The consequences of globalization for welfare states

The consequences of globalization for welfare states 21. december 2010 Alexander Rygner Holm 2606901073 Political Science, December 2010 STUs: 20051

Table of contents Introduction... 3 The concept of globalization... 3 The welfare state... 5 The welfare state in a globalized world... 7 Conclusion... 10 References... 11 Alexander Rygner Holm 2

Introduction The welfare state has after the end of the Second World War become the most used system of making capitalism and democracy compatible in the affluent countries of the West. Thereby it has disproved Karl Marx and John Stuart Mill who thought that those two were incompatible (Caramani, p 521). Different states apply different types of the welfare state. The common distinguished models are the typologies of Esping-Andersen s Three worlds of capitalism (1990) 1) the liberal model, 2) the social democratic model and 3) the conservative model (Caramani, p 532-533). However, for explanatory reasons I will also use the typology of CMEs and LMEs. Since the emergence of the welfare state came about a new concept, globalization has been evolved and deals with the intensification of cross border social transactions (Caramani, p 606). Every state has to compete economically with all other states including far away countries with different political systems, language and culture. Will the globalization change the welfare state? To answer this question I will briefly account for and discuss the consequences of globalization for the possible actions of the state regarding its economic policies. Then I will account for the traits and problems of the welfare state by looking at the theory of varieties of capitalism. Finally, I will discuss the impact of globalization on the welfare state now and in the future. The concept of globalization Globalization is not a well defined concept and in general it is contested concept. Giddens states that globalization can be defined as the intensification of worldwide social relations which link distant localities in such a way the local happenings are shaped by event occurring many miles away (Giddens in Caramani, p 606). In other words the different societies of the world have become more intertwined and it is harder to isolate yourself from the influence of others. This definition does not say anything about how this intensification of worldwide social relations come about, it does not say which social relations globalization affects and which is does not (assuming that one process cannot influence every thinkable social relation in the world). In general definitions of globalizations such as Gidden s can be criticised for being too vague and broad and thereby not telling anything other than world has become smaller. Alexander Rygner Holm 3

So to look into all possible effects of globalization is impossible because of the broad definitions available. However, different traits ascribed to globalization can be investigated and I will look at some of the economic aspects. Since the peace of Westphalia the state has been the most important international actor (Anne Leander Lecture 18). The states agreed on that each state was sovereign in their own territory and thereby a non-intervention principle was established. Each state was centred on a national government, a self-sustained national economy and a national identity. (Caramani, p 607). On all parameters the state has become less national. (Caramani, p 613) Today the economy cannot be characterized as national. Firms sell to different markets, not only domestically, and they produce their products in different countries especially by extensive outsourcing. E.g. Germany import goods and services equal to 33 % of their GDP and export 38%. In Sweden the equal numbers for import and export are 38 % and 46 % and the United Kingdom respectively 28 % and 25 % (Caramani, p 688-690). This transformation has happen due to the technological changes that occur more and more rapid. In short, technology has increased the overall capital cost of a product and often the domestic market is not capable of consuming enough of the product to cover the firm s capital cost. Therefore products are designed to and marketed on a multinational market (Strange, 1995). This fact has implications on the national government. It can no longer do what it pleases because it competes with other countries on attracting foreign firms into their countries because the firms have what the politicians 1 want: advance technology, capital to invest in the country and demand for labour (Strange, 1995). This competition limits the state possibilities of taxing and regulating which is the foundation of every welfare state. This argumentation of Susan Strange leads to the conclusion that trans-national firms become actors in the international society and authority has diffused sideways (Anna Leander, Lecture 19). Government centric scholars will argue that the state has not lost sovereignty but adapted and in some ways gained authority for example in EU where the states have the ability to change the course of the other members which they did not have before. They will also argue that despite the 1 Assuming that politicians have the goals of maximizing their votes (Rationonal choice model) by providing jobs and prosperity to the voters (Caramani, p 340-341) Alexander Rygner Holm 4

fact that trans-national companies play a big role the state still upholds its sovereignty because there is no final political authority outside or above the state" (Georg Sørensen in Caramani, p 612). I tend to agree with Sørensen but only in theory. In theory states can for example set their corporate tax at the level they want, however, corporate taxes lie generally between 18-30 % i.e. pretty similar (with the exception of the US, Japan, and Ireland) whereas income taxes vary from 35-60 %. (OECD). This indicates that even though states are sovereign their possible actions are limited. This would lead to the conclusion that states have lost authority sideward and even some authority has evaporated (Strange, 1995) e.g. the authority of deciding your own corporate tax without severe consequences. Regarding the affluent welfare states this would intuitively lead us to the hypothesis that welfare states would devolve in order to be competitive (the efficiency hypothesis) (Caramani, p 538), however, as I will discuss later on this is not necessarily the case. The welfare state Having discussed the consequences of globalization regarding the possible actions of states I will now move on to account and discuss the welfare state as a concept and why welfare state are different in some aspects, to be able to discuss what impact globalization has on the welfare state in the next section. Harold L. Wilensky defines the welfare state as government-protected minimum standards of income, nutrition, health, housing and education assured to every citizen as a political right not charity. (Wilensky in Caramani, p 522). This definition includes the aspect of universal social rights secured by the state. However, according to the typology of Esping-Andersen mentioned in the introduction the state is not the only provider of welfare. The family as well as the market has important roles to play in some models of welfare. The state centric definition of Wilensky is good, as long as we keep its limitations in mind, because it simplifies the subject. According to Esping-Andersen welfare states express politics against the market (Esping- Andersen in Caramani, p 554) i.e. the welfare state makes up for the flaws of capitalism. For Marxists the flaw was the commodification of labour so the welfare state had to decommodify labour in order to cope with newly emerged social risks. For functionalists the welfare state had to Alexander Rygner Holm 5

provide functions that the family in the feudal society had taken care of (elder care, child care etc) which industrialization had partly removed (Caramani 524). Scholars of the theory of varieties of capitalism see the welfare state and capitalism as complements not adversaries. This theory distinguishes between only two types of capitalist systems: liberal market economies (LME) and coordinated market economies (CME). The main independent variable that distinguishes LMEs and CMEs are the kind of skills firms demand. When firms demand general skills and low education it is in the interest of the firms and the labour force to have a high degree of commodification of labour because regulations, minimum wages, employment protection etc. will change the market quilibrium to the disadvantage of the firm (Caramani, p 554). Hence firms will move and more will be unemployed. When firms demand high skilled and educated labour it is beneficial for the economy to have high social spending. This ensures some degree of insurance against losing your job which makes the worker more willing to educate themselves which is beneficial for the company. Thus the CMEs have no incentive to unravel the welfare state and become an LME because they have a comparative institutional advantage over LMEs regarding skilled quality work whereas LMEs are superior in unskilled quantative production (Caramani, p 554-555). This model is and can be criticised especially for its simplicity. First and foremost it does not take into account the role of the family or market in providing welfare. E.g. the fact that the US has a low public social spending does not alter the fact that public + private social expenditure as % of GDP is similar to most of the CME countries (Caramani, p 560). So in the US people are also encouraged to educate because by educating they have a higher social security (assuming they get a job at some point in their life and thereby being able to buy unemployment insurance). Besides this model assumes that people are only willing to educate themselves if they have insurance that it will pay off. This is highly contestable assumption and intuitively other factors play a role in this matter, e.g. job preferences, personal identity etc. So often we will see a mix of high skilled labour and low skilled labour in a state, and according to this theory we will have a higher amount of skilled labour in CMEs than in LMEs. This model of varieties of capitalism also simplifies the variety among welfare states. If we look into the typology of Esping-Andersen, the liberal, the social democratic and the conservative Alexander Rygner Holm 6

welfare model, we see significant differences among social democratic and conservative welfare states which must both be seen as CMEs according to Jørgen Goul Andersen (Caramani, p555). E.g the theory states that in CME firms benefit from a high degree of employment protection. This is not considered the case in the social democratic welfare state with its flexicurity model. This somehow lowers the explanatory power of the model because when the assumptions are not external valid the conclusions must to some extent only be internal valid 2 or modified having this fact in mind. If we keep in mind the constraints of the model it is still important to explain one of the aspects of the welfare state. It explains why some of the differences among welfare states exist, first and foremost the differences in education, employment and unemployment policies, and certainly it explains why these differences persist. However, this model does not take the globalization into account. To what extent the globalization has an effect on the welfare state in general will be examined in the next section. The welfare state in a globalized world Now I have discussed the welfare state and some of its problems and we have discussed in general some of the impacts of globalization. From the discussion on globalization scholars have deducted the efficiency hypothesis and from the discussion of welfare state scholars of varieties of capitalism have explained the benefits of CMEs with high share of public social expenditure despite the efficiency hypothesis. The efficiency hypothesis has lacked empirical evidence. We have not seen a race to the bottom among welfare states created by globalization. Instead others scholars argue that in order to have economic openness you need to compensate the losers of this openness. This is called the compensation hypothesis (Caramani, p 539). The underlying assumption is that without this compensation the cleavage between the beneficiaries and the losers of the consequences of globalization will undermine the foundation of the welfare state. Without compensation the welfare state will instead experience devolution of the welfare state which leads to the end of the welfare state. 2 Lack of external validity is not nessecarily a bad thing you just have to be aware ot the methodological constraints of the model (Caramani, p 66) Alexander Rygner Holm 7

Two arguments are made in favour of the compensation hypothesis. The first is that investors value a political and social environment high because it makes investments less risky especially when decisions of investments are taken with a high degree of uncertainty (Caramani, p 539) which is nearly always the case (Frank, 2010). Second the theory of varieties of capitalism explains why welfare policies can create competitive institutional advantages for CMEs. Stephens conclude that to the extent that they (welfare states) enabled wage restraint and provided collective goods valued by employers such as labour training, the generous social policies actually contributed to competitiveness (Stephens in Caramani, p 540). This indicates that even though a country lacks comparative cost advantages in can make up for this by its comparative institutional advantages. An institutional advantage could be the flexicurity model of Denmark that combines liberal employment protection and high unemployment benefits (leading to a high skilled labour force according to the varieties of capitalism theory). These are things that most high-technology firms demand and is not provided in LMEs or in the developing countries (Campbell and Pedersen, 2005). So there is no reason why CMEs should do worse in terms of economic measures than LMEs everything else equal. This is perfectly in line with findings by different scholar (Pontusson, Lindert and Atkinson) that LMEs and CMEs have almost similar economic performance (Caramani, p 558-561). All this leads to the conclusion that both CMEs and LMEs can survive globalization with a few small changes and the efficiency hypothesis will be invalid, at least in the minds of the authors in Caramani (2008). However, the efficiency hypothesis is still valid due to some critical points in the analysis above. The compensation hypothesis mainly thinks of welfare states competing against each other not against the rest of the world. First of all LMEs might have a comparative advantage over CMEs but in a globalized world the LMEs must also compete with modernizing states such as China, India, Brazil and Russia (BRIC). According to the analysis of varieties of capitalism we conclude that LMEs comparative advantages are their liberal employment protection and the low wages. These comparative advantages vanish compared to the BRIC countries where especially China are leading with low wages and many jobs, especially low skilled production, are outsourced to China (P1,2010). LMEs have only their high degree of innovation (Caramani, p 555) left for job creation or the possibility Alexander Rygner Holm 8

of recommodifying labour making the labour market even more liberal to match the markets of the BRIC countries and whether this is enough is uncertain (Caramani, p 542). Regarding the CMEs their competitive institutional advantages may in many cases not be sufficient in the long run, even though countries like Germany and to some extent France is doing alright at the moment with GDP at expected respectively 2.2 % and 1.5 % (Economist, 2010). The institutional advantages of the CMEs seem stronger than those of LMEs; however, many CMEs have budget deficit problems (France, Spain and Italy). Austerity measures in line with the neoliberal thinking of the efficiency hypothesis seem as part of the policy paradigm at the moment. Another problem for future companies is the rigidity of the employment protection in the conservative welfare states such as France who recently in 2006 had a huge debate on whether or not to liberalise the employment protection. Trans-national companies regard entry and exit barriers as highly important when choosing the state to invest in (Salvatore, 2007) and employment protection is an issue of a high exit barrier. The fact that a high degree of employment protection is one of key aspects of the conservative welfare state leaves this type of welfare state in a crisis (Caramani, p 542). In the future BRIC countries will have higher skilled labour forces (P1, 2010) and CMEs can no longer compete only on this parameter everything else equal making the CMEs less competitive. That said it is very unlikely that for example China adopts a flexicurity system as the Danish merely because of the administration of 1.3 billion Chinese in a system like the Danish designed for 5 million people would be enormous. According to the theory of governance in international relations authority have drifted sideways to the businesses indicating that the states have to comply with the demands of trans-national firms (which in some cases would be lower welfare standards). As stated above this is not the case. One explanation of this is that the devolution of the welfare state contains a major political risk for politicians, especially because welfare policies have generated strong interest groups for their preservation. Giving in to the theory that politicians are vote maximizers (Caramani, p 340) few politicians would dare start devolving the welfare state. Other explanations could be that they strongly believe that the comparative institutional advantages will outweigh the loss in comparative cost advantages. Alexander Rygner Holm 9

Conclusion Despite the fact that globalization as a concept is very vague we can draw some general conclusion from the debate that most scholars can agree on; that is that the world has become more intertwined economically, socially and politically. The economic globalization has happened because of the rapid technological development which creates the need for trans-national firms. What impact this development has had on the possible actions of the state is debated. Government centric scholars think the impact is very little and governance scholars think that this process has changed the international society bringing in firms as new actors. This leads to the efficiency hypothesis which says that we will see a race to the bottom concerning welfare states in order to be competitive and attract the trans-national firms. The opposing theory is the compensation hypothesis that states that the losers of economic openness have to be compensated and if not the welfare state will lose its legitimacy as institution. Empirically the compensation hypothesis stands strongest and the theory of varieties of capitalism explains why we don t see a race to the bottom. Coordinated market economies with big public social expenditure have a comparative institutional advantage over LMEs and developing countries. Both LMEs and CMEs do face great threats from globalization. The fact that BRIC countries is rising makes LME vulnerable and they might have to adapt and experience some kind of race to the bottom. CMEs have stronger comparative institutional advantages that are likely to last longer but some of the advantages especially education might disappear in the long run because BRIC countries are also investing in education. Especially the conservative welfare model has profound problems relating to their employment protection whereas the social democratic as well as the conservative model needs to address its budget deficit problems. However, the comparative institutional advantages might be so deeply rooted in the CMEs that they in long run might overcome the challenges of globalization especially when we see that the predicted loss of authority from governance theory is not as evident and that states domestic institutions and politics matter a great deal when dealing with the welfare state in a globalized world. However, these are merely qualified guesses and more research into the consequences of globalization is needed. Alexander Rygner Holm 10

References Campbell, John L. and Pedersen, Ove K. (2005) Dansk Institutionelle konkurrencevne i den globale økonomi International Center for Business and Politics CBS for Funktionærernes og Tjenestemændenes Fællesråd Caramani, Daniele (eds) (2008), Comparative politics, Oxford Univeristy Press EU-oplysningen (Webpage) URL: http://www.eu-oplysningen.dk/spsv/off/alle/eu_danskelove/ (First accessed December 2010) Frank, Robert H. (2010) Microeconomics and behaviour McGraw-Hill/Irwin Eight edition Leander, Anne (2010) Lecture 18. November 29 th Leander, Anne (2010) Lecture 19. December1 st OECD (2010) Webpage URL: http://www.oecd.org/document/60/0,2340,en_2649_34533_1942460_1_1_1_1,00.ht ml#c_corporatecaptial First accessed December 2010 Salvatore, Dominick (2007) Managerial Economics in a Global Economy Oxford University Press Sixth edition Strange, Susan (1995), The defective state, The MIT Press on behalf of American Academy of Arts & Sciences, Vol. 124 issue 2 The Economist, (2010),December 11 th vol. 397 issue 8172 P1 (2010) Horistont: Kineserne kommer, off-air recording, 5 shows the first starting March 30 th, podcast Alexander Rygner Holm 11