The development of EU social policy

The Lisbon summit of March 2000 set an ambitious aim to EU governments: making the EU “the most competitive and dynamic knowledge-based economy in the world, capable of sustainable economic growth with more and better jobs and greater social cohesion”. [1] Even though some progress has been made, one can say that the desired goals are still far from being achieved. [2] Low employment rate, low economic growth and ageing of population are just a few of the elements that question the success of this ambitious project.

In this paper we try to analyse the impact that EU social policies have on the overall economic performance of the EU territory.

The first part of our paper focuses on the development of EU social policy, by describing its evolution and the main differences existing among EU social models. The second part gives a theoretical framework on the controversial trade-off concerning social equity and economic efficiency. In the third part, we analyse the main economic losses connected with EU welfare policies. Finally, we use these outcomes to provide some practical examples of EU social programmes and assess their negative impact on EU economic efficiency.

European Social policy

According to the Treaty of Rome, social policies remained mostly under national affair, as the countries didn’t manage to reach a compromise about their harmonization. One of the achievements of the Treaty of Rome is the provision about the establishment of the European Social Fund (ESF). [3] It was mainly concerned with the simplification of the employment of workers, the increase of their mobility in the Community and their adaptation to change by means of vocational training. [4] 

The Single European Act, the Maastricht treaty and the Nice Treaty brought further changes in terms of social policy. [5] 

The Lisbon Summit gave a new boost to the development of the European social policy. The Open Method of Coordination (OMC) is defined as an instrument of the Lisbon Strategy. This new tool of governance is aimed at the coordination and harmonization of social policies and is based on European guidelines, which are transferred into national action plans. [6] The OMC established common indicators for comparing best practices. The evaluation and review of the national plans are periodically organized at the European level. [7] 

European social models

Despite initiatives trying to harmonize social policies at the EU level, we can notice that a single European social model cannot be detected, since the preferences vary among member States.

Sapir distinguishes between four types of European social models. Nordic countries (Denmark, Finland, Sweden and the Netherlands) are characterized as countries with the highest level of social spending, high taxation rate and strong labour unions. [8] In Anglo-Saxon countries (the United Kingdom and Ireland) cash transfers are mainly directed to the people in working age. The labour unions are weak. As to wage dispersion, it is quite wide and increasing. [9] Continental countries (France, Germany, Austria, Belgium and Luxembourg) are characterized by high expenditure on employment protection, health and pensions, still having strong trade unions. [10] In Mediter­ranean countries (Italy, Spain, Portugal, Greece) the main part of the social spending goes to pension funds. The social welfare systems of these countries acknowledge employment protection and early retirement. [11] 

Economic perspective of welfare policies

Extra-economic considerations are also at the base of welfare policies, and can explain the reason why they constitute nowadays such a controversial issue. [12] The core concern regarding welfare policy is due to the dilemma of the complex relation between equity and efficiency.

Equity versus Efficiency

The reason why welfare policies are considered important relies on social considerations implying more equitable economic perspective on one hand, and significant costs on the other. [13] 

The degree of inequality, existing in any country, can be explained by the Gini coefficient derived from the Lorenz curve, which shows the relation between the cumulated distribution of income to the cumulated distribution of households. [14] 

In Figure 1, the diagonal represents the curve of absolute equality, where each person should have the same amount of income. A hypothetical curve in the left-bottom corner will represent the curve of absolute inequality, where one person will receive the total income. [15] The curve ‘c’ shows a hypothetical country where the distribution is in between the two opposite extremes.

Curve of absolute inequality

Figure 1 – Lorenz curve (Source: based on Samuelson, Nordhaus) [16] 

The area in grey represents the Gini coefficient [17] . It varies significantly among EU member States, with an average of 30.6% in 2007 [18] and of 30.5% in 2008 [19] . In 2009, the social welfare expenditure in the EU accounted for 42.2% of governments expenditure [20] , but the data available till now don’t give evidence of an improving situation in terms of equity (Table 1).

Table 1 – Source: Eurostat [21] 

The “leaky-bucket” experiment – developed by Okun – can give an explanation of the trade-off between equity and efficiency. [22] Okun illustrates the cost of redistribution policies by demonstrating that not the entire amount of money taken from the richer goes to the poorer. [23] 

Figure 2. Source: based on Pestieau [24] 

Pestieau uses a simple example to explain this economic metaphor. [25] As in Figure 2, he assumes that at point A, Robinson has 8 oranges whereas Tintin has 2. If we want to redistribute the oranges equally, we should transfer 3 from Robinson to Tintin. However, as we transport those oranges in a “leaky bucket”, some of them will be lost: Robinson will have 5 oranges and Tintin 4 (point B). [26] The lost orange represents the cost of transfer, showing a loss in terms of efficiency. In real life, that cost is due to factors such as administrative costs and lower efforts in work made by the tax-payers and savings. [27] 

The Matthew Effect

Another reason at the base of welfare policies inefficiency is the so-called Matthew effect. The Mathew effect supports the idea that – usually – the people who benefit the most from social spending are those who need it less. [28] This is due to cultural and institutional reasons: the lowest socio-economic groups are often stopped from benefiting from EU social policies because of “administrative complexity and fear of stigmatization”. [29] 

The result of this phenomenon is an increase in inefficiency of welfare policy, related to the disregard of its main goal: redistribution of wealth.

Economic Losses

The nature of the trade-off between equity and efficiency is a controversial issue. Even though the statistics appear to show a correlation between public spending and GDP, we can argue about the direction of the causality. [30] Furthermore, as Pestieau mentions, “we cannot correlate social spending with GDP because less generous social systems […] experienced globally higher growth rates than more thriving systems such as the Northern states of the EU in the early eighties”. [31] In fact, if we analyse the tendency over the years, we notice that countries with a laissez-faire economy had a better GDP performance during the last decades. [32] 

In the next paragraphs we will focus on the impact of EU welfare policies on economic efficiency, namely through the influence that these policies have on savings and investment, competition and disincentives to work in the European Union. In addition, we will present the inefficiency of the EU welfare policies, not always in line with their expected outcome. Finally, we will use those tools to discuss on the economic efficiency of some EU policies being currently undertaken.

Savings and Investment

Basic macroeconomic theory debates about the importance of savings and investment in order to achieve increased economic growth. Many economists claim that “since the tendency to save increases with income, policies redistributing revenue from the richer to the poorer would reduce savings and growth by the same token”. [33] In other words, richer European citizens will set aside an increasingly large proportion of their additional income on savings, while disfavoured socio-economic groups are likely to save less. Therefore, inequality can be economically desirable to some extent, since economies with greater inequality levels would experience a higher economic growth. [34] 

Competition

Given the recent failure of the Lisbon strategy, the concern about the ability of the EU to compete with other world major economic powers, such as the US and China, is being seriously questioned.

EU welfare policies would not prevent the fact that part of the social protection financing comes from labour taxes. In a globalized world where the EU acts as a major trade player, the existence of these taxes would cause an adverse effect on EU’s competitiveness. In fact, the higher the European firm’s wage cost and cost of production is, “the less competitive it will be relative to firms from countries with lower tax burdens”. [35] Thus, taxation schemes can be an “element that makes the EU a less attractive territory” [36] , by discouraging foreign investors and encouraging tax evasion and emigration. Consequently, it is important that EU social policies do not negatively affect competition and that private companies are able to compete freely, as they are naturally more efficient.

EU welfare policies would also cause deadweight losses through the distortions of consumer choices [37] , given that the variety of products decreases without competition. [38] Taking into account Ricardo’s model of comparative advantage, the adjustment of wages implied in payroll taxes would give a comparative advantage to both labour and capital intensive countries when trading products with the EU.

Disincentives to Work

Another important aspect of EU welfare policies is the problem of the disincentives to work and the effect of individual behavioural responses to the incentives implicit in them. Both have a large impact on economic efficiency. For instance, “social security can induce socially undesirable early retirement”. [39] Also, “disability insurance can lead to more absenteeism on grounds of minor health complaints”. [40] 

“Traditional micro-economic reasoning is based on the concept that an individual will only seek employment when it provides him with material gain”. [41] If stopping to work and accepting benefits was more financially attractive than earning money via work, employees would assume the possibility to reduce their labour supply, catching them in an “inactivity trap”. [42] Furthermore, some people would consider the possibility to work in the unreported economy while still illegally benefiting from minimum pension provisions.

Inefficiency of the implementation of EU policies

Finally, it is essential to consider the inefficiency of the implementation of EU social policies. Following the Matthew effect – described earlier – the distribution of the EU’s social expenditure has a negative impact on economic efficiency in the EU. Indeed, public expenditure associated with EU policies often favours the wealthiest social groups, by providing them with “social provisions intended for the disadvantaged groups”. [43] 

Finally, the Administrative costs should be mentioned. Even though it is true that having EU common social policies generally reduces administrative costs, these are still considerably high, as the implementation of such European policies is made on a national level.

Figure 3. Best Practice frontier (source: Pestieau [44] )

To sum up, the productive inefficiency in the allocation of resources should always be considered when it comes to social policies. As seen in Figure 3, there is a productive inefficiency if the same production of goods and services can be carried out with fewer resources (point a to c) or if more can be produced with the resources used (in point a to b). This denotes that “better can be done with less”. [45] 

Now that we know to what extent social policies affect economic efficiency, we can focus on the impact that some of the EU welfare policies may have on its economic performance.

Examples of EU welfare policies

Lifelong Learning Programme

At the EU level, lifelong learning programmes – such as Erasmus and Grundtvig- are seen as “critical factors for achieving the Lisbon strategy’s objectives of enhancing economic growth, competitiveness and social inclusion” [46] by improving the knowledge, skills and competences of European citizens.

Notwithstanding the social benefits of such programmes, we can still question whether there is an economic payback for the €7 billion spent for 2007 to 2013 [47] .

For instance, the Grundtvig programme aims at “supporting adult learning staff to travel abroad for learning experiences”. [48] Setting the social benefits aside, we can debate whether the marginal economic outcome of teaching an adult is the same as of teaching a younger person that will be longer in the labour market. This will cause a deadweight loss. If the increase in productivity doesn’t make up for the money invested on that programme, there is no economic benefit in doing so. This will have a negative effect on EU’s competitiveness when compared to other countries.

Moreover, we should ask if the people benefiting from these programmes are the ones who really need it, as in the Matthew effect. The considerable personal financing needed in programmes like Erasmus can exclude lower socio-economic groups. This has a counter-efficient result on equity too.

Furthermore, the outcome of these programmes highly depends on individual behavioural responses.

Finally, the administrative costs and other actions of the Life Learning Programme should also be taken into consideration, as it accounts for about €180 million per year. [49] 

Health and safety at work

The Health and Safety regulations can have a negative effect on the efficiency of EU economy too. As a matter of fact, there is an opportunity cost when complying with these regulations, as more productive investment decisions – such as industrial expansion plans – have to be either delayed or abandoned. This builds a clear disadvantage to the competitiveness of the EU towards other countries.

Health and safety at work “represents today one of the most important advanced fields of the social policy of the European Union” [50] according to the European Commission. However, the obligations concerning for instance workplaces and work equipment can have a negative effect on the economic side. These regulations – supported by the PROGRESS programme – can in some cases arm the competitiveness of EU companies, given that international competitors will always have the option to make other investment choices, based exclusively on whether they are more efficient or not from an economic point of view.

Environmental policies

Environmental Directives [51] can also cause the same problems as the Health and Safety work regulations. An example of this can be the Directive on Environmental Noise and on Waste prevention and management, which represents one of the EU’s Sixth Environment Action Programmes. Even though the aim of these EU policies is also related with lowering overall costs, it is always more efficient to operate in an unrestricted market. If those directives really had a positive impact on economic efficiency than the private sector would implement them automatically.

Concluding, there are many fields in which EU social policies can have an undesirable impact on the efficiency of EU economies. The most important is to assess whether “the losses associated with these welfare policies exceed the associated gains”. [52] It is in this relationship between the total economic gains and losses that economists don’t find a consensus.

As in Figure 4, there is an optimal point (A) where net gains can be maximised.

Figure 4. Economic Gains and Losses of the Welfare State. (Source: based on Haveman [53] )

It is a fair question to ask if one of the reasons for the poor economic performance of the EU during the last few decades might not be related with its size. Indeed, the dimension of the EU policies might not be at an optimal point, as in point B. Furthermore, we could even argue whether economic losses engendered by these welfare policies surpass or not – nowadays – the economic gains, as in point C of Figure 4.

Conclusion

In this paper we tried to give a general overview of the European social policy in an economic perspective, highlighting the economic costs related to those policies.

After reviewing the development of the European social policy, different social models and analysing some economic aspects, we linked both perspectives together and structured them into four main categories. Moreover, we used them to assess the economic efficiency of some of the social programmes being currently implemented at the EU level.

Despite the potential social benefits of EU policies, we can conclude that there is economic inefficiency. Those social policies have a negative impact on savings and investments, an adverse effect on EU’s competitiveness, and can even create disincentives to work among its beneficiaries. Moreover, we discussed the inefficiency in the implementation of these social policies. The Best Practice Frontier graph showed that “better can be achieved with less”. [54] 

Taking into consideration all these arguments, we can conclude that some important reforms need to be implemented at the EU level. Structural and financing changes have to be made in order to maximize total gains and minimize total losses [55] , making the EU welfare policies more economically efficient and sustainable.