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The political economy of labour markets in Germany and the United Kingdom: a primer
Open Republic: July / August / September 2005

Robert Sproule, Department of Economics, Bishop’s University,
Lennoxville, Québec

THE IMPACT OF ECONOMIC FACTORS ON TWO LABOUR MARKETS

Tony Blair’s Labour Government was first elected in 1997. The electoral success of Blair’s team came principally from its repudiation of the past, from its rejection of “Old Labour” in favour of “New Labour”, and hence from its rejection of the “First Way” (viz., capitalism) and “Second Way” (viz., market socialism) in favour of a new “Third Way”.

What is at the core of Blair’s “Third Way”? Writing in The Guardian, Elliot (2002) notes that New Labour’s “(t)hird way economics boils down to this. First, the market is a natural state of affairs, a bit like the weather. Second, it is neither possible nor desirable to control the market in any meaningful way. Governments have to learn to live with globalisation. Third, governments should strive to make their respective nations as ‘business friendly’ as possible by gearing monetary, fiscal, environmental, educational, transport and social policies to the needs of large corporations. Finally, working people must fit into the new ‘market agenda’. They must show ‘flexibility’, work harder for longer and be prepared to shoulder the burden of ‘adjustment’, whether that be migrating to where jobs are or making good the holes in their endowment policies or pensions due to the misjudgments - or malfeasance - of the financial establishment.”[9]

Another fix on Blair’s “Third Way” is offered by Dixon (2000) in Le Monde diplomatique. He writes: “Alignment of Labour’s economic policy with neoliberal ideology was concluded in 1996. Compared with the Conservative version, only the terminology and wrapping were changed. Labour market flexibility, imposed in the heyday of Thatcherism, was now taken over as an objective of the left. Provided, of course, that it was ‘reasonable’, did not just serve to increase job insecurity, and involved the workers themselves in a strong commitment to their new terms of employment. The role of the state was confined to providing a stable framework for unrestricted competition between companies. Any government intervention had to be on the supply side, such as reform of the education and training system, to meet the demands of international competitiveness ... According to Blair, ‘the growing integration of the world economy ... means that it is not possible for Britain to sustain budget deficits or tax regimes that are wildly out of line with the other industrial countries. One of the requirements of our tax structure is to attract enterprise into the UK from overseas’ .. ‘Social democratic governments cannot resort to the traditional methods of demand stimulation and state intervention because the financial markets would not allow it.’”

Dixon’s (2000) comments draw a parallel between the policies of the Blair and Thatcher governments. Dixon is not alone in doing so. The Economist, for example, observed the same in 1998, when it stated: “Having demonised … Tory governments while opposing them Labour is understandably reluctant to admit that it is following the path they marked out. So a big part of the business of the Third Way consists of making up a story about what the Tories stand for which makes their Labour replacements look clearly different”. Likewise, Clarke (1999, p. 303) observed, in his 1998 Creighton Lecture in History at the University of London, “We can surely agree that the impact of Thatcherism has survived the political demise of its eponymous exponent – sometimes in ways faithful to her intentions, but sometimes not. In short, we have entered a post-Thatcherite phase of political economy: a statement with the election of the Blair government has done nothing to weaken.”

Tony Blair has been so convinced of the merits his Thatcher-like “Third Way” policy regime that he has flogged his wares to foreign leaders. A high-water mark of such efforts is the UK-German joint-declaration entitled “Europe: The third way/die neue mitte” [Blair and Schröder (1999)]. What then are core ideas of the “Third Way” that Tony Blair would offer, impart, or export?[10] Many of these are captured in the following five observations:

(1) Writing in International Organization on the impacts of the new reality of international finance, Geoffrey Garrett (1998, p. 779) notes that, “governments can no longer maintain, let alone expand, the generous welfare state–progressive taxation mix. Mobile firms are deemed unwilling to pay the taxes to fund government programs. … (T)he future of the welfare state can only be secured by shifting the tax burden from mobile (firms and financiers) to immobile (labor) asset holders, emasculating its redistributive effects.”

(2) Writing in Inroads, Eric Shaw (1999) notes, “To succeed, New Labour has concluded, a government has no option but to ‘convince the markets that they have the policies in place for long-term stability.’” He continues, “The welfare state sought to protect people from the impact of market forces; the social-competition state aims to equip people to adapt to market forces.” And finally, he observes that, “(a) credible government is a government that pursues a policy that is ‘market friendly’; that is, a policy that is in accordance with what markets believe to be sound. The confidence of the financial markets has been secured by implementing ‘a rules based approach to macroeconomic policy, an independent central bank with an inflation target and a framework of medium term fiscal targets.’”

(3) In European Political Science, Shaw (2003) also notes, “Social democratic governments have no option but to rein-in social spending, lower direct and corporate taxation, encourage more private sector participation and give greater scope to the spur of market competition and individual incentives.” Likewise, he notes, “… for the Blair Government, the real problem is not globalisation, but its political resistance to it.”

(4) In a working paper, Coates and Hay (2000, p. 18) observe that: “Welfare is no longer an end in itself, but must be recast as a means to the economic imperative of competitiveness and rendered answerable in such terms.” They also note that the core of Labour’s competitiveness strategy “is the elimination of supply-side rigidities that impede wealth creation”, and that the core tenets of this strategy parallel the ‘trickle-down’ economics of the Thatcher and Major years. They then argue that “(t)he reality is that wealth creation is more important than wealth redistribution. It is successful and prosperous businesses which can employ more and more people and also ensure that public finances are sound, to that we have the resources to fund those essential public services like health and education”. And finally they state that, “(e)ntrepreneurs take risks in the face of uncertainty and open up new markets. Government should and must not hinder them, but work to ensure that the market functions properly and contributes to a strong, just and fair society. There can be no return to the outmoded interventionism of the old left. The corporatist state was tried and it simply did not work.”

(5) In a later paper, Hay (2004) notes that, “New Labour’s political economy has been informed consistently by the dual objectives of credibility (in financial markets) and competitiveness (in the productive economy). These, in turn, are seen as fundamental and non-negotiable economic imperatives imposed upon any government by the harsh economic realities of globalisation, and they provide the standard by which its economic policy should be judged. They are reflected directly in New Labour’s ‘open economy macroeconomics’ and its agenda of supply-side reform and human capital formation respectively” (p. 41).

One unintended casualty of New Labour’s commitment to an international competitiveness strategy may be New Labour’s willingness to offer unconditional support for the adoption of the EU’s common currency, the Euro. Central to this willingness is a favourable evaluation of the arguments for and against a single currency. These arguments are outlined by Eudey (1998). She notes that the benefits of a single currency include reduced costs of exchange, reduced exchange rate uncertainty, the prevention of competitive devaluations, and the prevention of speculative attacks. Regarding the costs of a single currency, she writes: “Probably the biggest cost is that each country cedes its right to set monetary policy to respond to domestic economic problems. In addition, exchange rates between countries can no longer adjust in response to regional problems.” In the case of the Euro, she notes that “the EMU member countries have … agreed to limit the use of fiscal policies”, which is a passing reference to a dictate of the Maastricht Treaty. [11]

The implications of Eudey’s observations for the UK are threefold: (1) A country that adopts the Euro would forfeit the option of pursuing an independent, counter-cyclical monetary policy. (2) A country that adopts the Euro would forfeit the option of pursuing an independent, aggressive, counter-cyclical fiscal policy because of provisions in the Maastricht Treaty and in the Growth and Security Pact. (3) A country, which forfeits the option of pursuing an independent counter-cyclical monetary and fiscal policy, must rely on wage adjustments and labour mobility to restore equilibrium in the face of an exogenous shock.[12] Thus, if it does adopt the Euro, (1) the UK would lose the capacity to run counter-cyclical policies, a policy option rarely exercised by the current and by recent governments in the UK, in any case, but (2) the UK would retain its flexible labour market, at least in the short term. However, in the longer-term, UK could lose even that equilibriating mechanism should the EU succeed in imposing its burdensome workplace- and tax-harmonization rules.

In view of high stakes associated with the decision to adopt the Euro, and the lack of a clear-cut argument in support of its adoption, it is not surprising that, on April 20th, 2004, Tony Blair reversed his long-held position; the decision to adopt the Euro would be put to the people in a referendum vote. A precipitating factor in Blair’s change of heart may have been the polling results taken between April 1st and April 6th, in which voter opposition to adopting the Euro reached a near-term high [Hutton (2004)].[13] Referendum or not, will the UK will adopt the Euro? The above arguments suggest that this is not likely.[14] But there is an additional important consideration: the Blair Government did assert early on in its first mandate that the proposition-to-adopt had to pass five (economic) tests,[15], [16] , and so far only one test has been met.[17]

Now to Germany. What has been the impact of the EU and the Euro on Germany? Germany is a founding member of the EU, and it adopted the Euro in 2002. As a consequence, Germany has forfeited its capacity to run a counter-cyclical domestic monetary policy to the ECB, and its capacity to run a counter-cyclical, domestic fiscal policy of any note. Because of Germany’s inflexible labour market [18], [19] German officials cannot count on wage adjustments and labour migration to dissipate quickly the adverse effects of an exogenous shock. These facts help to explain the difference in the relative performance of the two labour markets in 2004.

footnotes

[9]For more detailed, academic discussions of Blair’s “Third Way,” see Arestis and Sawyer (2001), Balls (1998), Hamilton (2001), and Hay (2004).

[10] Regarding the recent efforts of the Blair Government to export its public policies, one is reminded of a parallel a generation earlier. John Redwood (the Head of Prime Minister Thatcher's Policy Unit, 1983-1985) stated in the PBS three-part video series, The Commanding Heights: The Battle for the World Economy, “A whole lot of people who were left of center thought that nationalization was Britain’s great gift to the world, and one of my phrases at the time was that having exported the disaster of nationalization to the world, Britain should offer them the antidote; it was the decent thing to do, to say we're very sorry, it didn't work.”

[11] For example, Yergin and Stanislaw (2002, p. 327) note that the Maastricht Treaty contains a series of extremely tough “benchmark criteria,” which must be met if a country is going “to climb aboard the euro wagon.” A key criterion is that its national budget deficit be less than 3 percent of its GDP. Likewise,
Mertes (2002, pp. 79-80) observes, “..the rules of budgetary discipline for EMU members prevent careless deficit spending. In Euroland countries, the ratio of the annual government deficit to GDP must not exceed 3 percent at the end of the preceding fiscal year, and the ratio of gross government debt to GDP must not exceed 60 percent.”

[12] Eudey (1998) notes, “.. when one or several countries within the currency union, but not all, face recession or an overheated economy, adjustment must occur largely through changes in wages and prices or through the movement of workers from one country to another.”

[13] About four weeks before Blair’s about face, the “Europe Yes, Euro No”, or simply the “No”, Campaign (a eurosceptic group that maintains the consequences to the UK of it adopting the Euro include slower economic growth, higher unemployment and prices, and public service cuts) put its campaign on hold [See The “No” Campaign (2004), and White (2004)]. Perhaps this decision was motivated by its anticipation of Blair’s statement, or by the no-verdict in Sweden’s referendum to adopt the Euro a half a year before [BBC (2003c)].

[14] It should be noted that these same arguments that are some of the core arguments of the “No” Campaign in the UK [BBC (2003b), Balls (2002 and 2003), and HM Treasury (2003b)].

[15] Several comments are warranted here: (1) The answer comes down to an evaluation of the costs and benefits under the options, adopt and the status quo [much like Minford (2002) has done]. (2) Those who argue for staying with Sterling include Minford (2002). (3) Those who argue for going with the Euro include Begg et al. (2003), Layard (2002), and Layard et al. (2002).

[16] In brief, the five tests are: (1) convergence with the Eurozone, (2) flexibility, (3) impact on jobs, (4) impact on financial services, and (5) impact on foreign investment [BBC (2003c)]. For more detail on the five tests, see Balls (2002 and 2003), Minford (2002), and HM Treasury (2003b).

[17] This is the “impact on financial services” test [BBC (2003c)].

[18] Several comments are warranted here: (1) For international comparisons of “labour market flexibility,” see Brodsky (1994), Sorrentino and Moy (2002), and HM Treasury (2003a). (2) A recent study reports that amongst the G7 countries, the UK had the second most flexible, and Germany had the least flexible, labour market in 2000 [Lawson and Bierhanzl (2002)]. (3) See Siebert’s (1997) and Zawadsky’s (2004) call for “labour market flexibility” in Germany.

[19] The conceptual link between an increase in labour market flexibility and the ensuing reduction in unemployment can be outlined two ways. Cox and Alm (1992) view that the labour market is turbulent, and this turbulence they term “the churn.” They argue that increase in labour market flexibility enhances labour market turbulence, which enhances job creation, which reduces unemployment. Karanassou and Snower (1998) present the “chain reaction theory” of unemployment, which posits that “high-unemployment countries require not only policies to reduce structural unemployment, but also policies that improve labour market adjustment processes.”