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The Social Market Economy in a Globalised World

25 February 2014
by Guest author
Ludwig Erhard

Ludwig Erhard, one of the founders of the social market economy

Today’s post is from OECD Deputy Secretary-General Yves Leterme, based on a speech he gave on 17 February to the 5. Frankfurter Ludwig-Erhard-Dialog at Frankfurt’s Goethe University

The Social Market Economy is often contrasted with the Anglo-Saxon capitalist model. While the term “social market economy” (soziale Marktwirtschaft) in its original sense is used primarily in Germany and Austria, across Europe, we find a range of different approaches to social and health policy – with vastly different implications for public expenditures, for social security contributions and tax rates, as well as for the role and responsibilities of the public sector, the private sector, and the individual.

What these models have in common is a basic vision of what is needed for social cohesion. All of them seek to provide comprehensive coverage to the entire population against a standard set of risks, which include unemployment, poverty, sickness and disability as well as old age; in addition, there are benefits in cash and in kind for families to ensure that having children does not result in economic insecurity. And in a wider sense, this ambition also includes equality in access to good quality education. Another goal, even though not explicit, is to keep income inequality at low levels; most European countries use their tax and benefit systems as well as publicly-provided services to this end.

One of the main criticisms of the European social model is that it is expensive and constitutes a drag on economic growth.

European countries lead the league of public social spending. France tops the list with about 33% of GDP going to publicly provided social protection, while in Australia, Switzerland and the United States public social expenditures account for about 20% of GDP, and in Canada 18%. All of these countries have large shares of private social spending, in particular  for pensions and health care.

Private provision of social protection, however, does not necessarily mean that the cost is reduced. European countries and the United States have similar levels of social spending once you factor in two things: first, many European countries tax social benefits which means that the state claws back some of the expenditures – this takes you to net public spending; and second, the United States and several other countries give tax incentives to employers and individuals to promote private provision of social protection, in particular for health care and pensions.

As private social spending is so much larger in the United States compared with other countries, its inclusion moves the United States from 23rd in the ranking of the gross public social spending effort to 2nd place after France when comparing net total social spending across countries. However, the implications for which groups of people are is covered to what degree by social protection can be very different.

Population structure is a key driver. Countries with a young population are much less likely to have higher social-spending-to-GDP ratios than countries with older populations, but have a greater share of education spending. The proportion of elderly in the population is around 15% across the OECD and on average they “receive” 40% of all public spending on education and social policy. In countries where only one in ten persons or less is over 65, only a quarter of social spending goes to the elderly. In Japan and Italy where 1 in 5 citizens is senior,  about 60% of all public social and education spending goes to the elderly. Population ageing will thus be a key driver of future increases in social spending. OECD projections suggest that public spending on health and long-term care services might almost double from 7% in 2009 to 13% in 2050 on average across the OECD.

OECD Pensions at a Glance and OECD Pensions Outlook show that in many countries pension reforms have improved the financial sustainability of pensions systems. The crisis has triggered faster reforms and more rapid phase-ins of already decided changes, for example in Greece, Spain and Italy. The pace and content of reforms has varied across countries but a common aim has been to promote longer working lives. While Germany was among the first to go beyond the age of 65 years, many countries have followed and now you could say that “67 is the new 65”. Often, pension promises for future retirees were lowered and more and more countries are introducing automatic links of key pension parameters to future increases in life expectancy. Some countries are also promoting private retirement savings.

Benefit systems for the working-age population have been particularly tested by the Great Recession. As unemployment benefit entitlements run out after certain periods and long-term unemployment has increased in many European countries, more pressure is now on last-resort social assistance systems. It is important to keep these schemes intact and also continue to help people on those benefits get back into the labour market.

Policy measures to boost job creation need to be cost-effective and focus on the most vulnerable groups. Labour market programmes can make a difference, and more investment in training would make the re-employment of jobseekers easier. As the OECD showed in the “Adult Skills Survey” – the “PISA for adults”- skills are very unequally distributed and this is a major source of entrenched inequality.

Even in a globalised world, this underlying philosophy of European welfare policies is unlikely to change. I believe that governments will continue to pursue the objectives of comprehensive coverage with a high degree of public sector involvement, be it as direct provider or as regulator and supervisor of private provision.

What if social market economy and, more precisely, welfare policies were not only a model for Europe, but also a precondition for a sustainable growth in developing countries and emerging economies?  Social policies are too often seen as either no fit or even as a threat for the growth of emerging economies, but a better welfare model in emerging economies would help in many ways:

  • In a global market for talents, it could help individuals to develop their skills so that they are well-equipped for a constantly evolving labour market, and can claim for better wages.
  • It could also drastically account for a more homogeneous tax system, providing a comprehensive pension scheme and allowing for more private consumption.
  • An efficient social system could also improve citizen’s trust in their institutions and governing bodies.

I am confident that the European social model will continue to adapt to a changing global context. This will require structural reforms which will inevitably have winners and losers and therefore be politically challenging at times. This, however, should be no reason for delaying action. We know that there will be no economic paradise on social ruins, but we also know that there will be no social paradise on economic ruins.

Useful links

OECD Social Expenditure database

OECD Income Distribution database

OECD Society at Glance


2 Responses
  1. March 3, 2014

    All well and good ! However, governments need to adopt a much more honest approach to to budgeting for social development.
    As an example. UK introduced pensions back in the 1920’s but failed to make sufficient charge for it, in the form of insurance contributions. This was possibly because most workers did not live beyond the age of 65 and thus they would be in surplus.
    Subsequent changes in social reform and life expectancy have continually been under subsidised by charges as it has always been a political hot potato.
    This has resulted in an escalation of debt that today has reached astronomical proportions and still continues to rise, despite the massive cuts in services and spending of the last 10 years.
    As Europe expands this issue will become a huge brake on any further social development, despite the expectations of the populace, which is a recipe for unrest.
    All social progress must be paid for. How it is supported will depend on each individual country but if harmonisation is ever to be achieved clear guidelines need to be discussed and become part of the averall budget strategy of all member and aspiring member states.
    No easy task I grant you, but essential for managed development worldwide.

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