compulsorily made to accept and the worth of the basket to him, the recipient loses value as it is shredded and ground to dust in the coercive social insurance machine. The lost value is subjective and cannot be readily measured, but it is a loss all the same.

The effect on employment is easy to diagnose. The demand price of labor is $100. The supply price is also $100 because the employer cannot hire labor that would cost him less, given the compulsory insurance premium included in the wage cost. However, if the whole wage were paid in cash, the supply price would lie somewhere at or above $80 but below $100 (though we cannot say precisely by how much below). At this reduced supply price, the demand for labor would expand until demand price and supply price reached equality again above $80 and below $100. It is this potential increase in employment that the compulsory conversion of part of wages from cash into kind (i.e., into “social” insurance) prevents. Putting it the other way round, moving from payment in cash to payment in kind destroys jobs by forcing up the supply price of labor.

The paternalist takes the view that social insurance must be compulsory, for workers would otherwise not insure themselves. This is a vast topic that offers no simple answers except possibly the moral one that it is wrong to deprive workers of the freedom to spend their wages as they choose. It is highly likely that while some would insure themselves, others would not, and to this extent the paternalists are right. In the longer run, however, they would be less and less right, for bitter experience would gradually ingrain the insurance habit and buying some cover suited to personal circumstances would become part of standard behavior.

In the meantime, compulsory social insurance keeps the cash cost of labor way above the supply price of labor that would obtain if the wage were paid in cash rather than kind. In the gap between the two, value disappears and chronic unemployment becomes the equilibrium in which the economy of welfare states maintains itself. It is a copper-bottomed bet that neither the paternalists nor the workers they treat as children realize the reason why this is so.

THE THINGS LABOR UNIONS ARE UP TO*

“Unions protect the worker on the shop floor.” “Unions foment strikes.” “Unions are the indispensable channel of communication between management and labor.” “Unions promote the interests of a blue-collar elite at the expense of nonunion workers and the really poor.” “Unions make for orderly industrial relations.” “Unions conspire with big business to rip off the consumer.” “Unions are an outdated relic of the smokestack era.” “Unions carry the workers’ cause from the bargaining table to the political arena.”

None of this is wholly false, but none reveals much of the chain that links effects to their causes. The difference unions can make to a society is one of the most complex and emotionally tainted byways in political economy.

At the level of the single firm, organizing the employees in a stand-alone union not affiliated to a larger body has effects on wages and nonwage relations. Prior to being organized, employees get the “rate for the job” according to local custom. The ultimate origin of custom lies in acts of individual bargaining that establish the area or band of ready acceptability. To change this, the union must be strong enough to discipline its own members so they will only work at the rate negotiated by it on their collective behalf, as well as to discourage nonmembers from free-riding on the union’s efforts. The bluntest way of achieving this is the closed shop.

Where the closed shop runs into strong opposition in the community because it violates the freedom to work, the union can still achieve its objectives if it can browbeat nonunionized employees into not under-cutting it and to support strike action if need be.

For collective bargaining to have a real point, it must achieve wage rates and nonwage conditions more favorable to the employees than the customary rate. It is difficult to verify whether it is really achieving this. Attempts can be made to compare the union rate with rates in nonunionized shops, but for these comparisons to be convincing, all other things must be equal, and of course they seldom are. All in all, however, it is reasonable to hold that unions can raise the wages of unionized labor. They also make wage rates more uniform and less flexible. This would tend to make the wage contract less efficient, equating the firm’s demand for labor to its (local) supply at a lower level than would be the case under less uniform and more flexible wages.

Higher average wages reduce the firm’s profit, lower its output, and raise its prices. How much of each depends on the nature of competition. A special case is conceivable where the firm continues to sell the same output at the same price under perfect competition, but what Alfred Marshall called its quasi-rent gets transferred to its workers. It is this case, in the form of a subconscious dream, that inspires much of prounion sentiment.

Everything becomes more complex and harder to disentangle when labor organization becomes industrywide, let alone nationwide. If wages are pushed up across a whole industry, prices may well follow suit all the way, since there is little or no competition to hold them back. Consequently, profits may be largely maintained. Most or all of the impact falls on the nonunionized sector, which operates under competitive conditions and cannot raise its prices. Therefore its terms of trade will worsen and its profits and employment levels shrink. The pressure will be mitigated and dispersed if capital is mobile and migrates, taking jobs from the unionized to the nonunionized sector, as it did in the United States when it migrated from the Northeast to the Southeast and Southwest, and as it is doing in Europe when it is “exporting jobs” to China, Thailand, and India.

Unionization also shifts the terms of trade in favor of (some) producers at the expense of (all) consumers. This is a common symptom found in all corporatist social organization, guilds in the Middle Ages, chambers of industry in Fascist Italy and Nazi Germany, and labor unions in Western democracies.

Looking at how matters may evolve over time, it seems that in the short run profits and employment in the economy as a whole may suffer but union wages may increase. Unions, then, will have acted to good purpose from their members’ point of view. However, since a far higher proportion of profits than of wages is saved, capital accumulation, productivity, and growth should all be reduced. The long-run damping effect on wages should eventually swamp the short-run boost unionization can give them. Yet like all elected officials, union leaders cannot afford to worry about the long run.

Analyzing the manner, purpose, and effects of union action in largely economic terms is a good enough approximation to American conditions. American political culture accepts capitalism as the best of possible worlds. It finds it normal to think of wages as the price of labor and of labor as one of the several factors of production. In most of Europe, this is either not understood, or if understood, it is rejected. For several generations, the political classes and the teaching professions have taught the people that labor was not an economic, but a “social” category, deserving of higher consideration and a different treatment from the mere economic.

It is something of a philosophical puzzle to decipher what is meant by the word “social,” though it is used confidently enough to suggest that it has a clear meaning. One key to understanding policy and politics in most European countries is to take it that “social” indicates that the matter in hand imperatively demands a political decision to override any market solution that would otherwise emerge.

It should be no surprise, then, that European labor unions are really political organizations, straddling the economic and the “social,” closely allied to left-wing movements, and permanently camping in the “corridors of power” of all governments whether left or right. Their interest is as much to “change society” as to negotiate good wages and conditions for their members.

An exception to most of this is Britain, where the Thatcher reforms of the 1980s have transformed the union landscape. “Official” strikes now require vote by secret ballot, picketing has been curbed, the most glaring legal immunities of the unions have been removed and the rule of law enforced. After the chaotic disruption of the 1970s, Britain has since these commonsense reforms enjoyed unprecedented industrial peace and a clear lead in prosperity over most of continental Europe, where governments of all shades sought to appease and share power with the unions.

Like in most of the industrialized world, union membership in Europe has been declining for decades. But it is not numbers that make for union strength. Union membership as a share of the labor force is over 80 percent in Scandinavia, in the mid-20s in Britain, Germany, Italy, and Spain, and only 8 percent in France, with virtually zero in the private sector. Yet if you guessed that it is in France that the unions have the tightest armlock on the government, you would not be far wrong.

Of the four largest French unions, the largest is the CGT; it is orthodox Communist. The third and fourth largest are the FO and SUD, both of Trotskyist persuasion. Only the second-largest, CFDT, is moderate. The CGT has a mere 670,000 members. However, they are concentrated in the state-owned railways, the Treasury, and the public schools. The CGT can stop all the trains, disrupt tax collection and government payments, and shut the schools. While the latter might not unduly upset the government, the former two fill it with visceral dread.

Led by the CGT, the unions keep on refusing a spate of long-overdue reforms of all kinds, condemning them as “neoliberal.” The government either keeps postponing them, or withdraws them altogether if the unions cry “boo.” Having a comfortable majority in the legislature is no use; it is the unions’ consent the government thinks it needs.

Unions are supposed to live on members’ dues. In France, they cover perhaps a quarter of the budget of the only union, the CFDT, that is honest enough to publish any accounts. It is common knowledge that the bulk of union expenditure, including the cost of keeping their bureaucracies in the comfort they feel entitled to, comes from the government, some avowed, some disguised in more or less ingenious ways.

The system began in 1968 and kept growing in the fond belief that one could buy the cooperation of the unions by bribing them outright. This has never worked, but the bribes have proved habit-forming and curtailing them would drive the union hierarchies to paroxysms of fury.

Yet union strength depends on their members’ obedience, and the members follow the leaders almost entirely because the government treats them as if they were supremely powerful. There is no one to say loud and clear that they are not, that it would suffice to face them down once and for all to realize that the emperor has no clothes.

However, this is not the first nor the last time that governments fail to do what is good for them and their peoples. If failing to do the sensible thing were not their habit, this column would soon be reduced to writing about apple pie and motherhood.

THE INSTABILITY OF THE WELFARE STATE*

Stability is a property—most of the time rightly regarded as a desirable, virtuous one—of economic variables, such as price, output, demand, or indeed an entire economic system. When dislodged from its position (in statics) or from its path (in dynamics), resistances are generated that will eventually return the variable to its original position or path. The resistances that achieve this act as automatic stabilizers.

Throughout economic history, the demand for money balances—what was later called “liquidity preference”—acted as such a stabilizer. In sharp cyclical downturns, commodity prices fell, often drastically so. The real value of money balances in the hands of consumers and merchants rose accordingly, exceeding the proportion of their wealth they would normally wish to hold in cash form. Consequently, when they no longer expected prices to fall much further, they started to spend money to reduce their cash balances. The total quantity of coin and liquid paper money being broadly given, they could not reduce its nominal amount, but its value in real terms was reduced as the higher spending led to higher commodity prices as well as to greater income and wealth, until the real value of money balances again became equal to the real amount demanded.

The last time this old-fashioned stabilizer had any noticeable effect was exit from the Great Depression from about 1934 onward, though of course the recovery had other causes as well. Since World War II, economists have been, quite rightly, dismissing the stabilizing potential of the price level, since they found that average prices, like average wages, can in the modern world hardly ever move downward and that the money supply will in practice always accommodate a rising price level.

GOVERNMENT—THE PASSIVE BALLAST

Instead of the value of money, economics, in assimilating the Keynesian schema of analysis, discovered another stabilizer, the public sector. In a downturn, sales taxes fell promptly and in proportion to the drop in sales, while income taxes fell with a lag, but more than proportionately. Government expenditure, much of it fixed well in advance by legislative or contractual commitments, was maintained. As a result, the public sector pumped a maintained stream of income into the private sector but pumped a reduced tax charge out of it. The sharper was the downturn, the stronger was this effect, and the greater was the share of central and local government expenditure in the national income, the more resistant became the latter to cyclical fluctuations. The beauty of this effect was that all the government had to do was to remain passive as a heap of ballast at the ship’s bottom; no policy response was required from it, hence it could not get it wrong.

Then came, first slowly, but accelerating rapidly, the rise of the welfare state with successive Labour governments in Britain, with the social democracy of Giscard in France and Helmut Schmidt in Germany, and of course LBJ’s Great Society in the U.S. Under these governments, two things happened to the public sector. It expanded in a seemingly inexorable way as a proportion of national income, and as welfare entitlements took a growing share of it and welfare entitlements moved inversely with economic activity, government spending actually rose when the economy turned down. The automatic stabilizer became, so to speak, a supercharged turbo engine.

In the last three decades, the amplitude of economic fluctuations has in fact been relatively moderate by historical standards, though of course a large public sector was only one of the likely reasons. That initially, at least, it did have a smoothing-out role is hard to deny, even if we believe that its other, less easily discernible effects did greater long-term damage than the good stabilization may have brought us. In recent years, however, the public sector, and more particularly its welfare component, has very likely become a powerful factor of instability, pushing the system ever farther away from equilibrium once it has been dislodged from it.

“MERIT GOODS”

Goods that the political elite thinks ought to be consumed in greater quantity than they would be if left to unaided matching of supply and demand are flatteringly called “merit goods”—they are said to merit a better sort than the market would mete out to them. “Culture” is the classic merit good, and in its name concert halls and theaters are built, museums, operas, and libraries subsidized, artists kept afloat with public money. The class of merit goods can be stretched almost at will to include anything of which people might consume too little for their own good if left to themselves. Cod liver oil is a merit good, and so is saving for a rainy day and for retirement.

What the welfare state—more precisely, the version of it practiced above all in Germany and France that calls itself the “European model”—has gradually done was to replace a large chunk of everyone’s wages by merit goods. Instead of earning, say, $1,300 a week in cash, they earned $800 in cash and $500 in the form of mandatory deductions (employees’ and employers’ contributions) to pay for the foremost merit goods: unemployment insurance, health care, and pensions.

Paternalism, the inseparable satellite of the welfare state, firmly holds that if wage-earners had the extra $500 paid out to them, they would buy little or no unemployment insurance and would save too little for medical care and retirement. This may or may not be the case. What is certain, though, is that if they were paid the $500, they could spend it on these merit goods, but also on anything else they wished, so that having the $500 would never be worth less to them than the merit goods they received in its place, and might be worth appreciably more depending on individual preference and judgment. Cash of $800 plus merit goods provided by the welfare state at a cost of $500 would be worth less than $1,300 to the average worker but would cost $1,300 to his employer.

A MACHINE TO GRIND JOBS

The real cost of labor to the employer and the real remuneration to the worker are normally equal. Welfare, given in merit goods, opens up a gap between the two: the cost of the part-cash, part-welfare package to the employer rises above the real value the workers subjectively place on the package.

Real cost to the employer and real value to the employee are two jaws of a machine that grinds and destroys jobs. Unemployment that should hover around 5-6 percent gradually moves to double digits. It is now 11.9 percent in Germany, 10.2 percent in France, and 9.6 percent in Italy. These are official statistics that need some interpretation. In France, for instance, the unemployment figures do not include about 1.2 million people who do not qualify for unemployment insurance but are paid a minimum income by the state. In every country run on the “European social model,” the public sector is stuffed with make-work jobs whose sole real purpose is to keep some hopeless young people off the streets. These jobs, too, escape the unemployment statistics.

If due to some shock unemployment rises from 5 to 10 percent, but the welfare state maintains the income of the newly unemployed, there is a temporary rise in the budget deficit. However, maintaining aggregate income eventually restores employment and rebalances the budget.

Under the new dispensation of the modern welfare state, with the big job-grinder going round and round, this does not happen. The gap between the real cost of labor and what labor really receives remains rigidly in place. A double lock is, in fact, put on it because dismissing labor is now very expensive and may involve legal procedures lasting many months and sometimes years, and the employers will not hire if they won’t be able to fire. The same total income and the aggregate demand consistent with 5 percent unemployment are now consistent with 10 percent unemployment. The budget deficit, too, becomes chronic and steadily rises above the diminutive growth of the economy. In the short run, there is stability of a miserable situation, but in the longer run there is a seemingly inexorable decline that is cumulative, self-reinforcing.

Serious reform will not take place before the apparent short-term stability is widely enough recognized as creeping instability. Such recognition seems now to be dawning.

SOME BAD NEWS COULD BE GOOD NEWS*

The bad news is that despite the harsh experience of the last decade or more that should have brought home the damage done by socialist tinkering, there is still no electoral majority for a more liberal economy in “core” Europe. Crucial elections in Germany last September were supposed to sweep away the social-democratic government and install in its place the alliance of conservatives and liberals whose program openly aimed at cutting the overblown welfare state down to size and at tackling unemployment by doing away with the more absurd features of the prevailing “job protection” laws. Instead of winning the comfortable majority predicted by the polls, the center-right alliance failed to gain control of the legislature. The social democrats, the “greens,” and the hard left, though by no means united, could and assuredly would defeat any radical reform proposal. Mathematically, the only issue was a coalition government of the center-right with the center-left, capable only of uneasy compromises and half measures, and bound to preserve the essentials of the “social protection” that the electorate insisted on maintaining.

All this had a profound knock-on effect in France. The French left is leaderless, has no program, and is in disarray. The right has the majority by a wide margin. However, the right is internally divided into a mainstream and a radical reformist part. The mainstream wants to continue the postwar tradition of an anti-“Anglo-Saxon” ideology and of “social” appeasement at almost any cost. It is led by a second-term president who, contrary to his high-profile postures in foreign policy, in domestic policy never faced down a strike and never failed to give way to noisy street demonstrations. Interest groups have duly learned the lesson and have become more intransigent and menacing than their intrinsic strength would normally permit. Despite the overt and covert government subsidies meant both to strengthen and to buy them off, French labor unions are intrinsically feeble, with a total membership of less than 8 percent of the labor force, but behave as if they held all real power in the land.

Until recently, the reformist wing of the French Right looked highly likely to defeat the mainstream at the next presidential and parliamentary elections in April 2007. The result of the German elections caused all calculations to be remade and all positions to be shifted leftward. “A liberal economic program is the surest way to lose the election” has become the received wisdom.

If this wisdom is in fact true, it has a drastically simple explanation. The “average” voter, frightened by the chronic 10-11 percent unemployment rate, is desperately clinging to the system of “social protection” that prevails in Germany and France. He stubbornly refuses to see that it is the very system of “social protection” that is the main cause of unemployment.

The good news lurking behind these bad ones is that it is never possible altogether to outlaw and smother the adjustment process by which an economy pushed off balance by shocks and extraeconomic constraints, seeks to right itself. If cowardly politics shuts down one corrective mechanism, another will start up. The result will not always be as smooth or efficient as if the first, most obvious, mechanism had been allowed to work, but adjustment will still take place, albeit in roundabout and costlier ways. The Soviet Union had banned profit-and-loss and frozen the price system. In their place, much of the work of resource allocation shifted to queues, black and gray markets, and the sort of corruption that spreads when direct ownership interest is suppressed or overlaid by principal-agent relations.

With all adjustment mechanisms intact, unemployment depresses wages, which in turn stimulates rehiring. As capital’s appetite for hiring labor increases, investment using standard technology to create work-places expands. Expansion continues till the demand for labor lifts wages sufficiently to arrest the process. Throughout, there is a sort of pendulum movement between the share of profits and the share of wages in national income. More appetite on the part of capital to hire labor boosts the share of wages and reduces the share of capital—as used to be the case in the 1960s and ’70s when employment was still near to full.

What happens instead in the Franco-German welfare state “model” of today? Companies do not hire, because under “job protection” laws they may not be able to fire should it become advisable to shed labor. It is extremely difficult to reduce wages or tighten working conditions; indeed, there is pressure from the government and the media to do the opposite. Everybody would like to cut costs by shedding labor when this is feasible. German companies now manage to do it, but the cost is fearful; Daimler Benz is providing 960 million euros to fund the cost of letting go 8,500 workers from its plants in Baden-Württemberg. In France, even high severance payments may not permit payrolls to be cut. Hewlett Packard intended to reduce its work force in Grenoble by 1,250 persons, mostly by natural wastage over two years. Because the company was profitable in its worldwide operations, there was outrage at this manifestation of ruthless and shameless greed. President Chirac called upon the European Union to intervene, there was a barrage of accusations against the management, and Hewlett Packard eventually back-pedalled some of the way. The example can only encourage other companies to shed labor when they can get away with it at an affordable cost, and in any case not to create new jobs.

However, there are exceptions and they also tell a tale. Toyota did create several thousand new jobs in northeast France. Its president is reported to have said that he chose this location in preference to England because English workers do not fear for their jobs and will “talk back,” while French ones are so intimidated by the surrounding unemployment that they are easier to handle. Unions are highly aggressive in the public sector but hardly ever strike in private industry.

Despite such exceptions, the overall tendency is to refrain from hiring and fire (or “delocate” to eastern Europe, India, or China) when one can get away with it. Manufacturing employment is now 22.5 percent of the total in Germany and 15 percent in France, still way above the American and British figure of 10 percent, but falling. Investment has a strong labor-saving bias as companies are reaching out for new technologies. Instead of “widening” it, the stock of equipment is being “deepened.” As the nineteenth-century Austrian economist Böhm-Bawerk would have put it, the “period of production” is lengthening (without necessarily taking more time).

The irony is that to relieve unemployment, it is precisely “widening” and not “deepening” that would be needed. It is “widening” that the normal corrective mechanism of falling wages and the ensuing demand for labor would have produced.

What the roundabout adjustment mechanism permitted by the counterproductive policies of the Franco-German “social model” is bringing about is bad for employment and bad for wages in the short term. In the long term, however, it may prove to have been a great leap forward. Sooner and faster than would have been normal, it forced the “core” European economies to adopt technologies appropriate for tomorrow’s economies that are short of labor—an unexpected achievement for countries suffering from double-digit unemployment. It greatly accelerated their exit from traditional manufacturing industries and their transformation into service economies along much-maligned Anglo-American lines—another unexpected by-product of the European “social model.” Whether lagging growth, unemployment, and rising national indebtedness are prices worth paying for this result is of course an open question, but at least these prices are not being paid only to keep up the futile illusion of “social protection.”

BUILT-IN UNEMPLOYMENT

SOCIAL PROTECTION COSTS MORE THAN IT IS WORTH*

A generation ago, unemployment was understood to be a cyclical phenomenon, not quite as regular as the four seasons of the year but rather like periods of wet and cold following periods of balmy sun. However, unlike the weather we could not change, we have found ways that promised to give us control over unemployment. We were taught that the awful years of the 1930s need never return. We could largely smooth out fluctuations in activity by commonsense methods of demand management. Fiscal and monetary policies, with an occasional nudge from exchange rate manipulation, were powerful enough to prevent major swings, while the human cost of the minor ones that could not be avoided was alleviated by social insurance, a small burden society could easily bear and broadly approved.

Those confident times are gone—it would seem irrevocably so. By the mid-’70s, “smoothing out” ceased to function as the books said it should. Unemployment became significant again, and its social cost began to be felt. By the ’90s, both economic and political alarm bells started to keep up a shrill music, social safety nets were spread in haste, shedding labor was made ever more difficult in order to keep the employed at work, but blocking the exit discouraged the entry and the unemployed numbers went on rising. Today in Germany and the other core countries of the euro-zone, for every ten or eleven members of the active population, one is out of work. Though some of those are suspected of not trying very hard to get harnessed, there is little doubt that the bulk is involuntarily idle. For a little green man just landed from outer space, this situation must be wholly incomprehensible. For us, it is a matter for shame, a proof that we have ruined a mechanism of economic adjustment by trying to fix it. Unemployment looks to have become endemic, stable. What makes it so grave is that no realistic observer expects it to be reversed in the foreseeable future. Something must have gone very wrong.

Let us shift the perspective for a moment. Between the fifteenth and seventeenth centuries, when wage labor in industry was in its infancy in England and the money economy was displacing payment in goods, the payment of wages in kind was fairly widely practiced and just as widely detested. In handloom weaving, framework knitting, the making of nails and other hardware, though nominally there was a customary wage fixed in shillings and pence, many masters paid their men in kind, choosing goods they could procure cheaply, goods that were a little shoddy, or indeed some of their own products. Two griefs were felt by the workers against this “truck” system. The basket of goods they got instead of the money might be counted by the master at more than it cost him—he made a profit out of imposing payment in natura. But even if he gave full value, the basket of goods was worth less to the worker, because he lost the freedom to buy exactly what he wanted in the exact quantities that most suited him. He was deprived of the advantages of a money economy and the value of consumer choice.

Parliament tried to outlaw this practice by Truck Acts in 1604, 1621, 1703, and 1831. Ordinary market forces helped more than legislation to do away with truck, for the best workers could only be hired for cash wages. Nevertheless, as late as 1871 a royal commission into truck still found cause to condemn the “outright compulsion” involved in the deprivation of consumer choice. A lesser degree of compulsion subsisted in the United States into the 1930s, especially in the mining industry, where some wages were paid in “company scrip” the miner could only spend in the company store. By and large, however, truck as a substitute for money wages has withered away before World War II . . .

. . . Only to be reborn, a thousandfold bigger, in our day.

And, as the saying goes, this explains that.

A German worker earning, say, 3,500 euros a month is paid about 2,100 euros in cash before income tax. The remaining 1,400 is paid directly by him or indirectly on his behalf by his employer in premiums into various social insurance schemes, notably against sickness, accident, disability, old age, and unemployment. Generally, the greater part of the premium is called an “employer’s contribution,” the smaller his own contribution, but it has all been earned by his work. Though purely formal, this distinction between the two contributions has some psychological significance—it tacitly suggests that the employer gives the employee some kind of extra bonus on top of the wage. In reality, all social insurance premiums represent money that is the counterpart of the employee’s work but that he does not get to take home and spend as he and his wife would choose.

Instead of the money, he gets the various kinds of insurance against most of life’s risks that may or may not materialize (including the “risk” that he does not die before age, fatigue, or the rules in his branch of industry induce him to stop working).

Whatever else this is and whatever it may be called in our day, this is a system of payment of wages in kind, once known as “truck,” and it is done on a gigantic scale. It may well be a marvel of universal, wise, and caring social protection. It is nonetheless a case of “outright compulsion,” to cite the pithy judgment of honest nineteenth-century English liberals, for the worker is forced to accept a large part of his earnings in kind (i.e., in social insurance) unless he is prepared to dive down into the illegal “black” economy where he gets all-cash wages. Compulsion is applied to both him and his employer. The latter pays in kind not because he profits from it, but because the law says that he must. The law, in fact, is a sort of Truck Act turned upside down.

Since the scheme works on an all-encompassing, gigantic scale, it would be surprising if its effects were not comparably vast. Yet the strange fact is that economists and sociologists seem to pay little attention to what the massive shift from the cash nexus to the truck system may have done to the “European social model.” There is lively debate about the virtues and vices of the welfare state, about rewarding failure and punishing success, about forcing the strong to help the weak, about the economic effects of redistribution in general. None of this debate takes into account the likely effect of forcibly moving two-fifths of all wage incomes from the money economy into the economy-in-kind where one good or service is exchanged directly against another and where the range of available goods is limited to one or two. What would be disposable income in the former takes the form of “social” insurance cover in the latter.

It is perhaps worth reflecting a little on what the most basic economic theory can tell us about the implications for unemployment.

For two nights in a row, an economist had a nightmare. The first night, he dreamt that a mad dictator had ordered all employers to pay him a payroll tax of 40 percent and had ordered all the money so collected to be paid out to the wage-earners as a supplement to their wages. The economist then woke up abruptly, rubbed his eyes, and found that if he had continued his dream to its conclusion, the employers would have started paying only 60 percent of the original wage, but the workers would still be getting 100 with the state supplement, so that nobody would end up either worse- or better-off. Things maintained their old equilibrium.

The next night, his nightmare took a different turning. The mad dictator again collected the 40 percent paytoll tax, but did not pay out the money to the wage-earners. Instead, he gave them insurance cover against sickness, disability, old age, and unemployment. The cover cost just 40 percent of the previous payroll to provide. The provider was the dictator’s own insurance company that was no more inefficient than most private insurance companies and did not make any profit. Waking up again abruptly, the economist worked out how the dream would have ended. The employers again tried to reduce wages by 40 percent, arguing that 60 in wages and 40 in payroll tax made 100, the wage cost level at which it just paid them to keep employment at the previous level. However, the wage-earners could not accept this, for they were doubtful about how much the insurance cover was worth to them. Some said it was a useful thing to have and worth buying for 40. Most, however, said that if they had their initial 100, they could always buy the full insurance cover for 40, or a part of it for 25, or not buy it from the dictator’s insurance company, or not buy any insurance at all and spend the money on a great variety of other things. If they were really forced to accept the cover provided by the dictator, they would not give up 40 of the wage for it. Maybe a deduction of 30 would be acceptable, leaving a money wage of 70.

This second nightmare would thus end with the employers’ wage costs per employee rising from 100 to 110 in order to give the marginal employee the same total wage (cash plus insurance cover) as before, i.e., the equivalent of 100 in cash. The economist would conclude that wage costs in reality would settle somewhere midway between 100 and 110 and employment would fall below its previous equilibrium level. Unemployment would result, and it would be “built in,” perfectly stable as long as social insurance remained universal and compulsory.

He would find this prognosis confirmed by the facts he found, even though they had not come about by the same process as in his dream. The fundamental cause would be the same in both dream and reality: providing universal and mandatory social protection costs more than it is subjectively worth to the beneficiaries. The difference is a net loss, a deadweight burden on the economy.

Beyond the loss of economic welfare, which we cannot objectively measure because much of it is a matter of the subjective value individuals place on the basket of goods available to them both when they can freely choose its content and when they cannot, and both when they are employed and when they live on unemployment relief, there lurks another intangible yet real loss.

Replacing a part of the cash wage with social protection also has an ethical dimension. It is just as important to clarify it as the economic one, and we can hardly get much clarity if we do not simplify it just as brutally as we did the economic aspects.

The ethical problem has two main components. One is the curtailment of free disposal of incomes, which is prima facie objectionable. However, even in modern libertarian doctrine, compulsory social protection is not unanimously condemned. Hayek, for example, thinks it is a lesser evil, and as such he accepts it. The reason is the threat of a particularly noxious form of “moral hazard.” Moral hazard infects all kinds of insurance, for if you are compensated in case of a loss (e.g., the loss of your job), you try less hard to avoid the loss. Apart from this more or less “normal” moral hazard, voluntary social insurance throws up a different, nastier version. If you are not forced to insure yourself, you may quite cynically and coldly leave yourself uninsured in the safe knowledge that if worst comes to worst, the state will not allow you to suffer too much misery but will rush to your rescue at the taxpayers’ expense.

Since this is very likely to be the case, only two choices are left. One is to resign ourselves to living with the stifling machinery of universal protection and bear its severe and degrading economic consequences. The other is not to rush to the rescue of the irresponsible and the cynical when, lacking insurance, they get into trouble, but pour encourager les autres, let them suffer and scramble for private charity. This could be politically very difficult to do. But if it were done for a period, lessons would be learned and the problem would progressively diminish.

The second hard-to-digest lump in the ethical problem has to do with the question: “Do people know what is good for them?” If allowed freely to spend their money as they choose, won’t many of them bitterly regret their choice a month, a year, or half a lifetime later? It is quite likely that many in fact do regret having spent some of their income on life’s little luxuries rather than on more generous health insurance or a private pension. Orthodox theory considers, reasonably enough, that each person strikes a balance between present and future goods according to his time preference, and nobody has any business striking the balance for him. But is today’s young buyer of the shiny motorcycle or the designer dress really the same person as tomorrow’s sick patient or pensioner? And if these young buyers somehow become different persons with the passage of time, what is the moral status of the decision of the young that affects not only their own well-being but also that of their future alter ego?

Each of these questions can spawn dozens of more subtle ones. The literature of modern utilitarianism is overflowing with them, and each is more sophisticated than the one before it. A clear view over the entire complex seems more and more unattainable. Some clarity can nevertheless be had if instead of trying to assess “utilities” arising from free and unfree consumer choices, we pursue a simpler question: “Who is entitled to decide for another?”

Forcing someone to do something for his own good is immensely widespread, and its tradition is as old as humanity. Fathers and mothers have been doing it to their children ever since fathers, mothers, and children have existed. Nothing can seem more natural, more in tune with our sense of the right order of things.

When we do it to grown-ups, we still call it “paternalism,” though we cannot claim paternity. The word nevertheless lends our action an air of benevolent wisdom, of knowing better and “tough love.” However, while we may have the force to force those whose happiness we try to further, we simply do not have the innate authority for it that parents have traditionally had over their children.

LET ’S THROW THIS MODEL AWAY*

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 not only is 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 is 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 the 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 can 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 state 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 policies? 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 lost 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 illustion that it is neutral and innocent must not be indulged.

HOW TO STIFLE EMPLOYMENT BY “SOCIAL PROTECTION”*

In 1998, nearly one European in eight is involuntarily out of work, due largely to the state-sanctioned (indeed forced) return of labor-market practices that were rightly decried as unfair when practiced by private industry in the not-so-distant past.

In 1871, a royal commission in England reported on the “outright compulsion” exerted on workers by “truck,” the payment of wages in kind. The customary (and later, the collectively bargained) wage rate was set in money, but in some trades the less scrupulous masters converted it to a basket of goods of their own choosing and gave that to the laborer. Room was thus made for abuse, cheating, the passing off of shoddy goods, and so forth. But even if the truck was a fair exchange, employees would invariably rather have the money to do with as they chose.

The practice of truck went back a long way. It was widespread in handloom weaving, and there were legislative attempts to ban it between the fifteenth and seventeenth centuries. Truck was likewise entrenched in framework knitting, as well as in the handmade-nail trade that employed sixty thousand nailers in northwest England in the early nineteenth century. Less uniformly, it was resorted to in other hardware trades in the British Midlands. Employers practicing it were generally badly regarded and tended to lose the best employees, who gravitated to employers paying proper money wages. In this way, the labor market started to correct some of the ill effects of the truck system.

“OUTRIGHT COMPULSION”

Nevertheless, there were repeated legislative attempts to do away with it altogether, with Truck Acts in 1604, 1621, 1703, and, particularly, 1831. All were largely ineffective. Though truck survived in isolated coal mines for a few more years, as a system it was practically extinguished in Britain by the end of the nineteenth century—not by regulation, but by the ordinary interplay of supply and demand. In the United States, in mines and mill towns isolated by geography or langauge, the practice was preserved somewhat longer. As late as the New Deal era, the National Recovery Administration was impelled to turn its attention to employers paying in company scrip to be spent in the company store, an attenuated form of the “outright compulsion” involved in pure truck.

What is the point of turning over these old leaves today? Is it relevant to modern industrial society how Staffordshire nailmakers, Montana miners, or estate laborers in East Prussia, Poland, and Hungary were paid generations ago? Before proposing an answer, two things should be noted. First, as a matter of historical fact, employees hated truck, often reselling the goods in question for far less than their nominal worth. Second, there is a strong potential defense of truck: The goods a worker gets in exchange may go to feed and clothe the worker and his family, while if he gets money, he may improvidently blow it on payday and leave wife and children in misery for the rest of the week. This is the classic paternalist argument for gentle constraint, if not for “outright coercion” of the working classes for their own good. For all its plausibility, it was little used to defend wages in kind. Tellingly, it is not used at all to justify the massive reintroduction of the truck system into the modern welfare state. In fact, the mere suggestion that the manifold aspects of social protection are perfect products of (and difficult to justify without frank recourse to) paternalist doctrine makes the left blush with embarrassment or explode in fury.

For the truck system is back with a vengeance, more uniformly and inescapably than ever, and instead of trying to liberate them from it, state power now turns “outright compulsion” on workers and their employers and forces them to live with it.

It is readily accepted by public opinion that everyone needs some security against the common hazards of illness, unemployment, or in-capacity to work. Plainly, some people will voluntarily buy insurance to protect themselves and their families, but some others won’t or can’t. The incipient welfare state will insure the latter in a fairly minimal way. The notional “premiums” are either borne by general taxation or—politically less unpopular and administratively easier—are charged to payrolls, with the employer seemingly paying all or most of it. Once the system takes hold, there usually develops a strong democratic constituency in favor of extending these policies to cover ever more risks, ever more generously. With social insurance, it is obscure who pays what for whom. As a result, health benefits become progressively more comprehensive, unemployment pay longer-lasting and less conditional, and pensioners get younger as time goes by. The incipient welfare state is transformed into a mature one. Willy-nilly, it conducts itself like the lady who could not say “no”—indeed, to stay in office, modern democratic government must say “yes” even before being asked. (Take France’s new 35-hour workweek.)

More benefits paid out on policies of social protection mean that more premiums must be collected. Whoever pays them in the first place, ultimately they fall upon capital and labor. How much is really borne by employers and how much by employees may matter a good deal to present well-being and future growth, but it is not germane to understanding how truck, the provision of social protection as part of the wage, may generate endemic unemployment.

How this comes about is inherent in the compulsory nature of social protection. It is a benefit in kind. Its money equivalent to all wage-earners cannot be more than its total cost; to most individual workers, it is substantially less. They like the insurance, but if they could, they would rather have what it cost, or even a good deal less, and spend the money as they see fit. Whether they would be wise to prefer the money is immaterial if, in fact, they do. For if they do, they will subjectively undervalue social protection, and its cost will thus be higher than its worth to those it seeks to protect.

VICIOUS CIRCLE

However, this is tantamount to saying that the cost of labor—the money wage plus the premiums employers and employees must pay to produce all the social protection on offer—will nearly always be higher, perhaps much higher, than the effective wage—take-home pay plus the money value the worker puts on his prospective social insurance benefits. To offer any given effective wage, employers must incur higher costs under this social truck system than they would otherwise have to do. Consequently, they will “restructure” and eliminate jobs. The resulting unemployment will be endemic, in the sense that it will resist both cyclical upswings and fiscal or monetary stimuli. As long as the cost of labor is generally higher than the value such cost buys for the employee, employment will remain stifled.

The dynamics of this mechanism are intimidating. With more unemployment, more insurance benefits are paid out and more premiums must be charged, which should normally increase the gap between total labor cost and effective wages; enhancing the gap increases unemployment some more, and so on in a vicious circle. It is once this circle gets going (which may be a matter of passing some threshold) that the problem becomes nearly intractable, as it seems to have done in much of the European Union. For it is of little practical use to say that the one real cure of unemployment is to abolish the insurance against it at the very time when this could only be done over the dead bodies of the jobless and the justifiably scared.

WORKABLE ALTERNATIVES*

Just a few weeks ago, German or French workers accepting to work longer hours for the same pay, forgoing pay rises already agreed to, and conceding flexible work practices would have been but a delirious vision. All the news flow went the other way, and has been going the other way for decades. Shorter hours, higher pay, more “codetermination,” more workers’ “rights,” and fewer prerogatives for management seemed an inexorable trend. It demarcated the “European social model” from such deviations as the Thatcher reforms, the Dutch sobering-up, or the Swedish attenuation of their welfare state. The “model” entailed chronically high unemployment, which governments and unions took as a good reason for imposing still shorter hours to share the available work—and so the merry-go-round kept going round.

All of a sudden, the business scene is swarming with deals, concluded under negotiation or tentatively floated at board level, in which labor makes concessions in exchange for management forgoing job cuts or—the ultimate threat—moving operations and leaving the employees behind. Everyone in Paris, plus a vocal minority in Berlin, now indignantly cries “blackmail.” Is it?

OCCASIONS OF BLACKMAIL

Strictly speaking, a threat meant to extort a concession from someone is blackmail only if the threatened act is a tort. Making employees redundant or moving production from Baden-Württemberg to South Africa is not a tort. Nor is it, until further notice, unlawful. Any attempt to make it so would entail an ever-lengthening string of other controls to shore it up, leading to massive evasion, a speeding up of the euro-zone’s economic decline, or both.

However, while deals in which labor won all the concessions used to pass muster with public opinion, the deals management has recently been winning seem to create concerns for justice. For in a loose, colloquial sense there is indeed an element of blackmail in these novel agreements. They have the ring of blackmail because they have posed such drastic choices. It is as well to say, though, that anything less drastic would have failed to reverse the long-established trend of less work for the same pay.

The sophisticated case for the blackmail argument is that our choices are free when we have no or only a slight preference for one alternative over the next-worse one, but that the choice becomes progressively less free as the next-worse alternative gets worse and worse. With full employment, saying no to the boss and looking for other work is hardly worse than accepting his terms. With grim job prospects and unemployment at the French or German level, however, the next-worse alternative to accepting the bosses’ terms is bad indeed. The workers, as the saying goes, have “no alternative.” They are being blackmailed.

One might well ask: And whose fault is that? Who caused the loss of French and German economic vigor since the mid-1970s and its concomitant unemployment? Who dreamed up the “European social model,” who built it up by relentless tinkering, who is “struggling” for job creation, and who is resisting any timid attempt to let loose the normal forces of normal job creation?

Government apologists who boast of a relatively high level of inward foreign investment as proof that their economies are not as unhealthy and unattractive as all that, should look instead at the dismal trends in business investment from domestic sources. Across all industries, returns on capital in the Franco-German “core” of Europe are mediocre. Where the average is mediocre, too many individual branches and firms have sunk or fear soon to sink below the break-even point. The threat to relocate unless more work comes forth for no greater pay is an obvious enough escape route. Once a few bold spirits have shown the way by braving the political signposts that signalled “no entry,” “no through road,” the rush to cut costs by putting drastic choices before labor has quickened and broadened.

What of the near-term future? “Blackmail” is widely resented but will not be easily resisted. Despite its obligatory “social” overtones, German discourse still regards the employer-employee relation as a matter of contract and not the reserved domain of public law. Moreover, after several decades of asking water to flow upward, it is recognized that its natural inclination is to flow downward. Most Germans have some respect for economic realities, and major new legislative attempts to suspend them are on balance not very likely.

FRENCH HOSTAGES

The French case could hardly be more different: President Jacques Chirac has resolutely vetoed attempts to repeal the thirty-five-hour workweek, which he deems a “social right,” and calls tampering with it a “slippery slope.” His premier, Jean-Pierre Raffarin, has condemned the use of unequal bargaining power and declared that he will “not accept blackmail” of labor. On June 28 the official government spokesman promised measures in 2005 to “control the relocation of enterprise,” with a preliminary “social dialogue” to start next September. If this is what a government that calls itself center-right proposes to do, how would a government that called itself Socialist go about it? Some would answer that in France you could not tell the difference.

In any event, it is hard to see how the French, or any other, government can in practice “not accept” the purported blackmail of wage-earners. It can hardly make firing them any more difficult than it already is. It could, as a last resort, try and stop employers from escaping their own hard-to-fire employees by relocating abroad. Pushed to its logical limit, the remedy would be to take existing enterprises hostage within the national jurisdiction—never mind that there would thereafter hardly be any new ones. The suggestion is cloud-cuckoo silly. No logic, except possibly the renowned Cartesian one, could seriously advance it.

A TALE OF TWO MODELS*

French president Jacques Chirac has a knack (as he famously put it in 2003 with respect to Poles, Balts, and other “lackeys” of America) for “missing good occasions to stay silent.”

Campaigning last month in Barcelona for the new European constitution, he praised it as a fair compromise “between the European and the liberal model” (in American English, he meant classical liberal). Which is to say, he as good as laid it down that a liberal “model” could not be European. It very nearly follows that the European one must be socialist. With this in mind, we may enjoy watching the Battle of the Models.

In the liberal model, profits accrue to the providers of capital and enterprise, wages to the providers of work of all kinds. When profits run ahead of wages, it pays to expand employment, and wages catch up. When profits run dry, the opposite tends to happen. A natural pendulum movement keeps the share of wages and the share of profits in national income swinging back and forth over the economic cycle.

The European model will have none of this. Under it, the shares of profits and wages are first determined by ordinary economic forces. Society is watching the result as it emerges, and keeps adjusting it in a great variety of ways if it does not think it just (or, more prosaically, if the balance of democratic forces pushes for the adjustment).

In practice, for at least three decades now, the net adjustment has invariably been one way—in favor of labor. This is how the intricate system of entitlements of European welfare states has gradually been built up. Translated into moral terms, “social justice” was being done. No one thought of asking whether social justice can cut both ways and, if it could, why it always cuts only one way.

As was to be expected, reality in due course caught up with the European model, causing it increasingly to backfire in the face of the politicians who still pretended to steer it. Above all else, the model radically stifles the demand for labor, generating a seemingly incurable, endemic unemployment that for years has stuck at around 10 percent in the major euro-zone economies that still believe in the model, while it is only 4 to 5 percent in Britain and other European users of the rival “liberal” model.

This is a fact even French politicians recognize, although they refuse to accept responsibility for it. It does not, in itself, warrant an article in the Wall Street Journal. But it has intriguing implications that perhaps do, for they have not so far been openly discussed.

CAUSES OF UNEMPLOYMENT

Built-in unemployment around 10 percent is caused by two features of the European model. One is the weight of vast schemes of social insurance financed via payroll taxes, whose cost is greater than their value to the insured wage-earner. Hence the cost of wages exceeds their value and the demand for labor stays chronically deficient.

The other, perhaps less powerful, cause is job protection. Labor laws, meaning well, make the shedding of labor so difficult and expensive that employers are afraid of taking the risk of hiring. They either resort to short fixed-term jobs or just make do with the staff they have. Both these features of the European model—social insurance and job protection—are, of course, meant to favor labor over capital. But in practice, they do the exact opposite.

They make the economy function less well, but within a sluggish, sickly environment, they favor capital. They bring about a wholly unintended hiring strike by employers (who would never ever consciously organize one). Labor finds its economic bargaining power reduced to impotence. Companies learn to get by with stagnant or reduced payrolls, productivity rises, profits increase, and wages stay flat. Ironically, the European model does better by the corporate sector than the liberal one, and less well for its own supposed clients—the workers.

Even educated opinion seems to be unaware that this is going on at all, much less the reasons it is going on. Like the secret about the emperor’s clothes, it is still a secret, though it can hardly stay so for much longer.

Recently, the French oil major Total declared a 2004 net profit of €9 billion. Coming amid a rush of other brilliant earnings reports, €9 billion has proved too much. Within two days, the knee-jerk reaction duly came. French premier Raffarin issued a statement warning French corporations that “if they wish to continue making profits,” they must see to it that their employees share in them. The note of menace, though meant mainly to cheer up public opinion, which remains viscerally left-leaning, was audible.

THE ULTIMATE OWNERS

Needless to say (though you would not know from listening to the French chattering classes), the €9 billion did not go in the pocket of a Mr. Total. They were shared by hundreds of thousands of shareholders, the majority being present and future pensioners. Nevertheless, shared they must be again. Oddly, the European model and its conception of “social justice” nowhere provides that when the corporate sector is doing miserably and many companies are bleeding their net worth, there should be sharing too, but in the opposite direction.

Such “sharing” has been known to happen, notably in recent years in the U.S. airline industry, where labor made major wage concessions. But this happened within the liberal model through bargains that followed the normal two-way swings of the profit-wage pendulum. In the European model, there is no pendulum. Labor has been stripped of its natural powers, and all it has left to lean on is a solicitous government that is unwittingly keeping it poorer than it need be.

A VICIOUS CIRCLE OF SOCIAL KINDNESS*

Unemployment in the industrialized West is now clearly endemic and not cyclical as in the past. No reversal appears in prospect. At best the next few years will bring a minor rise in employment, at worst a further fall.

In the search for an explanation and cure, many old—but unsatisfactory—chestnuts are trotted out: a deep technological transformation is taking place (it always is); world trade has become too free and not fair enough (but freer trade, surely, brings greater riches?); or labor markets are too rigid and training inadequate (but did not the same apply twenty years ago?).

There may, however, be a different explanation for high unemployment in modern, redistributive democracies.

This is best illustrated with a simplified example. Imagine an economy where income comes from only two sources—profits and wages. Rents are negligible, and there is full employment. If the government wished to redistribute income in favor of wage earners, it would tax employers’ profits and add the money raised to wages.

The natural response would be for employers to cut the wages they offer—and for employees to demand less. Consequently, the impact in terms of redistribution would be negligible and harmless: there would be no unemployment created and after-tax, after-subsidy incomes would remain unchanged.

But imagine that instead of transferring money, the government offered employees a basket of “social protection”—insurance against illness, unemployment, or destitution in old age. If we make the (large) assumption that collecting the tax and distributing it in the form of social protection are costless, the effect on the demand and supply of labor would depend on the difference between the cost of the package and the value attached to it by recipients.

At first sight, it would appear that employees would attach great value to social protection: reaction to proposals for curtailing benefits is usually virulent. But that is because most wage-earners are under the illusion that the greater part of the “insurance premium” is being paid by someone other than themselves.

If wage-earners understood that, ultimately, the cost had to be borne out of their own wages, would they prefer to have the “social protection” on offer—or would they rather buy some private insurance, save some, and spend the rest?

There is a strong paternalistic argument for saying that wage-earners should not be given such a choice—improvidence would make many take the money and “blow it.” But the important point is that “social protection” costs more than it is worth to at least some of those that it protects.

The result is that, at the margin, employment is taxed more than the subsidy is worth to workers. The two no longer cancel out and there is a net extra burden on the economy. Enterprises have to “restructure” and unemployment is born of “social protection.”

Worse, a vicious circle comes into operation. The initial unemployment created by the tax-subsidy inequality increases the amount of “social protection” that has to be handed out.

That extra cost results in a further increase in the tax on employment, widening the gap between the nonwage costs of labor and the value of the benefits in kind. Demand for labor is further depressed relative to its supply, more unemployment is created, and the cycle is repeated.

Under an optimistic scenario, noncyclical unemployment would stabilize, at some point, at a level that society would have to support indefinitely. But under a pessimistic scenario the rise in unemployment would prove inexorable.

There is empirical evidence to lend weight to such a theory. Comparisons across countries show a high correlation between cyclically corrected unemployment and “social protection” expressed as a share of national income. Unemployment in Europe, where the welfare system is more costly per head, is twice as high as in the U.S. and many times higher than in East Asia.

Within post-Maastricht Europe, unemployment is worse in the center than on its periphery, and the more “social” the country, the more it is plagued.

Democracies, we are told, cannot relax social protection. Are they, then, condemned to smother the young and the long-term unemployed with their caring kindness?

[* ]First published by Liberty Fund, Inc., at www.econlib.org on April 3, 2006. Reprinted by permission.

[* ]First published by Liberty Fund, Inc., at www.econlib.org on May 1, 2006. Reprinted by permission.

[* ]First published by Liberty Fund, Inc., at www.econlib.org on February 12, 2004. Reprinted by permission.

[* ]First published by Liberty Fund, Inc., at www.econlib.org on August 1, 2005. Reprinted by permission.

[* ]First published by Liberty Fund, Inc., at www.econlib.org on November 7, 2005. Reprinted by permission.

[* ]Reprinted from L’Homme libre: Mélanges en l’honneur de Pascal Salin, ed. Mathieu Laine and Guido Hülsmann (Paris: Les Belles Lettres, 2006), 324-28. Reproduced by permission.

[* ]First published in the Wall Street Journal Europe, May 11, 2000. Reprinted by permission.

[* ]First published in the Wall Street Journal Europe, March 20-21, 1998. Reprinted by permission.

[* ]First published in the Wall Street Journal Europe, October 6, 2004. Reprinted by permission.

[* ]First published in the Wall Street Journal Europe, March 2, 2005. Reprinted by permission.

[* ]First published in Financial Times, April 29, 1994. Reprinted by permission.