So far I have examined a number of different aspects of European labour markets. In general, despite individual national initiatives aimed at improving the flexibility and adaptability of workers and the unemployed, and the fact that every eu member has signed up to both the oecd Jobs Strategy and the European Commission's version of it, it is fair to conclude that the hard work has yet to be done. In some cases, such as France and the 35-hour week, policy is moving in the wrong direction entirely. In spite of the French government's imaginative attempts to make the 35-hour week work by introducing a range of incentives for employers to have a larger number of employees, each working a smaller average number of hours, it is a policy which goes against the need for greater flexibility. Populist policies in this area are usually the wrong policies. In November 1998 Gerhard Schröder, the new German chancellor, floated the idea of a compulsory retirement age of 60, in order to achieve a more even spread of employment for people below that age. This book has not considered in detail the potential problems and welfare state strains Europe will face in the future from ageing populations. Limiting the age until which people can work at a time when longevity is increasing does not, however, appear to have much to commend it in this or any other context.

If Europe already has inflexible labour markets, low employment-to-population ratios, high unemployment rates and limited geographical mobility of labour both within and among countries, surely this is the choice of those European countries that have chosen this route. In the case, say, of Germany, the Rhineland model has developed in such a way as to provide high-wage, high-skill jobs for considerable numbers of people. The fact that it also throws up a large number of outsiders - the unemployed or never employed, or those on the margins of the workforce - can be seen as a matter of national choice. As long as the employed insiders generate enough wealth to provide sufficient levels of social protection for the outsiders, why should we worry? Why should the fact that Europe is embarking, in this environment, on a bold single-currency experiment be a cause of even greater worry? European governments, as has been shown, are prepared to spend large sums on passive and active labour market measures, and yet taxpayers have not been taking to the streets in protest.

The answer, of course, is that in the context of emu one country's problem becomes the problem of others. Suppose, for the sake of argument, Germany and France became the euro area's problem economies, with unemployment at 20% and rising and social discontent mounting. Even if every other emu member was enjoying a low-unemployment economic renaissance, it is hard to believe such a situation would be politically sustainable. This is perhaps not the most likely emu outcome, although it is possible. It is more likely, as now, that the extreme problems of high unemployment come not at Europe's core but at the periphery, and that they become worse. It would be a difference of degree, and perhaps of visibility, but not of substance. If emu is seen to be the cause of high unemployment, wherever it occurs, national governments and regional authorities will look to Europe to provide a collective solution (of which more below). But are there circumstances in which Europe can develop a flexible and mobile workforce? Could emu, far from being the cause of greater unemployment in Europe, contain the makings of a solution to the continent's labour market problems?
 

EMU as a catalyst for labour market reform

The European Commission has a robust attitude on this question, arguing that the benefits of emu will be lost if labour market reform is not stepped up:

Another way emu could act as a catalyst for labour market reform, raised by Bronk and others, is if countries in Europe are prompted to engage in intense job competition. The argument is that in a single-market, single-currency area companies could become much more footloose in terms of their location decisions. Any country that was noticeably out of line in the regulatory demands it placed on employers, in the burden of compulsory social costs faced by firms and in its tax regime could be expected to lose out. To turn this on its head, any country that offered a light regulatory regime, together with low taxes and social costs, could be expected to be a net employment gainer. To take this one stage further, countries could engage in what Bronk describes as `a competitive spiral of bidding down labour market regulations, social welfare support and tax rates'.

Although this offers the potential for driving labour market reform and tax competition, it should be noted that the authorities in Europe have seen it coming and have been anxious to head it off, perhaps calling into question the Commission's true commitment to reform. As employment commissioner Padraig Flynn said in a speech in October 1998:

Indeed, the adoption of binding Europe-wide protection could more than offset any labour market benefits the competition to attract capital within the euro area could bring. (There is, as discussed in the context of the geographical mobility of labour, considerable doubt about the extent to which capital will seek out the far corners of Europe, even if there is a cost argument for doing so. If the `hot banana' theory of location applies, and firms take the view that any benefits from easier regulatory regimes or lower social protection are likely to be time-limited, the incentive for governments to engage in social dumping may not exist.) The opposite danger, of countries being forced to adopt inappropriately high standards, is a real one. According to the cepr report, any action by European governments in this area has to recognise the limits of harmonisation. The degree of social protection and labour market regulation that may be appropriate for Germany or France could be wrong for, say, Portugal or Ireland. Drawing a distinction between recognising that national differences should continue to exist, for example, on minimum-wage and benefit levels, and allegations of social dumping will form one of the battlegrounds for eu social and labour market policy in the coming months and years. eu enlargement, and the prospective entry of former centrally planned economies from eastern Europe into both the eu and emu, will add considerable spice to this debate.

emu has been sold to the public, as the comments by Padraig Flynn quoted above imply, as a mechanism not for driving down social standards or wages but for increasing them, or at least ensuring that they converge on the highest. It is a message not lost on European trade unions, which have already declared that they will use the transparency offered by the euro to ensure that workers doing similar jobs (particularly with the same company operating in different parts of Europe) are paid the same wherever they work. Such a process will inevitably take time - the overnight conversion of east German wages into Deutschemarks at a one-for-one exchange rate rendered east German workers instantly uncompetitive and was a key factor in the sharp rise in unemployment following unification. But the fact that such a process is envisaged at all, at least by one set of social partners, should caution against the idea that emu will be a force for either lower wages or reducing social protection.

There are thus three ways in which emu could act as a catalyst for greater labour market flexibility in Europe. The first is if emu proves to be an economic success, with strong growth and falling unemployment providing an environment in which greater flexibility could be introduced while minimising the number of losers. The difficulty is that if Europe is seen to be working under emu, why should there be any political momentum for reform? The second possibility is that labour market reform is forced upon governments by an economic crisis, the first serious emu recession. European unemployment has ratcheted higher with every successive economic cycle. Eventually, a point will come when everybody recognises that enough is enough. As argued above, however, it is not clear that the solution in such circumstances would be sought in far-reaching labour market reform. The third possibility could be the existence of the single-market, single-currency area itself. If the prizes, in terms of jobs, are seen to be going to the least regulated, most flexible, economies, governments in other countries will be under pressure to follow suit. It could happen, but for the reasons outlined above it is hard to see this as the most likely outcome. This leaves an alternative set of possibilities. What happens if Europe does not reform its labour markets?
 

EMU and labour market failure

Walter Eltis, in a Centre for Policy Studies paper Further Considerations on emu, argues that Europe's job-creation problem has, if anything intensified in the 1990s. According to the European Commission, the eu should be creating jobs whenever economic growth exceeds 2% a year, but recent experience suggests that even stronger growth is required before there is any impact:

This would not matter too much if there were new employment opportunities for the displaced workers to take up. After all, corporate downsizing in the United States in the 1990s has not resulted in a high unemployment problem - it has led to the opposite. Unfortunately, in this respect Europe is not the United States. As has already been noted, the engine of job creation in the United States has been the services sector, and many of the jobs created have been for low-skilled workers at low wages. In Europe this engine either does not exist to the same extent, because of the high cost of employment, or has failed to get out of first gear. The other source of new jobs, as Eltis points out, is the small business sector, sometimes in the services sector:

The consequences of a high-unemployment EMU

The issue of the euro's external value is an interesting one. Although responsibility for the euro exchange rate remains with elected finance ministers rather than the ecb, as was the case for sterling following Bank of England independence, and is the case for the dollar, whose value is the responsibility of the US Treasury and not the Federal Reserve Board, this influence can be exerted only through currency intervention, very much a second-best means of acting upon exchange rates, rather than through the level of interest rates. The position is not clear-cut. In the UK tradition, but rather less so in the United States or Germany, the currency's strength or weakness has an influence on monetary policy decisions. One potential headache for the emu countries could be that the euro's novelty, and its appearance on the scene as a ready-made reserve currency which could, according to some analysts, come to rival the dollar, will guarantee that portfolio demand for it is strong in the early years, pushing it to uncompetitive levels.

The second response from politicians, to reactivate more expansionary national fiscal policies, if necessary by relaxing the terms of the Stability and Growth Pact, has already been discussed. In November 1998 Carlo Ciampi, the Italian finance minister, weighed in behind Lafontaine in support of such a strategy.

Ultimately, political self-defence mechanisms, in the context of a rise in European unemployment to socially dangerous levels, could react by abandoning emu itself. As has been noted, the politicians who were the modern founding fathers of the single currency are, in many cases, no longer in power, although those in office at the time of writing still support the euro project and would merely wish to refine or redesign it. Even this may not last. Governments openly hostile to emu could be elected on a wave of popular discontent sparked by high unemployment, at a time when the euro and the ecb are the obvious targets for such discontent. There have been, as noted above, apparently permanent monetary arrangements before. From a British perspective this has more resonance perhaps than elsewhere in Europe. Britain's experience of going back on to and then coming off the gold standard in the mid-1920s and early 1930s was a bitter one. In 1972, after the collapse of the Bretton Woods system, the Conservative government of Edward Heath took sterling into the European currency snake, but the experience lasted only six weeks. In October 1990, in a coup de grâce, the Thatcher government, with John Major as chancellor, took sterling into the exchange rate mechanism of the European Monetary System, an event that was supposed to represent a permanent closing-off of the devaluation/depreciation option. Less than two years later, on Black Wednesday (16 September 1992), this arrangement too came to an end.

emu is, of course, supposed to be different. It is supposed to be irreversible and irrevocable, and perhaps it will be. Just because one set of governments has negotiated apparently binding international arrangements, the ending of which would admittedly be messy and complicated, does not mean a future set, or one or more individual governments, cannot seek to reverse such arrangements. If emu turned out to be a European employment disaster, with no relief in sight, it would not last. Long before that point was reached, however, European governments would seek to make it work. In the case of chronically high unemployment, with particularly high levels in the most depressed regions, the main mechanism for trying to make it work, in addition to those set out above, would be large-scale fiscal transfers.
 

Fiscal union

These results are interesting, not least because they are somewhat counter-intuitive. We would expect the effect of net transfers to be much smaller in the US economy because other forms of adjustment, through labour market flexibility and geographical mobility, are high. We would also expect such effects to tail off fairly rapidly, because in the case of unemployment benefit payments under federal schemes are highest in the first six to nine months. But the fact that such transfers exist, and have been even greater in other countries with federal systems, notably Canada and Germany since unification, is grist to the mill of those who argue strongly for such a policy in Europe. At present, the scope for offsetting fiscal transfers from the centre in Europe (from Brussels) is limited to just over 1% of the gdp of member states, although as noted above the benefits to some member states have been disproportionately large.

Jacques Attali, former adviser to President Mitterrand and former head of the European Bank for Reconstruction and Development, set out in Time's Golden Anniversary Issue on Europe in 1996 what he described as a worst-case scenario for Europe, in which:

Fiscal conservatism

Does this mean that the idea of a European treasury, of those large-scale fiscal transfers to the regions emu would leave permanently depressed, is a non-starter? This may indeed be so, in which case the outlook for such regions and for the survival of emu would be even bleaker than it is. There are four reasons to suppose, however, that things could change. The first is that attitudes do shift. Conventional wisdom, even quite recently, was that the German people would never countenance surrendering their trusted Deutschemark for the euro, let alone a euro which included Italy among its participants. If voters can be softened up to accept monetary union, however grudgingly, it would not be stretching things too far to argue that they could also be persuaded into grudging acceptance of its tax consequences.

The second reason for believing that fiscal transfers will gain acceptance is that they could be preferable to the alternative. West Germans were not, in the main, persuaded of the need to rush to unification with the east following the destruction of the Berlin wall in 1989. Neither was the then Bonn government. The problem was that east Germans, together with ethnic Germans from elsewhere in eastern Europe, were voting with their feet. The only way to keep east Germans where they were, and to prevent west Germany being swamped by wave upon wave of economic migrants, was rapid unification, immediately followed by large-scale transfers of tax-funded resources. West Germans did not relish paying unification taxes, even to support their cousins in the eastern Länder. But the alternative was much less attractive. The same is likely to be true, but on a much larger scale, for Europe under emu.

Third, fiscal transfers would occur, certainly in the early stages of emu, not through the payment of ever-larger contributions to a central budget administered by faceless bureaucrats in Brussels, but (more likely) through a beefed-up committee of national finance ministers of emu countries, based on the existing Euro-11 committee. Such a group's decisions would be presented as co-ordinated fiscal policy and would focus on mutually beneficial expenditure, such as infrastructure projects, as the Commission has already sought to do through Trans-European Networks. European voters would, in other words, be party to the gradual Europeanisation of fiscal policy without being fully aware of it.

Fourth, perhaps most tellingly, monetary union itself could build popular support for greater centralisation of budgetary policy. If the perception grows of an all-powerful ecb, much more powerful than any national politicians, then the argument in favour of a political (budgetary) counterweight to the ecb could easily grow. This would be the case particularly if, as its supporters argue, emu means that people and businesses will increasingly think not in national terms, but on a European scale. It is easy to think of the euro area as being preserved in aspic, with 11 (initially) separate but integrated economies continuing to operate as they do now. Increasingly, however, the single market and a single currency will mean a unified economy. Taking this to its logical conclusion, the resistance of richer European regions to paying taxes to help out the poorer parts could be no greater than is presently the case, for example, for northern Italians reluctantly being prepared to transfer resources to the south, or, as already noted, Germans from west to east.

It may be, of course, that none of the above will come about, and that European electorates will adopt a stance of `thus far and no further' following emu, particularly when it comes to fiscal integration. The beginnings of a new approach can, however, already be detected. A single-market, single-currency economy will lead to inexorable pressure for tax harmonisation - in a transparent world of prices set in euros, member countries will be strongly discouraged from attracting businesses or consumers through lower taxes. It will also lead to similar pressure, as already discussed, for the harmonisation of welfare benefits and labour market standards, to prevent social dumping. Ultimately, it will lead to a drive towards greater centralisation of all fiscal policy decisions, although how rapidly this occurs remains to be seen.

In November 1998, at a meeting in Brussels, finance ministers from the 11 socialist countries in the eu, including Britain, Germany and France (thus Gordon Brown, Oskar Lafontaine and Dominique Strauss-Kahn), signed a joint document, `The New European Way - Economic Reform in the Framework of emu', drawn up by the EcoFin Group of the Party of European Socialists.15 It committed them to `macroeconomic policies that create stability and are conducive to sustainable expansion', `co-ordination of budgetary policies and economic policies in order to achieve strong and sustainable economic growth and full employment in accordance with the single monetary policy', and said that `further efforts have to be undertaken to avoid harmful tax competition among the member states'. All this, it should be noted, was couched in terms of adherence to the Stability and Growth Pact and `the importance of budgetary discipline'. The broad message, indeed, like that of Britain's Labour Party before the May 1997 election, was that by cutting welfare payments (`the bills for economic failure') resources would be freed for more productive, and employment-friendly, use of public expenditure. The omens, however, were not good. The Labour government, in summer 1998, announced substantial increases in public spending, notably health and education, alongside a significant rise in welfare (social security) spending.

An interesting question, with governments in power in most European countries that do not see reducing the share of public expenditure in gdp as a desirable policy aim, is how much upward creep there will be in that share, under the guise of co-ordinated fiscal policy. The consequence of this, coupled with greater moves towards tax harmonisation, will be a parallel increase in overall tax levels in Europe, at a time when the impact of high taxation on inward investment, enterprise and employment is already a significant competitive problem for eu countries. If government spending and taxation rise together there need be no threat to the Stability and Growth Pact, which requires, in normal circumstances, that emu countries restrict their budget deficits to 3% of gdp or less.

The pact itself, however, is not as tough or as binding as it is sometimes portrayed. Although there is provision for potentially onerous fines on countries exceeding the deficit limit, it was designed to tackle the problem of free-rider economies, which, it was feared, would jeopardise emu by persistently breaking the rules. It is hard to see how fines, which have to be decided upon by qualified majority voting among the member states themselves, could come into play if all countries decided on the need for a more flexible interpretation of the rules, that is higher budget deficits, at the same time. Countries do not typically impose fines on themselves. Similarly, there is provision for the rules to be waived if budget deficits increase as a result of events outside a country's immediate control. It would not be hard to construct a set of circumstances in which European economic problems, and continued high unemployment, were deemed to be the consequence of global economic events, or even events in another eu economy. Suppose, for example, that the German economy went into serious recession and thus gained automatic exemption from penalties under the pact. Others could argue that Germany's impact on them made the case for similar exemption, and so the process would go on.
 

How big an EU budget under EMU?

However, there is more than one way of skinning a cat. In its overall economic effects, greater fiscal activism in which individual member countries retain ownership of additional government spending, rather than leaving it to the discretion of the Commission, does not differ greatly from an increase in the eu budget. But what kind of increase in spending are we talking about? As we have seen, some eu members already spend more than 5% of gdp on labour market measures, both passive and active. How large might be co-ordinated spending to overcome labour market failures within emu?

The starting-point for answering such a question is usually the MacDougall report.16 In 1974 the Commission asked a committee of experts, chaired by Sir Donald MacDougall, then the chief economic adviser to the Confederation of British Industry, to examine the likely size and scope of the eu budget under various phases of European integration. The committee's report, published in 1977, envisaged the retention by national governments of responsibility for some aspects of public spending. But the experts were also struck by the extent of federal spending in the United States, and its role in transferring resources between rich and poor regions. The greater the degree of European integration, they argued, the greater was the need for similar mechanisms in the eu. The committee envisaged three phases of integration, with the European budget larger in each stage. It concluded that with Europe in a pre-federal stage of integration the central budget would need to be between 2% and 2.5% of eu gdp, rising to between 5% and 7% of gdp (or 7.5% and 10% if defence was included) at a more advanced stage of integration, and 20% to 25% of gdp for a full federation.

These figures, it should be noted, were envisaged as being not in addition to national public spending, then averaging 45% of gdp, but a replacement for it. Indeed, it was argued that it should be possible to generate economies of scale from the shift of spending from the national to the Community level, by reducing duplication. The context in which the MacDougall report was written, however, was one of significantly lower unemployment, and somewhat lower government spending as a share of gdp. Although Europe's unemployment rate had begun to rise following the first opec (Organisation of Petroleum Exporting Countries) price shock of 1973-74, the Community average was below 5%, and there were reasons to believe that this was a temporary phenomenon. Not until the beginning of the 1980s did European unemployment, in common with most other industrial countries, including at that time the United States, begin to rise to chronically high levels.

How much would government spending have to increase, on a co-ordinated basis, to alleviate the impact of emu on regional unemployment within the eu, and to provide the kind of resource transfers needed to compensate for the effects of labour market inflexibility and geographical immobility? The answer, of course, is that it depends on the degree of the unemployment problem, and the extent to which governments (and taxpayers) would accept the burden of compensating for wide unemployment differentials within the euro area. It is quite likely, for example, that governments within the more successful core (the hot banana) would resist such transfers, although even they would be forced to widen the scope of resource transfers, through benefits and much more active regional policies, within their own countries. It is hard to see how they could ignore the plight of peripheral countries for too long, however, for the reasons outlined above. Either emu itself would not survive in such circumstances, or it would do so only at a huge price, that of significant social unrest on the edge of the prosperous core.

An increase in the centralisation of spending decisions and in the scale of resource transfers to poorer areas thus appears inevitable; and over time this could become extremely significant. Where I would take issue with the MacDougall conclusions is in the idea that such action would merely represent a shift from national to eu-wide spending. If the broad conclusions of this book are right, and emu represents a significant addition certainly to regional unemployment differentials within Europe and to the overall unemployment problem, then such spending would be on top of existing national outlays. This is at a time, incidentally, when, to add to the list of concerns, there will be pressure anyway for rising government spending. For the 11 first-wave emu countries, ageing populations will mean that over the next 30 years, in the absence of compensating savings, there will be an increase in the public expenditure share of gdp of seven percentage points, according to the imf, to meet pension entitlements and healthcare requirements.
 

EMU: tax and die?

A fascinating European experiment is thus in prospect, but not one that offers much hope of success. According to the imf in its September 1998 World Economic Outlook:

If there is one thing we have learned about the European economy in recent years it is that growth always disappoints. The single market, despite the optimistic assessments by Padio-Schioppa and others, may be a desirable end in itself, but it is hard to discern that it has had any impact on the underlying growth rate of the eu economy, still less a rise in trend growth, if only temporarily, from 2.5% to 3.5% a year. Nor is emu likely to fare better, as the debate about trying artificially to inject growth into the European economy by fiscal means implicitly recognises.

The most worrying thing, after a long period in which European politicians at least paid lip-service to the need for labour market reform, is that there are governments in power in Europe now which have never really bought the story about the need for greater labour market flexibility, let alone increased mobility. Their belief, more or less, is that Europe's unemployment problem is a result of lack of demand, and that governments can make up for that lack of demand. Europe, in other words, has too little public spending, not too much. The difference now is that the irresistible force of governments wanting to indulge in expansionary fiscal policies will meet the immovable object of an ecb determined to bear down on inflation, and prepared to put up interest rates if it believes governments are behaving irresponsibly and threatening the terms of the Stability and Growth Pact.

In conclusion, for all the reasons outlined in this book, it seems highly unlikely that we will see significantly greater geographical mobility of labour in Europe, or indeed that such mobility will be sought as a goal of policy. There are serious doubts that the hot banana at the core of Europe will in fact be that hot, or that it will expand beyond the core to become, perhaps, a hot marrow. The new economic geography, which suggests that such an outward spread of activity will take place, says nothing that the old economic geography did not. Without wage flexibility capital will not be geographically mobile enough to compensate for an absence of geographical labour mobility. It is hard, particularly now, to be optimistic about either wage flexibility or more general labour market flexibility in Europe, or to believe that, beyond a possible short-term growth boost (relative to what would otherwise have been the case), Europe is about to embark on a new, high-growth era. Even if this were the case there would be no guarantee that such growth would be accompanied by lower unemployment. Europe could have high growth owing to large productivity gains but without any reduction in unemployment, that is, a prolonged period of `jobless' growth.

The result is that the pressure will build inexorably for large-scale fiscal transfers from the centre, for a beefed-up European budget, albeit one, initially at least, that operates on a co-ordinated basis, rather than as a centralised, Brussels-run eu finance ministry. Resource transfers will occur, but they will not solve the underlying problem, namely that European labour markets do not have the characteristics necessary for the achievement of a successful monetary union. Resource transfers and higher public expenditure generally will mean, as sure as night follows day, higher taxes, which Europe needs like a hole in the head. Benjamin Franklin said that nothing is certain in life except death and taxes. Nothing is more certain than that a highly taxed, inflexible Europe under monetary union is doomed to eventual failure.
 
  Return to top