U.S. and Europe: Shaping a new model of economic development

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The Great Recession of 2008-09 has put enormous strain on the social contracts of Western economies. This paper provides an American perspective on how well the social welfare systems of the United States and the European Union countries have performed in cushioning their populations against the economic dislocations associated with the Great Recession and how effective U.S. and European policy has been in softening the severity of the recession and in creating the conditions for future socio-economic progress.

In many respects, the responses of the United States and the European Union to the onset of the Great Recession have followed very predictable patterns. With a tradition of an activist and Keynesian oriented macroeconomic policy but with a relatively weak social safety net, U.S. authorities responded with a large $787 economic recovery program and with swift Federal Reserve action to stabilize the financial markets, including measures to buy mortgage-backed securities. By contrast, the core European economies were generally more conservative in their fiscal response, relying on the automatic stabilizers in their social welfare systems to soften the blow to the economy.

Thus, it is not surprising that while the U.S. economy show signs of a more vigorous recovery than does the European Union as a whole, the core European economies can claim to have weathered the Great Recession with less social and economic dislocation than the United States. But the Great Recession has also revealed wide variations in the experience of countries within the European Union showing that the Union is far from offering a shared European standard of social security. While the Germans, Dutch, and French weathered the crisis comfortably in spite a serious fall-off in economic growth, those in the economies on the so-called periphery are experiencing double digit unemployment and facing prolonged economic slumps and fiscal crises that will erode living standards for years to come.

The Great Recession has also exposed serious structural weaknesses in the capacity of the European Union to respond to serious economic downturns and to generate ongoing socio-economic progress among all its member countries. Not only does the Europe’s Stability and Growth Pact inhibit robust macroeconomic responses to economic downturns, the very structure of euro-zone membership eliminates many of the standard tools of adjustment, such as exchange rate depreciation, to such crises, and places the burden of adjustment on the weaker members. Indeed, the Great Recession has more than ever cemented the reality of a two-tier Europe and puts into question the very model of economic growth that the European Union has pursued over the past decade. In that sense, the experience of the European Union is very similar to that of the United States, where the Great Recession has also reinforced America’s growing two-tier society and put into question its model of economic growth. The question for the future is whether the United States and Europe can find a common agenda to expand their social welfare systems or whether they are forced to become greater competitors in a demand-constrained world dominated by Asian mercantilism and producerism.

Comparing the American and European Safety Nets

The Great Recession may have revealed the advantages the United States has with its tradition of expansionary macroeconomic policy. But it also clearly exposed the many holes in America’s rather porous social safety net.  Ironically, it was the much touted modernization of the safety net for the new economy that has caused the greatest gaps in America’s economic security. In the late 1990s, reforms in America’s social welfare system made many benefits contingent upon work not anticipating that unemployment might climb to double digits. Other so-called modernization measures embraced the notion of the ownership society, ignoring that housing and equity prices can go down as well as up.

Since the Great Recession began, the inadequacies of America’s social and economic security system have quickly showed up in the data. To begin with, the ranks of America’s poor have swollen by at least an additional 2.5 million; child poverty has climbed to 19 percent from 17.8 percent a few years earlier. One in eight Americans, including one in four children, is now on the food stamps because they are not eligible for unemployment compensation or any other social welfare program. Nearly 50 million Americans lack health insurance, and over 17 percent of households report that they have postponed or delaying seeking healthcare over the past year for financial reason.

As to the ownership society, for a period of time rising home prices and access to credit helped mask the effects of stagnating wages. But now the debt left in the wake of the housing crash, is dragging down millions of American families. As of October 2009, nearly one in four mortgages was underwater, meaning the mortgage holder owes more on the mortgage than the underlying home is worth; that number is expected to increase to 48 percent by 2011. Overall, American households have suffered a $12.6 trillion loss in household wealth, a significant portion in their homes and retirement accounts, and as a result, one in four Americans over 62 are putting off retirement because they cannot make ends meet.

By contrast to this American picture, there has been little increase in poverty in the core EU countries, no precipitous drop in household wealth or income, little or no evidence of people having to forego health care for financial reasons, and little or no increase in the number of people who are putting off retirement for financial reasons. If one were not rich and one could choose where to experience an economic downturn as serious as the Great Recession, one would clearly choose Germany, the Netherlands, France, Belgium, Italy, or the Nordic members of the European Union, not the United States. The experience of working and middle class in other European economies of course has been more difficult but these economies do not have the same level of social welfare protections as do the richer core economies.

There are three reasons why the United States has done so much more poorly in cushioning the impact of the Great Recession on its working and middle class than has these core European Union economies. First, the American system of social and economic security revolves much more closely around employment—having a job—than does Europe’s. As is well known, health insurance in the United States is still largely employer based; if you lose your job, you most likely lose your health insurance as well. But so are other features of America’s social welfare system. As a result of the welfare reforms passed under the Clinton Administration, America’s principal welfare program—Temporary Assistance for Needy Families—is now linked to work requirements. Not surprisingly, the number of people accessing the program has scarcely expanded during the recession because employment itself has declined even as the number of poor has increased alarmingly.

Likewise, America’s main program for helping the working poor—the earned income tax credit—is dependent on being in work or having earned income. Individuals who can show they have earned income up to a certain level are eligible for a refundable tax credit to supplement their income; those who have not been employed and have no earned income are not. And what is true for America’s working poor is as true for America’s middle class.

Many of America’s most important social welfare state benefits relating to education, child care, home ownership, and retirement are delivered through the tax codes as deductions against income. This has created a social welfare state that heavily favors upper and middle income groups; indeed the majority of benefits now go to the top 20 percent not to those who need them most, creating in effect a two-tier welfare state. But that also means that as unemployment and underemployment rise and the incomes of those in the middle decline, so do their social benefits for education, child care and retirement. As a result, they can quickly find themselves pushed into the bottom tier of America’s social welfare system fighting for limited resources.

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