Seminar 4: Political Institutions and Economic Growth in Europe

Introduction

What made the rapid economic growth in Europe possible after World War II? What explains the slow down from the 1980’s onwards? What public policies can governments pursue to maximise economic and employment performance?

It’s the latter question that every political party in government must consider.

In the post-war era, convergence is defined as the process of transferring the technological and organisational knowledge that had been developed during the war years to European firms and economic development.

The re-building of the capital stock in Europe, and all the labour that was required to do this, spurred the initial period of growth. This was subsequently sustained by commercialising those new technologies that developed during the two world wars.

For Barry Eichengreen (2007), Europe was singularly well suited to take advantage of this period of technological improvement because of a given set of domestic institutions.

Growth was facilitated by encompassing trade unions, cohesive employer associations and growth-minded governments. Together they mobilised savings, financed investment and stabilised wage-income levels consistent with full employment.

  • It required a set of domestic institutions (formal and informal) and a public policy regime aimed at solving a set of problems that de-centralised markets could not.
    • It required coordinated capitalism, made possible by a relatively broad consensus among centre-left/centre-right governments on the role of the state.

Economic institutions 

The origins of post-war industrial production in Western Europe, in effect, required systems of human capital formation (emphasising apprenticeship training and vocational skills) and an active role for the state and social partners.

It was the period of manufacturing-led export growth.

Convergence and catch-up was also attempted by the command economies in the Soviet Union. The institutions of these countries had severe limitations. Extractive political regimes, as argued by Acemoglu and Robinson (2011), don’t last long.

Europe relied on extensive growth in the 30 year post-war period, which meant that a growth in factor inputs (labour and capital) accounted for the increase in productivity and employment outputs.

But from the 1970’s onwards, changes in the international monetary regime, and the opening of the global economy, Europe faced a new set of problems: The challenge of intensive growth.

This is growth that must occur through innovation, technological and productivity improvements (i.e. not just increasing the input of capital and labour).

Intensive growth proved a more difficult task, as the domestic institutions in Europe that enabled extensive growth were now an impediment to reform.

Centrally planned economies were particularly inept at this. All of this facilitated a gradual shift toward more liberalised markets, particularly across the EU.

Europeanisation

European integration was directly related to this process of global economic change, as it required nation-states to liberalise their capital and product markets.

In the 1950’s, six European states put the planning of their iron and steel industries under multinational control. In the 1960’s, they built the first regional customs union (a free trade area with a common external tariff). These countries then went on to construct the single market (1986) and a single currency (1992), as discussed previously.

But what exactly were the domestic institutions, associated with the golden age of European capitalism, which gave rise to post-war growth, high investment, rapid export growth, low inequality and wage moderation? How did these institutions change?

Can we generalize from this experience and say that domestic institutions are the determinants of long-term economic growth? If so, what exactly does this mean?

Four regimes

Peter Hall (2010) suggests that economic performance depends upon success in four institutional fields that differed in the 1950-1970’s ( for the sake of analytic parsimony, we can call this the Keynesian era) and the 1980-2000’s (the neoliberal era):

  1. Production
  2. Labour relations
  3. Socioeconomic policy
  4. International regimes

In Western Europe, the era of mass Fordist production (manufacturing oriented export growth) required long-term capital investment (1 – production regime).

This meant that firms needed certainty about aggregate demand and profits.

Coordinated collective bargaining, among economising social partners, ensured sufficient wage growth to maintain demand but also allowed profits to grow, whilst simultaneously workers invested in specific skills (2 – labour relations regime).

At the same time, national governments took active steps to manage aggregate demand aimed at full employment via the Keynesian welfare state (or think the Rehn-Meidner model in Sweden (3 – socioeconomic policy regime).

Simultaneously international monetary regimes, such as the fixed exchange rate regime in the European Community, accommodated and tolerated an interventionist domestic demand management strategy (4 – international regime).

Keynesian era

All of these economic institutions had deep political roots.

They were not the outcome of an intelligent techno-rational engineer. Rather, they were born out of distributional conflict, constructed by country specific electoral coalitions, which manifested itself in the various forms of the social state.

For Peter Hall, the post-war distributional compromise was shaped by:

  1. Memory of war and recession
  2. Keynesian ideas that appealed to left and right
  3. Partisan electoral competition

In post-war Europe, class-based distributive politics shaped electoral competition and the policy-platforms of mass political parties.

Political parties of the left and right converged around the “mixed market economy” and a “compensating social state”. This class-based electoral competition drove forward the development of wage-led growth regimes. Wage growth sustained demand.

Class discussion: Can we identify an analogous institutional architecture for the subsequent era, from the 1980s to the mid-2000s?

Neoliberal

It is now commonplace to describe the period of socio-structural economic change from the 1980’s onwards, the neoliberal period economic change. Others call it a shift from demand-managed economies, to supply-side managed economies.

In terms of production, the major change was a structural shift away from manufacturing to services, particularly with respect to employment, outsourcing, and the emergence of new information technologies that have fundamentally re-shaped global supply chains (1 – production regime).

These structural economic changes, however, were made possible by shifts in the international monetary regime, which facilitated FDI, capital flows, off-shoring and global financial liberalization aimed at free capital movement (4 – international regime).

In response, there has been a premium placed on high-tech skills, labour market competition, leading to skills-based technological change. Collective bargaining has gradually shifted to the market (firm level) whilst trade union density rates have declined in response to new forms of employment (2 – labour relations regime).

Governments have been less concerned with managing aggregate demand but introducing supply-side reforms aimed at cost reduction (3 – socio-economic regime).

The politics of liberalization

But what were the political conditions that made this shift to post-1980 market liberalism possible? Or more precisely, who were the actors? The electoral coalitions?

Peter Hall identifies the following factors:

  1. Memory of failed state intervention
  2. New classical economic ideas built on monetarist foundations
  3. Fragmented electoral competition

Politically, new electoral cleavages have emerged that cut across the left-right spectrum, and in turn, have restructured political conflict.

Class dealignment, declining voter turnout among low income groups, shifts in occupation structure and rising electoral volatility have meant that centrist parties converged on “supply side policy choices”.

But this consensus has had important consequences: the electoral space is increasingly occupied by populist far-right parties (who have shifted to the left, economically).

In the study of comparative political economy, this has led to debates about whether all countries are converging on a neoliberal model of capitalist development?

As we will see in next weeks seminar, whilst there are certainly commonalities across European countries, but important cross-national differences still remain.

European varieties of capitalism

The policy response to this paradigm shift in the macroeconomy varies between countries, particularly in how they have sought to generate employment growth (i.e. in the absence of state commitment to sustaining aggregate demand).

  • In the liberal market growth model (particularly US and UK) private debt (primarily in mortgage markets and housing finance) during this neoliberal period replaced real wage increases, and consumption sustained aggregate demand.

Housing (funded by cheaper mortgages) became a form of social policy, whilst cheaper imports enabled higher levels of consumption.

The wealth effect, according to recent research, ensured political support for low-tax parties, which generally favour the new right.

In continental European social market economies, two divergent approaches emerged.

  • In the small open Nordic economies the trajectory of liberalization meant an expansion of public services: healthcare, education, childcare, funded by high tax rates. These “flexicurity” regimes often built on the Rehn-Meidner model.
  • In conservative welfare states the new response was built around expanding employment in secondary labour markets (Germany, Italy, Spain) by relaxing restrictions on part-time work and temporary contracts.

Most comparative political economy research suggests that countries with “conservative welfare states” developed “dualised” labour markets, divided into spheres of stable employment in the industrial and/or public sector, and precarious employment in the expanding low-skill private sector services.

Discussion 

If these two different paradigm reflected a generation of socio-structural change, it is worth considering whether we are we now entering a new 30 year period that will shape the architecture of European political economies? What will this trajectory look like?

Class discussion: Is there a new European wide growth regime?

Case study: post-war Germany (that is no more)

Prior to the late 1990’s, Germany was governed by a set of domestic institutions that made for strong international competitiveness that facilitated high-wages and low inequality of incomes and living standards. How was this possible?

For Streeck (1998) the post-war institutional framework can be summarized as follows:

  1. Markets: price competition was mitigated by product specialization. Competitive markets (with strict competition laws) were designed to serve public purposes and to co-exist with an extensive social welfare state.
  2. Firms were considered social institutions and not just networks of private contracts for the property of shareholders. This incentivised long-term relations with banks rather than relying on equity in the stock market.
  3. Labour: human skills in these export firms were considered a fixed productive asset that encouraged employer investment in education and training. Co-determination and employment protection were high.
  4. State: the state was enabling rather than laissez faire. Sovereignty was divided horizontally and vertically, and constitutionally dedicated to competitive markets and a hard currency, whilst public spending on infrastructure and research high. Spending on social protection was high because there is a constitutional obligation to equalize living standards across the Länder.
  5. Associations: economic governance is delegated to centralized and economically sophisticated collective bargaining actors with quasi-public functions: skills, insurance, health and safety, product regulation, quality. Note: union-employer density is now in free-fall, along with bargaining coverage.
  6. Culture: savings rates are high and consumer credit low, which suggests that building long-term orientations are a social norm, and reflected in the qualification-based organization of work.

Beneficial constraints 

In the 1990’s the argument was that these densely regulated institutions imposed a beneficial constraint on employers, forcing them to compete on quality rather than price.

However, three broader conditions to make this strategy successful had to be met:

  1. High global demand for product markets
  2. High investment in product innovation, research and development
  3. Steady supply of high-skilled labour/jobs (and therefore balanced against retirement)

Germany could not sustain the latter (it’s welfare system, and in particular, the cost of pensions). Social institutions that rule out a low wage economy, in order to sustain a high wage economy, will eventually be overrun by market forces.

This is what happened to Germany from the 1990’s onwards.

Germany initially responded to this by reducing retirement (cutting the labour supply of labour). But this became too costly in terms of pensions.

Eventually the government liberalized the labour market (Hartz I and II), leading to a rapidly expansive low-wage sector and an increasingly dualized workforce.

This is an important observation, as it might explain the EU’s response to the Euro crisis in southern Europe, and why the SPD are in such electoral difficulty today.

Three factors can explain the transformation of German capitalism over the past decade.

  • A shift in the bargaining power of actors.
  • The shock of German unification, European integration and globalization.
  • Active management of wage restraint (and growing income inequality), and low-wage employment.

Conclusion 

Discuss. Can the post-war German social market economy (even though it doesn’t really exist anymore) be shifted upwards and exported to the EU as a whole?

This is very difficult for four reasons:

  1. The EU is an international organization constructed through diplomacy not the class politics that gave rise to soziale Markwirtschaft
  2. The German firm is embedded in the broader institutional matrix of the German political economy that is not easily replicable.
  3. There is no EU wide state capacity to equalize living standards
  4. There are no collective bargaining associations with the capacity for high-skill investment

Class discussion 

Screen Shot 2017-10-02 at 22.13.45

Do you agree with the argument by Acemoglu and Robinson that political and economic institutions are the fundamental cause of long-term economic growth?

What’s the causal mechanism in their theory? Does it suggest that economies with higher levels of economic inequality will have lower levels of economic growth?

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