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The American Left’s Two Europes Problem

Wednesday, February 29, 2012

The American Left is far more interested in northern Europe than it is in southern Europe, despite the fact that southern Europe constitutes the majority of the population of the core 15 European Union members. Why?

A century or so ago, German sociologist Max Weber observed that Protestant countries in northern Europe tended to outperform the Catholic and Orthodox countries in the south of the continent. Weber believed that the northerners had a stronger work ethic, were thriftier, and possessed more of what is today called “social capital.” Though Weber attributed these differences to Protestantism itself, we should note that countries did not randomly convert to Protestantism. The roots for the cultural differences might very well go even deeper.

Economists have since largely abandoned Weber’s insights, and in general have turned against “cultural” explanations for economic outcomes. Yet Weber would not be surprised if shown a map of credit downgrades in Western Europe anno 2012. Western Europe can still roughly be divided into a northern, Germanic language, Protestant region, and a southern, Latin/Greek language, Catholic/Orthodox region.

These two Europes differ both in terms of culture and in terms of social and economic outcomes. France, Italy, Spain, Belgium, Portugal, and Greece have all been downgraded by Standard and Poor’s, sometimes repeatedly. Meanwhile, Germany, the United Kingdom, the Netherlands, Switzerland, Denmark, Sweden, Norway, and Finland all currently maintain the highest credit rating.1 Southern Europe on average has a debt-to-GDP ratio of more than 100 percent and deficits as a share of GDP of more than 5 percent, while northern Europe is closer to a balanced budget.

Europe and how Europe is perceived matters for the political debate in the United States. Liberal intellectuals such as Paul Krugman, Ezra Klein, Matthew Yglesias, and others view the European welfare states as role models for the future of the United States.

You will, however, quickly notice that the American Left is far more interested in northern Europe than it is in southern Europe, despite the fact that southern Europe constitutes the majority of the population of the core 15 European Union members.

If your aim is to make Europe a storefront for social democracy, why not go ahead and showcase the nice part of town?

The fascination of the American Left with northern Europe can be illustrated using some simple Google searches: Matthew Yglesias mentions countries in northern Europe at twice the rate of southern Europe. In the Krugman archives there are one and a half times as many mentions of northern Europe as of the continent’s southern part. Both authors mention Sweden, with 9 million inhabitants, more often than Italy, with 60 million inhabitants.

Krugman and Yglesias make roughly as many mentions of the Scandinavian countries as they make of Italy, Spain, Portugal, and Greece combined, though the latter together have a population of 130 million compared to 25 million Scandinavians. The psychology behind this favoritism is understandable. Northern Europe in general and Scandinavia in particular has superior social and economic outcomes compared with southern Europe. If your aim is to make Europe a storefront for social democracy, why not go ahead and showcase the nice part of town?

The justification for using northern European countries to showcase the welfare state is the notion that only these countries are “real” welfare states. Certainly some decades ago, focusing on northern Europe made sense. Historically, this region was the first to industrialize, the first to witness the rise of labor movements, and the first to build welfare states. However, during the postwar period the two Europes rapidly converged, both in terms of average income and economic policy. Today, the welfare state is roughly the same percentage of the economy in Italy, France, Spain, Portugal, and Greece as it is in northern Europe. Southern Europe is at least as left-wing in their economic policies as the north, leaving American liberals no excuse to sweep their poor economic outcomes under the rug.

Let us compare welfare state policies and outcomes in the two European “cultural zones” systematically. For this purpose the Western European members of the European Union are divided into two groups. I define southern Europe culturally to include Latin speaking France, Italy, Spain, and Portugal, and Hellenic speaking Greece. Belgium is mixed language, but Catholic, and therefore included here. These countries have a combined population of 200 million and a combined GDP of $7 trillion. Northern Europe includes Germanic language group members such as Sweden, Denmark, Finland, Germany, the Netherlands, and Austria. These countries have a population of 130 million and a GDP of $5 trillion.2

Northern Europe consistently outperforms southern Europe. Per capita income is 16 percent higher. Unemployment in 2008 was 6 percent, compared to 8 percent in southern Europe. Differences in poverty rates are remarkable. If calculated using the American poverty threshold, 8 percent of northern European citizens were poor prior to the crisis, compared to 25 percent of southern Europe.3

Tino Poverty

Sources: Geranda Notten and Chris de Neubourg (2011) for Europe, based on U.S Census definition of Poverty and Census Bureau 1998-2008 average for U.S.

The conventional wisdom is that differences in outcomes must be due to differences in policy, most importantly the size of government. Yet, it is today difficult to find fundamental policy differences between the two Europes, as the welfare state in northern Europe has shrunk a bit while the state has expanded in southern Europe. Government spending as a share of GDP is the most commonly used and most straightforward measure of the size of the welfare state. In the United States prior to the crisis, government spending was around a third of GDP. In northern Europe, the government in 2008 constituted 46 percent of the economy, while it made up 48 percent of the economy of Southern Europe.4 This is strong evidence against the notion that southern Europe should be excluded when evaluating welfare states.

Tino Government Spending

Source: Eurostat. Average for Years 1998-2008. Bureau of Economic Analysis.

Top marginal taxes on higher labor incomes are still somewhat higher in northern Europe, but the gap is now minor: an average of 62 percent in northern Europe versus 60 percent in the south.5 The highest effective marginal tax is 74 percent in Sweden and 70 percent in Denmark, but next is Portugal at 65 percent followed closely by France at 61 percent. Corporate tax rates are similar in north and south, as are rates of compensation in unemployment insurance and the generosity of public pensions. Indeed, on all three measures, southern European policies are slightly more welfare-state oriented than in northern Europe. The share of the workforce covered by union collective bargaining agreements is today higher in southern Europe than northern Europe. According to various OECD and World Bank indices, the regulatory burden of government is again if anything larger in southern than northern Europe, both regarding labor regulation and regulation of businesses.

Paul Krugman and Ezra Klein have argued that the size of the welfare state is best measured using public “social expenditure.” This definition is narrower than it sounds. It includes healthcare spending and entitlements, but not, for example, education spending, so that it tends to only include around half of total welfare state spending. Leaving aside the problems with this measure, even by the liberals’ own empirical definition southern Europe is as much a welfare state as northern Europe. Public social expenditure prior to the crisis was an identical 25 percent of GDP in southern and northern Europe.6 Currently, social expenditure is actually a higher share of the economy in the south than north, though this may be a temporary result of the crisis.

Tino Social Expenditure

Source: OECD Social Expenditure Database, 2007.

The confusion in defining welfare states is in part due to the tendency to conflate policies and outcomes. When reading about the “Teutonic Model” or the “Iberian Model,” it is rarely made clear if we are talking about unique policies or unique outcomes. Similar policies can and do lead to vastly different outcomes, as can be easily seen by looking at different regions of the same countries. We have so far confirmed that social indicators, such as poverty and unemployment, and macro variables, such as debts and deficits, are far better in northern than southern Europe. But those are outcomes, not policies. If we want to evaluate the performance of left-wing economics, you can obviously not define welfare states based on only successful outcomes, casually discarding all failures in the analysis. All nations that pursue welfare state policies must be included in the evaluation, both those who achieve favorable social outcomes and those less successful.

If calculated using the American poverty threshold, 8 percent of northern European citizens were poor prior to the crisis, compared to 25 percent of southern Europe.

Southern Europe today is no less a welfare state than the north, defined as the involvement of the state in the economy. While we observe sizable differences in social and economic outcomes, there is no evidence that this is due to policy itself being radically different. A more likely explanation is that outcomes from welfare state policies are mediated through the deeper structures of society: culture, norms, social capital, etc. so that similar policies produce different outcomes in different countries. These “soft” factors are hard to measure, but the fact that a concept is hard to measure or to perfectly define does not mean that it is not important.

Indeed, some such patterns can be discerned in data such as the World Values Survey and in aggregate national accounts. Just as Max Weber would have predicted, the saving rate in northern Europe remains higher than in the south. The political systems in the south are still characterized by corruption, instability, and narrow interest politics rather than broad national responsibility. Weber also believed the work ethic to be stronger in the north. It is interesting that around 60 percent of Scandinavians state that they are proud of their job, compared to 30 percent of Italians and merely 15 percent of the French. Trust in strangers, perhaps the easiest way to measure components of social capital, is also far higher in northern Europe than in the south. While 66 percent of Swedes, 63 percent of Finns, and 55 percent of the Dutch state that they trust strangers, those numbers are 34 percent in Italy, 23 percent in France, and 21 percent in Portugal.

The interaction of policy and culture can be seen in the size of the shadow economy. The difference between Sweden and Greece is not only the tax rates determined by politicians, but the extent to which people actually pay their taxes. The shadow economy share has been estimated at 7 percent in the relatively low tax, rule-compliant United States, around 14 percent in high tax, rule-compliant Scandinavia, and 21 percent and 24 percent, respectively, in high tax, weak-compliance Italy and Greece. The share of the population that states that it could be justified to “claim government benefits to which you are not entitled” is 33 percent in northern Europe and 45 percent in southern Europe. These figures are likely to underestimate the historical differences, since long periods of welfare state policy appear to undermine social norms.

France, Italy, Spain, Belgium, Portugal, and Greece have all been downgraded by Standard and Poor’s, sometimes repeatedly. Meanwhile, Germany, the United Kingdom, the Netherlands, Switzerland, Denmark, Sweden, Norway, and Finland maintain the highest credit rating.

It is easier to lower poverty through social insurance programs in countries where pro-societal norms limit abuse. When a generous welfare state was initially built in Scandinavia, the rates of welfare dependency remained low. In cultures with strong social control it was a stigma to exploit the public. Over time, however, ever more generous benefits and lax controls undermined the foundation of the welfare state even in Scandinavia. Thus, in 1970, an estimated 11 percent of Swedes lived off government welfare rather than working, while in the mid-2000s the figure had doubled to 22 percent. Norms for work and against exploiting public programs were taken for granted by social scientists from both Marxist and liberal traditions. They therefore did not anticipate that generous entitlements would eventually eat away at social capital accumulated over centuries. More than globalization, I suspect it was the gradual erosion of norms that eventually forced the welfare state in northern Europe to retreat. The challenge of redistributing income without disincentivizing work was even greater in southern Europe. Employment and hours worked appear to have reacted more aversely to the expansion of the welfare state and rising taxes in southern than northern Europe. Today in southern Italy, half the working age population doesn’t work. Constantly.

There are policy implications from all of this for discussion in the United States. When European welfare state policies are to be evaluated, all welfare states must be included, not only the best performing ones.

Nicholas Kristof wrote recently in the New York Times, “It’s absurd to dismiss Europe. After all, Norway is richer per capita than the United States.” This is certainly true, but is it fair or scientific to compare the richest oil-extraction economy in Europe with the entire United States? Would the New York Times accept a comparison between the average income in Connecticut or Delaware (both richer than Norway) and the entire European continent?

Ezra Klein recently wrote that “Germany spent 25.2 percent of their GDP on [social policy]. Greece spent 21.3 percent on social policies. Yet Greece is in crisis, and Germany is fine.” He appears to suggest that the current fiscal disaster in Greece has nothing to do with welfare state spending. But selectively picking two examples is not convincing. Generally, southern Europe spends no less on public welfare state policies than northern Europe, and countries that spend more on social policy are indeed currently in worse fiscal shape.

Paul Krugman took this data-mining further in trying to deny that the crisis in Europe reflects poorly on the welfare state. In an article subtly titled “It’s not about the welfare state,” Krugman wrote, “Sweden, with the largest social expenditure, is doing just fine. So is Denmark.” Sure Paul, Sweden and Denmark, constituting 4 percent of the population of European welfare states, are doing fine. But France, Italy, Spain, Portugal, Greece, and Belgium, constituting half of Western Europe, are not doing fine, all having been recently downgraded. On average, the public sector constitutes 48.5 percent of the GDP of those six countries, compared to 51.8 percent in Sweden and Denmark. The difference is a matter of rounding errors. When it suits Krugman, Europe consists of Sweden and Denmark, with the rest of the continent’s welfare states blissfully ignored.

Krugman once memorably made the case for Europe outperforming the United States by pointing to the attractive appearance of its two richest cities: “Frankfurt [and] London.” Some common sense is sufficient to realize that the correct comparison would be rich American cities such as New York and San Francisco. Cherry picking the (by far) richest parts of Europe and comparing them with the United States as a whole is a tactic of weakness, chosen only because of the poor performance Europe makes in the aggregate.

Around 60 percent of Scandinavians state that they are proud of their job, compared to 30 percent of Italians and merely 15 percent of the French.

It is always problematic to think that one is in fact comparing policies or “systems” when comparing countries, since countries differ in deeper ways than in the policies they adopt. If we nevertheless want to compare “models,” let’s at least do it right. It might have been justified in 1960 to focus on Scandinavia, Holland, and Germany alone when trying to discern the effects of the welfare state. But today, most of Europe consists of welfare states, both to the south and to the north, with no major overall differences in the size of government. There is no justification for cherry picking a small number of above-average performers while ignoring the majority of poorer performing European welfare states.

The American Left has convinced itself that the relative success of the welfare state in northern Europe happened in a cultural vacuum and can be replicated anywhere, anytime. Yet numerous European countries that attempted to replicate Nordic policies without having uniquely Nordic levels of social capital and population homogeneity have so far failed. This suggests that more factors determine outcomes than economic policy alone, and that similar policies can have different outcomes in different countries. If America follows Europe in building a full-scale welfare state, we have no idea if the results will be closer to “Sweden and Denmark,” southern Europe, or (as is most likely) somewhere in between.

For all their fascination with Europe, southern Europe doesn’t loom large for the American Left. But France, Italy, Spain, Belgium, Portugal and Greece are more representative of European outcomes than Sweden, Denmark, and Finland, and have equally sized welfare states. Their failure should not be ignored in the American debate.

Tino Sanandaji is a researcher at the Institute of Industrial Economics and holds a PhD in public policy from the University of Chicago.

FURTHER READING: Sanandaji also writes “Why Keynesianism Works Better in Theory Than in Practice.” Daniel Hanson contributes “Headed for the Rocks in European Waters.” Alex J. Pollock adds “Waiting for Hamilton: The ‘Imbecility’ of the EU.” Desmond Lachman says “Shrink the Eurozone to Save It” and asks “Was the Euro a Mistake to Begin With?” Michael Auslin authors “Europe Whole or Divided (Or 1648 and All That).”

Footnotes

1. One exception is tiny Iceland, which has been downgraded.

2. The United Kingdom, Ireland, and Luxembourg are excluded because they are arguably not classic welfare states. Similarly, Norway and Switzerland are excluded, both because they are not members of the European Union, and because Norway’s massive oil wealth and Switzerland’s conservative economic policies make them too idiosyncratic to be used as examples of welfare states. Note that the inclusion of Norway and Switzerland would further underscore the gap between north and south.

3. Geranda Notten and Chris de Neubourg  (2011) “Monitoring Absolute and Relative Poverty: ‘Not Enough’ is not the same as ‘Much Less’.” Review of Income and Wealth 57(2). The American figure before the crisis was around 12%.

4. France 53%, Denmark 52%, Sweden 52%, Greece 50%, Belgium 50%, Italy 49%, Austria 49%, Finland 49%, Netherlands 46%, Portugal 45%, Germany 44%, Spain 42%. Average spending 1998-2008 was similarly 46% in Northern and 48% in Southern Europe.

5. Thomas Piketty, Emmanuel Saez and Stefanie Stantcheva "Optimal Taxation of Top Labor Incomes: A Tale of Three Elasticities". The American figure is 43%.

6. France 28%, Sweden 27%, Belgium, Denmark, Austria 26%, Italy, Finland and Germany 25%,  Portugal 23%, Spain 22%, Greece 21%, Netherlands 20%.

Image by Darren Wamboldt / Bergman Group

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