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Europe is finally reforming. Governments are starting to liberalize.
European Union leaders have pledged to nurture the new economy.
Germany’s parliament has approved radical tax reform. France’s finance
minister is talking about tax cuts too. Amazing. But is globalization
forcing their hands?

Many people think so. They reason as follows:

is breaking down walls between national markets. Countries, like
companies, increasingly compete for capital and workers. So if
governments set high taxes to fund socialized medicine and generous
welfare schemes, people and firms will exit. If they impose costly
labor and environmental standards, jobs and investment will flee
abroad. Inexorably, globalization is stripping the "social" out of the
social-market economy. Europe is being forced to reshape itself in
America’s image.

This conventional wisdom delights
some free marketers and distresses some Europeans who believe their
model is fairer than America’s. But it should worry liberals too.
America’s vibrant economy is enviable, but there is more to life than
maximizing GDP growth. Europeans should be able to choose social
democracy if they are willing to pay for it. If globalization stops
governments from doing what the people want, then it might not be such
a good thing, however much it boosts growth.

conventional wisdom is wrong. Globalization is not forcing Europe to
jettison its ways. For one thing, the extent of globalization is
greatly exaggerated. Yes, labor, capital and products cross national
borders more easily than before. But the world economy is still more of
a ragged patchwork than a seamless web.

bankers may jet around the globe without impediment, but Indian
computer programmers struggle to get temporary European work visas.
Only around 1.5% of the world’s labor force worked abroad in 1993. Even
in the EU, with its free movement of labor, just 2% worked outside of
their homelands in the last year. For all the surge in global foreign
direct investment, to $827 billion last year from $50 billion in 1985,
domestic investment dwarfs it eight times over. And, despite 50 years
of trade liberalization, many barriers remain, not least in agriculture
and services, which together account for two-thirds of the global

Moreover, new barriers are forever
cropping up — even in cyberspace. Witness the EU’s data-privacy
directive, which discriminates against foreign firms. Consultants at
McKinsey reckon only a fifth of world output is open to global
competition in products, services or ownership. Even if all trade
barriers were abolished, many services would still not be traded. The
market for haircuts, for instance, will remain local.

importantly, the European model can survive, however much the economy
opens up. Competition between models of capitalism is a bit like
competition between different types of car. The American model is like
a pared-down sports car: it accelerates quickly and turns easily, but
the ride can be bumpy, crashes spectacular, and it’s a bit flashy for
some. The European model is more like a station wagon loaded with
extras: it feels safe and comfortable, but it’s cumbersome and slow off
the mark, and a bit boring for some.

In a
competitive market, there is no reason why one model should drive out
the other. Tastes differ. If all you care about is winning the race,
you’ll probably choose the sports car. If you prefer to travel safely
and comfortably, you’ll doubtless opt for the station wagon. And who
knows, the station wagon may even end up ahead if the sports car comes
a cropper.

Europeans can continue to cough up for
extras such as a generous welfare state if they wish. Some extras, such
as good state-funded schools, are actually a competitive advantage.
Others, Europeans may decide, are, like tailfins — costly and
redundant. But even then, that will be their decision. Globalization
does not force them to dump them. Indeed, even Europeans who want
Europe to become more American are unlikely to vote with their feet. A
Frenchman is hardly likely to emigrate to America, leaving behind
family, friends and, more importantly, cafes, just because he thinks
the government should spend less on health.

not convinced? Consider the facts. If globalization is forcing
governments to slim, it is doing a pretty poor job. For all the surge
in international trade and investment over the past 15 years, the share
of taxes in national income has edged up in most countries. The average
among OECD members is up to 37% from 34%. In Britain, despite Margaret
Thatcher’s efforts, the state still gobbles up two-fifths of GDP.
Moreover, the spread between low-tax and high-tax countries is as wide
as ever. The U.S. and Japanese governments still take less than a third
of GDP in tax, Germany’s around 45%. If anything, countries have more
sharply diverged: Italy’s tax take has shot up to over 46% of GDP from
38%, and France’s has risen to over 50%. Importantly, Germany’s reforms
and France’s mooted ones don’t alter this big picture.

that competition for FDI will force European governments to slash taxes
and regulations are also misplaced. The share of corporate tax in OECD
governments’ revenues has remained constant at 9% since 1965. The
reason why is simple. Taxes and regulation are rarely crucial in
companies’ location decisions. Surveys show that a skilled workforce,
good infrastructure, proximity to market (and good golf courses) are
usually far more important. Look at high-tax Sweden. It attracted $78
billion in foreign investment last year, more than any country except
the U.S.

Moreover, good regulations, whose
benefits outweigh their costs, are actually a plus. Prudential
financial regulation, for instance, may deter crooks while attracting
honest investors.

Politicians boast about bonfires
of regulations, but there is no evidence of a "race to the bottom" by
governments eager to attract foreign investment. A new OECD study finds
that firms rarely shift operations to take advantage of lower
environmental standards elsewhere. Pollution havens are a myth. In
fact, competition for foreign investment often raises environmental
standards. Governments want to attract clean, knowledge-intensive
industries. Multinationals often find that higher standards cut costs
and enable them to charge a "green premium." Skilled staff prefer
living in cleaner places. "Policy competition has raised standards [of
environmental protection] across much of Europe," the report concludes.

The evidence on labor standards also belies the
conventional wisdom. In an OECD study of 75 countries that account for
virtually all of world trade and investment flows, researchers found
huge differences in labor standards among countries. Most non-OECD
countries significantly restricted workers’ freedom of association,
while no OECD countries other than Mexico, Turkey and South Korea did.
Yet freedom-of-association rights have not deteriorated significantly
in any of the 75 countries since the early 1980s, despite the explosion
in overseas investment. In fact, they improved significantly in 17
countries, including Brazil, South Korea and Turkey.

you do, blame globalization" is the maxim of modern government. It is
short-sighted because it feeds a misguided backlash against openness.
There is no evidence that globalization threatens the European model.
Perhaps the real reason social democrats are worried is that
governments often fail to deliver what people want. They often
mismanage the economy, tax needlessly, spend wastefully and regulate
perniciously. Such domestic failings may turn voters against social
democracy. But don’t blame globalization for its demise.

Posted 08 Sep 2000 in Published articles

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