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 *

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?

PART 6

The Future of Europe

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