The Viability of the European Social Model: The German Welfare State and Labor Market Reform

In the wake of the financial and economic crisis, the European economies decreased in size, unemployment increased, investments contracted, and the austerity measures reduced social spending. What at first looked like a relatively small economic problem became a severe economic crisis that dramatically impacted the entire continent. It particularly affected the peripheral Eurozone countries such as Spain, Italy, Portugal, and, particularly, Greece. Greece saw an economic contraction of 0.2% of GDP in 2008, 3.1% in 2009, 4.9% in 2010 and 7.1% in 2011 (Hellenic Statistical Authority 2012a). The Greek unemployment rate increased from 7.4% in 2008 to 25.1% in 2012 (Hellenic Statistical Authority 2012b). Average incomes in Greece decreased from 20,457 Euros in 2010 to 15,729 Euros in 2011 (Yannopoulos 2012). Given those bad economic news, the state welfare provisions of the Greek government can no longer be maintained. In response to the shrinking economy and the ballooning debt, the Greek prime minister, Antonis Samaras, announced that he will reduce government spending by 12 billion Euros; 4.6 billion Euros in cuts are earmarked for pension, and 1.39 billion Euros for health care spending (Reuters 2012). These austerity measures have led to a collapse of the Greek health care system, where cancer patients can not even get critical treatment (Hojnicki 2012).1 The striking case of Greece and its rapidly declining welfare state is noteworthy given the context of the European social model that is hailed across Europe as a central defining feature, and that distinguishes Europe from most of the rest of the world. The European social model is defined as a set of common values, including democracy, individual rights, free collective bargaining, the market economy, equality and opportunity for all, social welfare and solidarity (Commission of the European Communities 1994, 2). The social welfare policies include a generous pension system, expansive child care provisions, universal health care and extended unemployment compensation among other provisions. The European social model is also seen as an alternative to American free market capitalism that includes fewer social benefits (Jepsen and Pascual 2005). However, with the visible disappearance of the Greek welfare state the pertinent question is whether the European social model can be sustained given the financial and economic pressures- that are often associated with globalization (Avi-Jonah, 2000; Habermas 2003, 90-91; Pinder 2011, 140) – to continuously reduce welfare expenditures. The head of the European Central Bank, Mario Draghi, articulates the matter very bluntly, saying that “the European social model has already gone” (Mabille 2012). According to Draghi, the end of the social model will happen as a result of over-indebted European countries that impose austerity measures on their population. Is the demise of the European social model really unavoidable? What exactly is the viability of the European social model? My hypothesis is that given the pressures of globalization, the European social model is threatened of disappearing and weakening.

I will add some clarity to this question about the viability of the European social model by focusing on a case study of the German welfare state. Why select Germany? After all, Germany is still a stable country that has remained relatively unscathed from the economic contraction I described in Greece. Germany is even considered an economic miracle (Rinne and Zimmermann 2011). However, the fact that Germany is heading back into a recession shows that not even the strongest economy is secure from a contraction (Spiegel 2012b), thus raising questions about the viability of its welfare system, and also those of other European countries. A second reason for my investigation of Germany has to do with the recent labor market reforms in Germany in the early 2000s that involves some changes to its welfare state that may include implications for the rest of Europe. I will begin my case study with a description of the historical origins and developments of the German welfare state. Then I will turn to the present characteristics of the German welfare state, especially analyzing the impacts of the recent labor market and welfare reform undertaken by German policymakers, examining particularly the economic impacts on the German people and the rest of Europe. I will then make a discussion of various viewpoints among policymakers and academics about the trends of the European social model, and highlight some economic and socio-political forces that shape the configuration of the European social model. In order to grasp the global significance of the welfare state, I will conclude with some reflections on the welfare state trends for non-European countries.

The German welfare state traces its origins to the late nineteenth century and the industrialization period2, when reichs chancellor Otto von Bismarck responded to the political demands of the rising working class movement in Germany by implementing a social insurance scheme that included medical insurance (1884), accident insurance (1885) and pension insurance (1891) to cover the industrial working class from sickness, accident and old age infirmity (Wikipedia 2012b; Dippong et al. 2009, 56). Bismarck was politically conservative, but decided to implement the welfare state in order to weaken the working-class and social democratic political forces that gained widespread popularity. Bismarck’s policy set the precedence for other welfare states across Europe (Cravens 2003). The German welfare state since Bismarck is considered a conservative corporatist welfare regime that prevails in continental Europe (Esping-Andersen 1990, 27). Its objective has been the maintenance of living standards, and a preservation of the traditional family model, consisting of a male breadwinner and female homemaker (Fleckenstein 2011, 61; Gottschall and Dingeldey 2000, 313-315). The social insurance scheme is equally funded by employers and employees, and the total benefit amount (entitlement) depends on the level of income. Means-tested social assistance benefits exist for non-workers and long-term unemployed, who have not contributed any social insurance premiums (Fleckenstein 2011, 61). Until 1920, the social insurance scheme was restricted to industrial workers. From then on, it was expanded to include white-collar employees. Unemployment insurance was added in 1927 (James 2004). The Nazi rule under Adolf Hitler in the 1930s and 1940s led to an improvement in medical care and old age provision largely financed by high taxes on the wealthy, and theft from Jews and the people of the conquered territories (Aly 2007, 7).

After World War II, Germany was divided in two halves, including West Germany (Federal Republic of Germany) and East Germany (German Democratic Republic). East Germany (1949-1990) developed a communist state, in which a strictly hierarchically organized welfare system was implemented. Job placements were guaranteed, making unemployment insurance redundant. Housing was assigned by the government. Old-age pensions were provided (Bollinger 2005, 878-879). Overall, the extent and quality of the East German welfare state was constricted by its poor economic performance relative to West Germany (Historical Boys’ Clothing 2011).

West Germany quickly recovered from the defeat from the war, and embarked on a course of huge economic growth in the post-War period. As a result of the greater prosperity, in 1957, chancellor Konrad Adenauer (1949-1963) implemented a pension reform law that linked pensions to worker’s past wages, and increased payouts tied to greater wages (James 2004). This addition in benefits was easily financed by an improving economy during most of the 1950s and 1960s. The boom era ended in the mid 1970s, when the oil crisis made the production of goods more expensive. The ensuing economic crisis increased the unemployment rate and reduced the state’s tax revenues (Fleckenstein 2011, 64). This situation put a constraint on the ability of the government to finance the welfare state and pensions. The government consisting of Social Democrats and Liberals (1969-1982) enacted the “Budget Structure Law” (Haushaltsstrukturgesetz) in 1976, which reduced the state allowance for persons undergoing vocational training, and ended state-sponsored full employment guarantees (65). The mid-1970s were a turning point in German welfare policy as the anti-cyclical Keynesian approach of active state intervention to maintain full employment was replaced by a commitment to budget consolidation (Webber 1987, 78).

In the early 1980s, the conservative-liberal government (1982-1998) implemented further restrictions on the welfare state through reductions in unemployment benefits, and a reduction in training allowance. An economic upturn in the mid-1980s led to a temporary increase in unemployment benefits and training allowances. Early retirement schemes were also put in place to mitigate the unemployment rate. By that time the demographic trend of an aging population started to take effect, increasing the costs for pensions and health care (Guillen and Ontiveros 2012, 61-62). In 2001, the old -age dependency ratio (ratio of people 65 and older to those from 20 to 64) stood at 27.5% in Germany. By the mid 2030s, this rate will double (Sinn 2007, 224). The aging population is caused by an increase in the life expectancy and a decline in the birth rate. Both factors are related to improved access to medicine and nutrition, and an increase in real standard of living (Weimer 1998, 441).

In 1990, when the poorer East Germany re-joined the wealthier West Germany, the West Germans had to increase their net contributions to the welfare system, because the East Germans started to participate in the West German welfare system. Greater labor market expenditures as a result of reunification led to the policy of deficit-spending throughout the early 1990s (Fleckenstein 2011, 69). The national debt doubled in the five-year period following reunification (Weimer 1998, 455). The government reacted to the escalating costs with several reforms to the social programs. Benefit generosity to the unemployed was diminished by reducing benefits by three per cent every year; training measures and requirements for accepting low-income and seasonal work were implemented for the long-term unemployed; early retirement was made less attractive (Fleckenstein 2011, 69-70). By the late 1990s, the governments’ labor market objectives changed from full employment, which had been the paradigm for most of the post World War II period, to job placements for unemployed people. The government also emphasized the individual’s responsibility to attain a job (72).

The social-democratic/green coalition (1998-2005) re-focused labor market policy to encourage more labor participation. The coalition government operated under the financial constraint of the political reunification with East Germany. The coordination between employment service and social assistance authorities were increased, and low-wage employment projects were initiated by the government (Fleckenstein 2011, 76). In 2000, the government abolished unemployment assistance for those that have never been eligible for unemployment benefits (Aust, Boenker and Wollmann 2002). In addition, it set up a commission to develop policy recommendations for social welfare reform. The recommendations were adopted into law between 2002 and 2004 under the name Hartz (I-IV) and Agenda 2010. This welfare reform and labor market policy has been considered a “radical reshaping of the German welfare state” (Zhong 2012). Indeed, the laws have been met with enormous resistance from trade unions and left groups, such as academics, that call the reform “a violation of the principles of social justice and an endangerment to the substance of the welfare state” (Einblick 2003). The laws merged social welfare benefits with aid to the long-term unemployed, reducing overall benefit eligibility: maximum unemployment eligibility was reduced to 12 months (Fleckenstein 2011, 82); temporary, low-income work for the long-term unemployed was expanded; and sanctions against the long-term unemployed for failure to comply with job-search requirements, such as benefit termination or reduction, were increased (85). The conservative/social-democratic and conservative-liberal German government led by Angela Merkel (2005-) continued the course of welfare state cuts, through an increase of the retirement age to 67 and a reduction in unemployment insurance contributions (Brenke and Zimmermann 2008, 120). Despite talks about implementing a minimum wage, it has not been introduced thus far (Dempsey 2011).

What precisely are the implications of the labor market reforms from the early 2000s? Agenda 2010 was a major move away not only from the commitment to full employment and integration into the labor force, but also a move away from standard employment and toward sub-standard or precarious employment (Fleckenstein 2011, 90). Standard employment is defined as full-time, continuous employment that includes a work contract with indefinite duration, stable work schedule and substantial benefits. In contrast, precarious employment is defined as poorly paid, insecure employment relationship with little control over the work process (Wikipedia 2012a). Whereas long-term unemployment was successfully reduced (Brenke and Zimmermann 2008, 123), precarious employment has increased in Germany (Duell and Duell 2002, 14). 23% of the workforce earns less than 9.15 Euros an hour (Spiegel 2012a). The average income of a low-wage earner decreased from 1,073 Euros in 2000 to 963 Euros a month in 2010 (Dempsey 2011). As a result, 15.5% of the Germans either live in poverty or are at risk of poverty, which according to the EU means an income below 60% of the median income (Spiegel 2010). Another effect of Agenda 2010 has been a 20% increase in employment among older workers between the age 55-64 due to the removal of early retirement schemes (Rinne and Zimmermann 2011, 4). Overall, the critics suggest that the German labor market reform has failed to “promote social cohesion and inclusion into the society”, because the reforms have fostered precarious employment without encouraging standard employment (Zirra and Buchkremer 2008).

On the other hand, Agenda 2010 is also praised as having restored economic growth to Germany, that prior to the welfare and labor market reforms were lagging behind the rest of Europe (Brenke and Zimmermann 2008, 118). Germany was cited as having the highest manufacturing wage costs in Europe between the 1980s and the early 2000s, making their businesses uncompetitive with other countries (Sinn 2007, 3-4). But since Agenda 2010 was implemented, labor costs were lowered in Germany, and export manufacturing and the economy were stimulated relative to other parts of Europe that increased labor costs to a higher level (Rinne and Zimmermann 2011, 5). And even considering the reductions in the welfare state, Germany still spends 25.2% of the GDP on social expenditures, which is above the OECD average of 19.2% (Adema, Fron and Ladaique 2011, 17). High social expenditures are sometimes cited as being a drag on economic growth (Levin 2011, 22). The economist Peter Lindert disputes this claim, and instead argues that countries with a generous welfare state do not grow slower than countries with a small welfare state (Challenge 2004, 12). Some scholars even suggest that high taxes, state spending and government regulation can enhance the economic performance of a country (Campbell and Pedersen 2007, 230-231; Sachs 2006).

The debate about the German welfare state is framed around the pressures of globalization (Paraskewopoulus 2003; Avi-Jonah 2000). There are three positions that are voiced in regard to globalization and the welfare state (Genschel 2004). The first are the so-called globalization skeptics, who think that globalization had no impact on the welfare state, leaving enough room for national governments to contemplate “leftist [pro-welfare] alternatives” (Garrett 1998, 4). The argument is also that globalization has only an impact upon welfare states insofar as the policy-makers conjure up a discourse about the inevitability of the external forces of globalization working against the welfare state, thus leading to a self-fulfilling prophecy as governments make hasty decisions cutting social services to retain competitiveness (Hay, Watson and Wincot 1999). Another group thinks that globalization is a solution to the problems of the welfare state, because the increased role of the markets in this scenario has disciplinary impacts on governments (Genschel 2004). The third group consists of believers in the globalization theory of the welfare state, who argue that increasing competition with low-wage countries, which leads to a transfer of capital investments from high-wage, high-benefit countries to low-wage, low-benefit countries, makes generous welfare benefits undesirable (Tanzi 2000, 15). The threat of capital leaving the country is premised on the policy of dismantling cross-border capital controls back in the 1970s (Korpi 2003, 603). This deregulation of the capital markets has effectively removed some power from the nation-states (Steger 2009, 64; Eroğlu 2010, 90). The nation-states are subsequently relegated to the task of promoting economic activities, such as offering lower corporate taxes to companies (Eroğlu 2010, 91). This dynamic has the tendency to undermine the scope of the welfare state.

In response to this interpretation of globalization as a driver of reduced social welfare provisions former German chancellor Gerhard Schröder, who implemented the Agenda 2010 reform, argues that the recent financial crisis and the elevated competition with the BRIC (Brazil, Russia, India, China) countries- that offer nowhere near comparable social benefits to their citizens- are major reasons for reforming the European social model by scaling it down. Schröder cites his labor market and welfare reform as being the major driver of Germany’s competitiveness that improved after its implementation. According to him, the success of his labor market reforms explains the historically low youth unemployment rate in Germany (8%), when it is compared to other European countries, such as Spain (50%) (Schröder 2012). According to some experts, it is precisely the lower wages relative to the productivity of the workforce that resulted from the labor market reform that make the Germans more competitive, and grow at a faster rate than the rest of Europe (Worstall 2012). The labor market reforms are also cited as having reduced the German unemployment rate by 1.2% (Krebs and Scheffel 2012).

However, critics of the reform argue that setting German labor cost increases below the levels of competitors in France, Greece, Portugal, Italy and Spain within the context of the monetary union in the EU has precipitated the Eurozone crisis. The argument is that Germany used its competitive labor cost advantage to increase its exports to the other Eurozone countries, who themselves were not able to keep up their production levels, because their labor costs put them at a competitive disadvantage. The net importing countries were subsequently forced to finance their consumption on credit, which produced the current debt crisis (Busch 2010, 4). The fact that the whole of Europe is mired in a debt and economic crisis, tapping even the resources of economically strong Germany, does not bode well for the European social model, as the increasing contributions necessary to maintain the welfare states can not be made in the face of huge obligations to bailing out the banking sector and paying down national debts (7).

The discussion of the German labor market and welfare reforms leaves me to examine the trends in the welfare states in the rest of Europe and analyze whether the European social model remains viable in the twenty-first century. Discussing these trends requires a comprehensive assessment of the socio-political and economic forces in Europe that shape the policy-making process.

Despite the pressures of globalization some optimistic scholars maintain that while the European welfare states have increased the burden on lower-class people to take any jobs available, they have maintained the benefit generosity to productive middle-class citizens (Abrahamson 2010, 89). Public social expenditure in the OECD has increased from an average of 15.6% in 1980 to 19.2% in 2007 (Adema, Fron and Ladaique 2011, 3). Given this trend, there are scholars, who argue that the European welfare states have remained resilient and will stay so in the future (Brooks and Manza 2006, 816). In Germany’s case, even though the country has committed to the policy of raising the retirement age to 67, and tightening eligibility for welfare benefits to the poor, it has not carried out a complete dismantling of its social welfare system (Cremer 2012).

However, some scholars dispute this optimistic prediction for the European welfare states (Allan and Scruggs 2004, 497; Starke 2006). The European social model is overshadowed by increased pressures, because the recent labor market reforms in Germany have been adopted in other countries as well (Korpi 2003, 600). Until recently Greece, Portugal and Hungary had increased their social welfare systems, whereas Ireland, Spain, Estonia, Latvia, Lithuania and Slovakia cut back on the welfare state despite improvements in the economy. In regard to the retirement system, there has been a shift from a defined-benefit to a defined-contribution scheme in most European countries, especially the formerly socialist countries of Eastern Europe (Busch 2010, 7). The debate about pension systems in the EU are currently marked by a permanent concern for the financial viability of the system, the call for a limitation in pension expenditure, and a need for implementing private pension schemes to complement and later replace the prevailing public pension system (Etxezaretta and Festic 2009, 183). Similarly, unemployment insurance has also been cut in most of Europe with only the health care systems remaining untouched by the governments (Busch 2010, 8). Even leading trade unions in France- who have traditionally been strongly in defense of the welfare state- are now calling for labor market reforms similar to the German version (Ira 2012). The indebted Southern European countries, including Greece, Spain, Italy and Portugal, operating under external pressures have already implemented labor reforms that ease the firing of workers (Ehlers et al. 2012).

One can infer from this trend of reduced social welfare programs that Europe has distanced itself from the commitment to full employment, which is considered the “bedrock of the welfare state” (Kleinman 2002, 16; Korpi 2003, 594; Lindbeck 1996). This connection exists, because low unemployment rates and plentiful tax contributions from workers allow a generous welfare state to be financed. On the other hand, a lack of full employment reduces tax contributions, while raising social expenditures to deal with more unemployment, making the social model more difficult to sustain (Kleinman 2002, 16). A lower rate of economic growth also weakened the welfare state (Kato 2003, 3). In addition, Europe has turned to the neoliberal model over the past several years. The neoliberal model involves a policy of reduced government participation in the economy, lower taxes and social spending, privatization, liberalization and the expansion of world trade (Unger 1998, 53; Steger 2009, 42). This policy change has led to an orientation of national policies around supply-side strategies, which “redistributes national income toward capital profits at the expense of wages and social transfers” (Goma 1995). An IMF (2012) report specifies that economic recoveries between 1980 and 2006 in the advanced European countries have benefited profits to a greater extent than labor income (37). Generally, the ascendancy of the neoliberal model has meant that in many parts of the world social safety nets are reduced to the bare minimum, while wages have been lowered and job insecurity increased (Harvey 2005, 76). In the case of Germany, the demise of socialist-controlled Eastern Germany and its universal welfare state has fueled the notion of the inevitability of the neoliberal doctrine (Bollinger 2005, 884).3

The rise of the neoliberal model goes parallel with the weakening of the traditional political left in Europe that is used to defend the welfare state. It was the political left that has historically fought for an expansion of the welfare state.4 Wherever the political left was strongly organized, the welfare states were generous and encompassing, and wherever they were weak, the welfare states also remained weak (Manow 2007). Social Democrats and labor parties as a political force were historically instrumental in advocating for the welfare state (Przeworski 1980, 52), but operating under the pressure of globalization and neoliberal policy resorted to measures that reduce the welfare state (55). The reason why traditionally left parties came to accept a smaller welfare state and neoliberal policies is because these social-democratic parties needed to become elected to power (Schumacher 2011, 3). Tony Blair in Britain and Gerhard Schröder in Germany have attained political power as leaders of Social Democratic parties under the label the “Third Way” in the late 1990s (Driver and Martell 2000, 148; Giddens 1998; Wikipedia 2012c). The “Third Way” was formulated by Tony Blair, who argued that the old social democratic commitment to full employment and a universal welfare state as well as the economically liberal dogma of the Thatcher- conservatives prevailing in the 1980s do not meet the requirements of globalization. According to Blair, the old social democrats with their heavy emphasis on government regulation and social protection disregard the importance of economic growth, which is threatened by the freedom of capital to exit the country. The economic liberals, on the other hand, too heavily emphasize market freedom while disregarding the welfare state as a means to provide social cohesion (Blair 1999, 5-6). Blair and Schröder (1998) promised to balance the two ideologies with their “Third Way”. They emphasize that even though public spending should continue to remain important, a constraint of public expenditures, including social welfare spending should be a government priority (3). Blair and Schröder also advocate a re-orientation toward supply-side policies (6) that encourage companies’ willingness to invest rather than maintain stiff labor protection and expansive social security. Government’s role is not to provide a safety net, but encourage people to educate themselves and become involved in the workforce (Blair 1997, 302). The “Third Way” model has shaped the policies of most social democratic and center-left parties in Europe (Keman 2003).

The fallout of the ongoing financial and economic crisis will likely lead to further strains on the welfare state based on the weakening economy, the increasing debt obligations of the governments and a shrinking pool of employed taxpayers to fund the social system (Busch 2010, 7). The recession will likely accelerate and reinforce the retrenchment policy of European governments (Whyman, Baimbridge, and Mullen 2012, 281). The investors in the financial markets have raised their speculative attacks against the Eurozone member states in order to enforce an austerity agenda of social welfare cuts (314). The economies of the 17 Eurozone countries have shrunk for two straight quarters in 2012. There is no growth projected at least until 2014. The Eurozone debt burden has climbed to 93% of GDP up from 80% in 2009, and the current Eurozone unemployment rate stands at 11.6% (Associated Press 2012). Even though the welfare states have not caused the debt crisis, the political environment in Europe quite clearly has become more welcome to cuts in social programs (Eiermann 2012).

The general course of the European welfare state has interesting implications for other parts of the world. In regard to the policy discourse in the U.S., that traditionally has a smaller welfare state (Alesina, Glaeser and Sacerdote 2001, 1), the presidential contender, Mitt Romney, suggested that if America does not want to suffer the Greek economic fate, then the U.S. has to get its fiscal house in order (Morris 2012). Following Romney’s idea, the Greek debt crisis was intimately linked with its generous welfare state that had become too expensive.5 While the U.S economy is still in a somewhat stronger shape than the European economy, the U.S. government has been facing huge deficits that the leaders intend to address by cuts in social programs, such as unemployment insurance or the Medicare program, among other provisions (Sahadi 2012). In stark contrast to the direction of the American and European welfare states, Latin America and Asia have seen their economies improve, which is leaving more room for government social spending. In Brazil, the government had announced in 2011 that $13 billion will be allocated over a five-year time period in order to reduce poverty with family stipend schemes, affecting about 16.2 million people (Leahy 2011). Indonesia has implemented a universal health care law, which should cover all of the 240 million residents, “making it the biggest single-payer system in the world.” Similar schemes have been introduced in India, China and the Phillippines. The wealthier South Korea has introduced a universal pension scheme and an earned-income tax credit scheme in 2008. Even though public health spending is only 2.5% of the GDP in Asian countries compared to 7% in OECD countries (Economist 2012), the trend is that with increasing industrialization a greater share of the national income is allocated to welfare services (Wilensky and Lebeaux 1958, ix-x). Therefore, the weakening of the European social model does not at all imply that the welfare state is doomed, but that this model may very well be adopted in other parts of the world that respond to the challenges of a modern industrial society, similar to Germany in the late nineteenth century.

My discussion of the European social model and my case study of Germany show that the viability of the model has increasingly become challenged. I will agree largely with Mario Draghi’s skepticism about the strength of the model. This conclusion is based on my analysis of the developments of the German welfare state, especially over the last ten years since the implementation of Agenda 2010. This labor market reform has reduced the overall eligibility for welfare provisions, and helped the German employers to keep wages low. This condition has served the German economy very well (even if it harmed the German workers), and has encouraged other European countries to follow suit in order to keep up with German competition by similarly carrying out changes in social welfare spending. I also explained the socio-political changes occurring in Europe, most importantly the move away from full employment and strong economic growth rates and toward neoliberal policies that advocate more freedom for capital, and a smaller welfare state. The economic contraction and the mounting debt crisis in Europe since 2008 apply further pressures on the welfare state. I conclude that despite some variations in policy within each of the European countries, there is a strong tendency in Europe that the existing European social model is in danger of disappearing and weakening if there are no significant changes in macro-policy.

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