As one of the world’s leading economies, the European economic model receives a lot of attention from experts, businesses, and investors. Compared to the U.S. economic model, which focuses on efficiency, European economies emphasize combating economic inequality.
The debates on which economic model is better have never stopped. Some scholars pointed out it is possible for governments to boost European economies without increasing economic inequality. In order to deliver solid economic growth while also reducing inequality, European governments could adopt more liberal economic reforms: linking unemployment benefits with returning to the workforce and funding social welfare spending from income taxes.
There are two types of economic models that are commonly used to approach the economic models of Western democracies: liberal market economies and social market economies. The main characteristics of liberal market economies are supporting the role of the market, small government, and privatization. Also, the absence of non-market coordination is a trait of liberal market economies. Liberal market economies are more comfortable with the role of the market in society, so they are more risk-acceptant and trusting in credit. Liberal market economies support the government with more limited power, known as a small government, to limit the ability to provide public services and set regulations. These government features lead to lower taxation in liberal market economies. With fewer regulations from the government, liberal market economies are able to pursue more market freedom. However, a small government cannot provide a well-rounded social welfare system due to its limited power and finance. Therefore, liberal market economies support the privatization of public services. They believe allowing private sectors to offer public services instead of the government will make them receive better services and goods because of the competition among private sectors.
On the other hand, the main characteristics of social market economies are opposing the role of the market and privatization and supporting the big government. Also, the presence of non-market coordination is a trait of liberal market economies. Social economies are less comfortable with the role of the market in society, so they are more risk-averse and untrusting of credit. Social market economies support the government with more expanded power, known as a big government, to increase the ability to provide public services and set regulations. With a powerful government, social market economies are able to pursue reducing economic equality through redistribution and social welfare systems. However, these government features lead to higher taxation in social market economies. Unlike liberal market economies, social market economies oppose the privatization of public services because they are less comfortable with the market. They believe allowing private sectors proving public services and goods might cause corruption.
Unlike the American economic model, which pursues a free market, the European economic model is very different because of its political culture. European states are mostly social democracies. Social democracy is a philosophy that emphasizes promoting social justice through economic and social interventions under a democratic political system (McCarthy, 2018). Therefore, compared to American political culture, European political culture focuses more on welfare, social security, and employment policy. The differences in political cultures in the U.S. and Europe lead to different economic models for the two regions. The philosophy of social democracy shaped the relations among states, society, and markets of Europe (McCormick 2010). The main traits of the European economic model are higher taxation and a solid social welfare system.
European states charge higher taxation because the governments are responsible for providing public services. Unlike Americans, Europeans promote collective delivery over the private delivery of services. Europeans also expect the government to reduce economic inequality through redistribution. In order to reach these goals, European social democracies usually require higher taxation. Another reason for higher taxation is that European states tend to have robust social welfare systems, such as public health insurance and unemployment benefits. European social democracies support a developed and interventionist state, known as a big government, to provide wide-ranging public services, such as strong social welfare systems (McCormick 2010). European political culture values the equality of results over the equality of opportunities. Most Americans believe people are poor because they are lazy. However, most Europeans believe people are poor because they are unfortunate. Thus, Europeans support the government in reducing income inequality through redistribution as a legitimate state goal (McCormick 2010).
By comparing the two economic models, social market economies are less competitive than liberal market economies in promoting economic growth. The main characteristic of social market economies is reducing inequality by redistribution and a strong welfare system through high taxation. The most significant weakness of this characteristic is that it causes lower job creation due to higher labor costs, leading to higher levels of unemployment. This is why long-term unemployment is a weak spot in social market economies (Pontusson, 2005). Moreover, the concern about unemployment might theoretically trigger a vicious cycle. Higher levels of unemployment lead to slow economic growth and increased demand for social welfare spending. However, the economy’s sluggish growth causes the government to be unable to maintain the social welfare systems with increasing spending. Thus, the government would seek unpopular reforms, such as increasing taxation, reducing benefits, and promoting immigration. The unpopular reforms might create new economic and political pressures on the government and turn citizens into supporting populist parties and candidates. However, some experts argue that social market economies can adopt specific liberal economic reforms in order to solve these concerns and boost efficiency.
Pontusson pointed out two reforms to make European social market economies more competitive: linking unemployment benefits with returning to the workforce and funding social welfare spending from income taxes (Pontusson, 2005). First, in order to solve the concern of the long-term unemployment rate in social market economies, Pontusson contended that the government should link unemployment benefits to incentivize people to return to the workforce, such as providing courses for unemployed people to develop new skills that would increase their competitiveness in the labor market. Unlike giving out pensions, making unemployment benefits the incensement for people to return to the workforce allows the government to decrease the long-term unemployment rate. Second, Pontusson argued the government should fund social welfare spending through income taxes instead of consumption or payroll taxes. Although funding spending from consumption and payroll taxes is a better redistributive method to reduce inequality, income taxes are more visible and politically fraught. Also, it is more likely for the government to avoid borrowing to pay for social welfare spending if it funds the spending through income taxes.
After analyzing European social market economies, we had a deeper understanding of the characteristics of the European economic model. Through adopting the reforms, the concerns of a higher unemployment rate and lower economic growth in European social market economies might be solved. Moreover, the reforms would increase economic growth which would make European economies more competitive.
Image source: The Economist
Bunn, D. (2022, June 3). Top Personal Income Tax Rates in Europe. Tax Foundation. https://taxfoundation.org/top-personal-income-tax-rates-europe-2022/
Crepaz, M. M. L. (2017). European Democracies (9th ed.). Routledge.
McCarthy, M. (2018). Democratic Socialism Isn’t Social Democracy. Jacobin. https://jacobin.com/2018/08/democratic-socialism-social-democracy-nordic-countries
McCormick, J. (2010). Europeanism (1st ed.). Oxford University Press.
Pontusson, J. (2006). Inequality and Prosperity: Social Europe vs. Liberal America (Cornell Studies in Political Economy) (1st ed.) [E-book]. Cornell University Press.