Economics 2: Balancing capitalism and social democratic ideas - European case studies (v1.0)

A key reference is Professor Edward F Stuart, Ph.D of Northeastern Illinois University.

In a previous essay, I talked about the key modern economic ideas. I talked about Capitalism, Socialism, and Communism. Communists believed Capitalism was fatally flawed and unjust and must be toppled – even violently. Communism can be delegated to the dustbin of history and will not be discussed here, but most economies today are a blend of free market capitalistic principles and social democratic ideas. Even China that started as a communist system has adopted many capitalistic ideas including a stock market. 

This trend to blend first emerged in Europe spearheaded by social democrats. Social Democrats believed that the inequalities of Capitalism could be addressed by reforms to benefit all members of society. They believed that such improvements can be achieved through democratic elections and reforms. They believed some form of planning or state management was essential to reform and sustain the capitalistic system. There were three key motivations. The ethical motives include that allowing poverty and unemployment to exist in society is contrary to ethical values. Prudential motives include that poverty and unemployment leads to social upheaval and class violence. The third motivation was a macroeconomic one which is that economists believed that a capitalist system was inherently unstable and prone to boom and bust. Charles Kindleberger’s tome “Manias, Panics and Crashes” was a major piece of work. There is a need for a stabilizer for the economy and this cannot be governed by private profit considerations. It can only be the Government or an extremely well-funded nonprofit. The stabilizer function is an especially important public good. For example, public projects for roads and bridges, public housing, schools and hospitals, and water and sewers, provide opportunities for private enterprises and employment for its people and offers some stability. Also, old age public pensions, and public unemployment compensation gives some people buying power and offers some stability.  Government Central Banks are another source of stability. 

But social democrats in different European countries implemented it in diverse ways, and for different reasons. In this essay, I will focus only on UK, Germany/Austria, Sweden, and France. I am not here to pass judgement on any system any country has adopted using democratic means, but to describe how it evolved and what is the balance that was picked, and the areas emphasized. Each society has different values and priorities based on their history, wealth, education level, culture, and dominant religions.

 Corporations and other businesses are the engines for the production of goods and services in a capitalist economy and capitalists funding it are key actors. The focus of corporation in capitalism is shareholder value. They care about employees only to the extent to increase shareholder value by retaining the good ones and squeeze the most productivity. They care about the environment only to the extent of gaining customer approval to increase shareholder value and meet regulatory requirements to avoid running afoul of laws and get penalized which decreases shareholder value. They care about social and moral issues only to the extent of gaining customer and employee approval all towards maximizing shareholder value. Despite these non-altruistic motifs, capitalism is the best economic system invented by man especially because it neatly aligns with human propensities. It maximizes economic efficiency. 

However, there are issues which cannot be examined purely from an economic lens. There are winners and losers built in and as a consequence it widens inequality. Opportunity is not often available for many segments of society, Meritocracy is crucial for an economy, but the opportunity to develop those merits is also crucial and is often missing for some. There are many who for a variety of reason are significantly disadvantaged to compete in a capitalistic system. Some like the old, sick and disabled cannot compete at all. Poverty and unemployment are not consistent with western values, and major levels of inequality, especially if perceived to be unfair, breeds discontent and rebellion against the system. Also, capitalism needs to be regulated to ensure justice for competing factions and to protect national security state interests (including incentives to go in a certain direction). A good legal and regulatory and government sponsored incentive system is essential.

 The key question early social democrats struggled with is what public goods must be produced, how much should be produced and how should it be paid for. Public good was best described by the American economist Paul Samuelson. He said private good was rivalrous (if I use some, there is less left for you) and excludable (you can be prevented from consuming the good). A public good on the other hand are non-rivalrous and non-excludable. Examples of public good is clean air, clean water, programs to eliminate communicable diseases, etc. The key problem with public good is the free rider problem.  The free rider problem is an economic concept of market failure that occurs when people enjoy a shared resource without having to contribute to it. Private companies usually can't profit from providing public goods, so they're usually supplied by the government and paid for with tax dollars. Capitalism was spectacular at producing private goods. But at least in its early days it was not good at producing public goods. But government expenditure on public good has some down sides. Europeans pay one of the highest taxes due to their social programs. Also, public borrowing if undertaken to fund public projects burdens future generations and corrals off a large proportion of income to service debt. Lastly government projects sometimes gets bogged down or incur cost overruns. 

 Initially the common belief favored always balancing the budget. A more elastic approach in the form of Keynesian deficit spending policy in times of economic downturns only emerged after World War II. Also, progressive tax rates emerged after WWII. This gave the social democrats better options to fund their programs. 

Without further ado, I will now dispassionately and factually talk about the blend of capitalism and socialism in UK, Germany/Austria, Sweden, and France in the rest of this essay. I will briefly summarize US policies at the end. 

 The beginnings of social democracy in Britain were with highly educated upper class strata of Victorian society in Britain. One such person was William Beveridge. He was part of a group of reformers called the Fabian Society that included Sidney and Beatrice Webb. They laid the groundwork for the establishment of the Labor Representation Committee. In 1906 it became the British Labor Party that still exists today. The British Labor party (first got a majority in 1924) began advocating for the government to produce public goods early last century. The origins of today’s NHS and public hospitals and the municipal water service can be traced to early struggles with communicable diseases. After the conservative Chamberlain reached his infamous deal with the Nazi’s to cede territory in Europe to the third Reich, the people’s view of conservatives in general was negatively colored for a long time. Also, the sacrifices for the war endured by the common people resulted in a more aggressive political posture for gains for the people. Only after World War II did the labor party have enough power to make significant changes. The labor party rolled out profound changes. The key architect of these reforms was William Beveridge. He produced the Beveridge report. The Beveridge report was the blueprint for the modern British social welfare state. Among its recommendations were a national health system funded and operated by the British government. It also pushed for a national pension program that supported the elderly retired population and unemployment insurance for workers who lost their jobs. Some people criticize the NHS (rationing, care quality, public cost, etc.). But at least on cost, America spends 18% of its GDP on health care while Britain pays half of that. It also covers everyone, and the British live slightly longer than Americans on average. One reason for prohibitive cost in US is due to all the paperwork and processes. Also, American medical professionals start their careers with a huge medical debt which they have to make up. It also pushes them into specialties with potential for higher income. In Britain, there are twice as many General Practitioners as in the US, and medical school costs are much more moderate. On rationing, all health systems have some degree of rationing. But in Britain it is more uniform, and the NHS is very popular in Britain.  

Britain has oscillated between nationalization programs and privatization programs depending on the party in power. The 70’s was a period of stagflation due to the oil embargo, and the Labor party nationalized a number of private enterprises including Rolls Royce and British Rail. This was primarily done to save them from bankruptcy. This is sometimes called lemon socialism – the government taking over lemons that no one else wanted. In the late 70’s the conservative Margret Thatcher who was influenced by Milton Friedman, instituted a significant tax cut, and hobbled labor unions. She also deregulated the finance industry. She also privatized many public organizations including Jaguar, Rolls Royce, Mini Cooper, Land Rover, British Petroleum, British Airways, British Telcom and British Rail (after breaking up). The Labor party again gained power in 1997 with Tony Blair who set a minimum wage and made NHS and unemployment benefits and old age pensions better for the people. The pendulum of labor and conservative power continues to swing back and forth.

  In the section on Germany/Austria below, I will skip the period of world war I and also Fascist Hitler and Nazi’s. Suffice it to say Hitler cynically exploited the socialist and communist platforms to amass power but once in power he turned against them and empowered the industrialists and capitalists and was a Fascist. I always beware of populists!! Once in power, populists often swing to one form of extremism or another. I will also skip much of the post-World War II division of Germany (until 1989) and the reconstruction period and Marshall Plan. These are dark periods.

 In Germany, social democrats arose a bit earlier than Britain under Otto Von Bismarck. Bismarck first unified Germany and was a driver of German Industrial and technological development. He understood that in a modern state power really comes from Industrial might. He was not much into democracy but was an autocrat and a believer in the German people. Bismarck was influenced to some extent by religious forces (Lutheran) on his social policies. There were also practical beliefs driving him like a person afraid of losing work will be less productive and frequently sick people will bog down the economy. People scared of finances in old age will be more focused on that than on working steadily and productively. He was also responding to pressure from communists (don’t forget Marx was a German!!), social democrats and worker groups. He was the founder of the German social system. Bismarck created the first system of public health care and unemployment and old age pension. He also channeled significant public funds to universities and research institutions to propel industrial growth forward. Today’s healthcare system is not that different. Both employers and employee pay 7.5% for healthcare insurance. A German worker does not lose health care when a job is lost because the state takes over the employer part.  

The social democratic party (SDP) in Germany was founded in 1863. By 1912 it was the largest party. The German social democrats like the British supported a national health care but they also pushed for labor unions for ALL workers (not just industrial workers but public employees, workers in service industries and even farmers). The SDP won its first election in Vienna in 1919. A key focus for SDP in Vienna was public housing. Public housing was the number one priority for SDP in the red Vienna period (ended in 1934). The public housing is beautiful and was designed to be indistinguishable from the private building housing the bourgeoise. Care was taken to integrate them into the fabric of the city. Today more than 60% of the city’s 1.8 million inhabitants live in subsidized housing and nearly half the housing market is made up of city owned flats or cooperative apartments. This quality affordable housing today has vaulted Vienna to the top of the world’s most livable cities. In 1990’s, Chancellor Kohl was a big supporter of the EU and the euro. 

After the EU, the united German economy took off and was the best in Europe. Because of the war’s destruction, West German factories were rebuilt with the most modern and up to date equipment and that helped. Germans are prolific savers, and German Banks channeled the money to industrialists. The workers Union had representation in each company’s board of governors. Germans are well paid and well educated. German labor laws are vastly different than US. Layoffs require proper notifications and a proper appeals process. So German companies are reluctant to lay off people. Germans also have a lot of time off. It is said that these policies are the secret keys to a much more productive and less stressed German worker. Today, Germany is an export powerhouse and has one of the largest trades surpluses.

 Sweden is the best example of a point between free market capitalism and government owned and controlled socialism. Scholars sometimes refer to the Swedish economic system as the third way. The modern image of Sweden is as a modern egalitarian economy with a high standard of living, a high level of social welfare spending, and a high level of taxes. Swedish GDP is just below the top 10. The Swedish income is the most equally distributed in the world according to the Gini coefficient (US is 45 and #23, Sweden is 25 and #1). The swedes have a very enhanced sense of national solidarity and equality which has deep roots in Swedish history. Feudalism was abolished exceedingly early. One of the primary kinds of institutions Sweden created was a cooperative where expenses, risks and rewards are shared. This notion of wide dispersion of ownership and few social classes is very characteristic of Sweden compared to other countries at that juncture. Sweden is predominantly a privately owned economic system with very limited direct government ownership. 

Sweden has a small population in a large country area and to be economically viable, it has always had to rely on foreign trade a lot. Almost all Swedish companies rely heavily on exports. As a consequence, Sweden pays a lot of attention to its exchange rate. That is one of the reasons it did not adopt the euro. In the 19^th century, Sweden became a big exporter of engineering and metallurgical products. Sweden formed cooperatives and trade unions at a fast pace. The workers formed a political party (social democratic workers party - SAP) linked to the trade unions. It first gained prime minister post in 1920 and mostly ruled ever since. There are many political parties in Sweden with the parliament having proportional representation. So, all stake holders are represented. This explains the reason that Sweden is so hospitable to workers. The basic premise in Sweden is that workers will work effectively and well if they think they are being treated fairly. But both workers and industrialists are very well aware that foreign trade is critical for their survival, and both enhance and align on that like for example on quality and cost. People assume Sweden is pacifist because it was neutral in World War II. But Sweden is a major producer and exporter of high-tech military hardware. The Swedish government was the first to use active fiscal policies to counter a downturn and to stimulate growth and lower unemployment. It also supported active labor market policies to enhance employment. These included subsidies to private employers to keep employees that might otherwise let go, and subsidies to public employers to increase hiring typically for the first job. The Swedish welfare state is quite extensive with free health care, free education, Unemployment insurance and pensions, and generous family leave. But nothing is free. The tax burden in Sweden is high and ranks 5^th in the high tax category (only Finland, Denmark, France, and Belgium rank ahead – US ranks 27^th and is considered a low tax country among high income countries). The swedes have democratically decided to give up some economic freedom for a more egalitarian society.         

France, though a latecomer to industrial capitalism, was vital in shaping influential socialist theories. Its system today reflects its history of wars, revolutions, and political battles between right- and left-wing political parties. Even the terms – right wing and left wing – are French creations. Even before the French revolution, the monarchists/right faced off against the abolitionists/left. Today the French system is a blend of capitalistic private property and industry and agriculture along with significant state ownership and control and influence. The French system of economic planning led by the state is called indicative planning (communist economic planning is different and is called command planning). The focus is to lead/influence the economy in the desired direction. For example, this led to safeguarding the farmer, while the urban workers had to pay more for food and industrialists had to pay workers more to afford the food. In the 19^th century unlike Britain France was a country of small farms and small industrial units. While Britain was in the throes of the industrial revolution, France remained a bucolic and peasant country outside of big cities. The big cities also were more centers of government, education, and culture more so than industry. By the latter part of 20^th century, the industrial British cities were still big and dirty but not as rich as globalization and deindustrialization kicked in. The French cities remained picturesque. 

After the French revolution, Napoleon brought in a professional military and a university system to train for civil service and a modern legal code. French social thought led the creation of social theories. The French socialist Party achieved its first electoral success in 1936. It enacted higher minimum wages, and nationalization of the railroad. But the rise of Nazi’s cut it short. I will skip the period of French Vichy collaboration with the Nazis.  De Gaulle led the resistance forces and helped the allies liberate France and was above all a French Nationalist. After the war, France was a defeated and demoralized country with a weak economy. De Gaulle believed that the economy required significant planning and government involvement. The architect of the blueprint was Monnet. His two greatest supports were the US government (Marshall Plan) and the French socialist party. The French socialist party favored reforming capitalism with democratic elections and the will of the majority, and maybe replace it later on. Indicative Planning was Monnet’s product. Nationalization of companies like Renault, telephone, water distribution, banking, energy, and transportation businesses were a part of it. The prevailing trend today in the world is to privatize enterprises, but even today, the French government owns significant industries. Besides direct control, France also used many indirect control methods. These gave the French government strong controls over the economy. The state offers protection of four key sectors of society – the sick or incapacitated, the elderly, the unemployed, and families. The French health care system is one of universal health care largely financed by government national health insurance. The French pay some of the highest taxes in the world. The French switch periodically between Left wing and Right-wing government. But no politician will change the public national health system which is rated among the best in the world. Left wing Mitterrand policies triggered big decreases in unemployment and encouraged growth but created large budget deficits and large balance of payments deficits. Right wing Chirac followed him and following him was left wing Hollande. The current leader is Macron who appears to be more centrist.

We went on a vacation to New Zealand, and I wrote about it. The New Zealand population is largely European, and policies lean on the liberal side. I described the economy and cost of living, income subsidies, health care and education of New Zealand in that essay. Here is the essay. https://jaykasi.blogspot.com/2024/02/our-vacation-to-new-zealand.html  

In the US, there is a perennial struggle between the conservatives and the liberals. Conservatives favor tax cuts and reduced spending. Liberals favor tax increases on the wealthy/corporations and social programs. Both are evenly matched and power toggles between the two. But the US has social security, Medicare, Medicaid, unemployment insurance, and the affordable care act. It is behind Europe in more uniform and widespread public health care (as opposed to a spotty patchwork of partial solutions) and mandated paid family and medical leave and favorable labor practices and environment control. The US has practically no industrial assets - it is all private ownership. The US spend on defense and national security is huge though and influence those industries. The US has little involvement in affordable housing but does offer low-cost loans for home ownership through the FHA and deductions for homeowners’ expenses in tax returns. While the US offers free public schools, colleges are not covered and could be very expensive. However, there are Pell grants and favorable rate student loans. The federal minimum wage in US is abysmally low but many states have set it higher. Compared to Europe, there is little direct government assistance for families although there is more favorable tax treatment for married couples, and some deductions for children. There are a number of programs for the poor including food stamps. Do the people favor more socialistic policies like Europe? The people are divided. The biggest resistance is to increase taxes to fund it. 

Is Europe a model for America or a warning? A thoughtful article on that. There are no easy simple solutions. Only nuanced thinking and seeking balance!! Opinion | Is Europe a Model for America? Or a Warning? - The New York Times (nytimes.com)