Lilia Costabile on the Debate between Equity and Efficiency in the European Union

July 2008

In this interview with PERI's Communications Director Debbie Zeidenberg, PERI's newest Research Associate Lilia Costabile discusses questions that arise from her new edited volume, Institutions for Social Well Being. The book is a collection of articles assessing whether there is a trade-off between equity and efficiency in a state's decisions about social policy. Contributors draw on examples from throughout the European Union and the U.S.

While the title of your book, Institutions for Social Well-Being, implies a focus on social policy, you and your co-authors bring to this topic broader expertise in macroeconomic and monetary policy. How does social policy relate to these larger economic questions?

One of the basic ideas developed in this book is that the political economy of the European Union is key to understanding its social dimension. While in the initial stages the main objective of the European project was to reduce intra-European conflicts, subsequently a central role came to be played by the external objectives: namely, insulating Europe from the asymmetries of the international monetary system, and gaining some degree of autonomy from the economic policies of the United States. The book – in the chapter written jointly by Roberto Scazzieri and myself – draws our attention to these asymmetries, to the political dimension of European monetary unification and, finally, to its most important implication, that the EMU and the Euro are instrumental to the objectives of pursuing social objectives and an independent foreign policy at the European level. They achieve this by affecting Europe’s balance of payments constraint and helping to promote the opportunity for external equilibrium. Given these premises, the book investigates the grounds for, and possible articulations of, a European social policy.

For those interested in theoretical roots, I add that Keynes linked countries’ (or groups of countries’) capacity to pursue their domestic objectives of “providing continuous good employment at a high standard of living” to their ability to maintain external equilibrium. To this end, he proposed reforming the international monetary system. In the absence of a world currency such as that proposed by Keynes in the 1940s, the Euro is certainly a second best solution, but one which may help to promote the interests of a “social Europe.”

Of course, full promotion of the social dimension requires that the alternative objective, that Europe should be merely a large, deregulated free market area, does not prevail. The road is long and winding, but les jeux ne sont pas faits: the game is still on.

One element of the debate over social policy in the EU turns on who is responsible for setting the terms and implementing social policy—the EU or its member states. You lay out the case for “an active role for the EU in definition of Europe’s common social ambitions.” This debate has been played out here in the U.S., where block grants to the states now allow a great deal of autonomy in their welfare programs. The resulting patchwork has shown that states have varying inequality aversions, and also that the costs of mobility for welfare recipients are high enough to be nearly prohibitive. Can this example be applied in the EU to support universally-defined policy goals and frameworks?

As your question helps to clarify, two keywords - decentralisation and autonomy (either at a nation, state, or regional level) – have dominated the political debate in recent years. This is just one example of a political campaign based on a common theme, but articulated in different forms in the two sides of the Atlantic.

In Europe, political campaigners opposing any strengthening of European institutions argue that decision making, particularly in the field of social policy, should be set as close as possible to the local “communities,” identified in this context with EU member states (or their subsets). These are represented in this approach as homogeneous “clubs” defined by their citizens’ shared preferences for a given degree of (in)equality, social protection and tax rates. In this scenario, people with inhomogeneous preferences would simply migrate to communities with tastes similar to their own, thus making true the proposed definition of communities. This definition of course underestimates the costs of mobility. In the Conclusion to the book, I use the example of people from Calabria (an Italian region with very low per-capita income, where poverty is geographically concentrated) moving en masse to Sweden, as they would be expected to do, according to this approach (assuming they were unable to obtain effective redistributive policies in the Italian national context). The arguments in favour of “fiscal federalism” are often said to be best suited to the U.S., where mobility costs would be much lower than in Europe. However, even in the absence of a language barrier, the costs of geographical mobility are high in the U.S. too, as you say, and some recent studies have shown that mobility is lower than commonly believed. The example you use supports our case for universally-defined goals in the field of social policy, as put forth by Tony Atkinson and by Massimo D’Antoni and Ugo Pagano in their chapters.

The Bowles-Jayadev chapter makes an interesting argument about the trade-off between the cost of redistributive policies and the costs of guard labor—that one or the other is necessary to maintain order in a heterogeneous society. This is a powerful argument that allows the ascendancy of a preference for equality, but one that seems somewhat complex to translate into policy. How do you think this research could be used to influence policy choices?

From a European perspective, it is easy to see the policy implications of this argument. It is often claimed that European countries should renounce their welfare systems and that Europe should rather learn from the American model, which is depicted as less equal but more efficient. The obvious policy implication of the Bowles-Jayadev argument is that we should think twice before accepting this advice, and stop until we have a reliable estimate of the hidden costs of inequality, which have been ignored thus far.

Your question leads to the fundamental question of which policies are effective in reducing inequality. I will give you just two examples set in the United States – drawn from the chapters by Roberto Artoni and Alessandra Casarico, and by Teresa Munzi and Tim Smeeding, respectively - of policies that qualify as good starting points in order to reduce inequality. The first is a health policy aimed at increasing coverage; the second is the adoption of policies for reducing the very high children poverty rate (21.9% in the U.S., compared to, for instance, 2.9% in Finland, 4.3% in Sweden, and 7.6% in Austria) and preventing the intergenerational transmission of poverty. The latter type of policies are also likely to produce dynamic efficiency gains if, as many experts agree, they positively affect the welfare and cognitive abilities of children, and hence human capital formation.

In the section of the book devoted to comparative analysis of EU member states, you talk about the relationship between the level of public resources devoted to the care of children and the elderly and the labor market participation of women. Is this a chicken-and-egg situation? Were governments led to put resources toward care activities by the demand of women flowing into labor markets, or did the resources in some cases come first? Why might this demand have differed between regions in Europe?

I do not think that the flow of women into labor markets can be regarded as the initiating factor. After all, although women’s participation rate is comparatively very low in the Mediterranean countries, it is certainly not nil. Moreover, for many decades after the Second World War, it increased steadily. But this process did not induce an accommodating reaction in the amount of resources devoted by states to care services, which is disproportionately low in these countries, as the chapter by Bettio and Plantenga clearly shows.

Possibly, demand factors, led by such factors as culture, religion, and values may have played a role, as I think your question implies. But, in my opinion, “supply” factors are more important. By this I mean that governments’ responses to demands for intervention would not be homogeneous across countries and times. Given similar social demands, the reaction would be sensitive to the coalitions of political and social forces supporting the governments in different situations and countries. Thus, it would not be surprising if welfare states influenced by a coalition of interests between industrial capital and the labor movement (such as in the Swedish case, as described by Bjorn Gustafsson) would react to a given increase in the demand for care services differently from welfare states dominated by more conservative interests. If these factors are important, the chicken-and-egg description may not apply.

Aside from the roots of the wide range of welfare and care regimes within Europe, why do you think it perpetuates itself? Can we point to variations in culture or economies, or artifacts of those, or does the explanation for the diversity lie elsewhere?

One factor is the strength of the state, which depends on the stability of the underlying coalitions of interests. A strong state based on a progressive coalition of interests or even on a paternalist approach to the welfare of “the labouring classes” will produce a more efficient welfare and care regime than a weak state which is prey to factious interests.

I agree that cultural factors play a role. But, in general, I do not think that “culture” performs very well as an explanatory variable in social sciences. We see so many “cultures” completely overthrown everyday by the strength of economic forces. Under this respect, I accept the economist’s view that incentives are a most powerful influence. After all, this is why economic policies can be effective: because they affect the behaviour of people by affecting the incentives that they face.

Chapter after chapter in this book underscores the finding that economic efficiency does not require renouncing the goal of equity. Why does that misconception so dominate the policy debates? How would you propose moving the discussion in the U.S.and the EU to a broader understanding of role of social protection in an efficient economy with healthy levels of growth?

I think that policy debates are shaped partly by a serene “battle of ideas” and partly by the conflicting interests of the actors involved. The actors interested in dismantling or scaling-down welfare states often coat their proposals in economic arguments (sometimes, but not always, originally developed by detached economists) in order to make them look logically cogent. The preferred arguments generally rely on some version of the equity/efficiency trade-off. This may be one possible answer to your first question.

As for your second question, I think that a necessary condition for helping to move the discussion on is to never tiring of using logic. This requires that we should refuse intellectual laziness and/or subordination to these supposedly incontrovertible arguments, which are often anything but watertight. This is why the book, chapter after chapter as you say, tries to show how our societies can be made both more efficient and more equitable. The second condition is that we try to exchange information about how things really are on the two sides of the Atlantic. Many misconceptions, I think, arise out of ignorance or misinformation. The book tries to correct this by proposing comparative studies, both between Europe and the U.S. and between EU member states.

In line with my previous comments, I should add that producing logically coherent, informed arguments is a necessary, but by no means a sufficient condition for moving the discussion in the U.S.and the EU towards the ends that you mention. There must also be ears willing to listen.