Accelerated economic internationalization

Broadly understood, globalization refers to the profound intensification of international economic interdependence. Since the 1980s, the liberalization of trade and financial markets, international outsourcing and subcontracting in production, the rapid pace at which technological innovations spread, increasing human migration, the expanded weight of multinational corporations, and the intensification of international communication (especially via the internet) have all contributed to a quantum leap in the interconnectedness of the world economy. To the extent that intensified economic internationalization exerts challenges to improve competitiveness, it reinforces pressures on welfare provision in affluent democracies. The impact of international competitiveness, however, affects different welfare states in varying ways and to differing degrees (Rodrik, 2007, 2011; Swank, 2010). National European economies are neither wholly absorbed into a new global order, nor are their governments, including European Union institutions, totally incapacitated to protect their citizens from market volatility. In times of intensified economic internationalization the policy interdependencies between economic and social policy, between the worlds of work and welfare, have become increasingly important for the long-term sustainability of the welfare state (Esping-Andersen, 1999; Scharpf, 2000; Scharpf and Schmidt, 2000a, b). With globalization, national welfare states are no longer closed systems. More than ever, domestic social policy is conditioned by the parameters set by other countries. The costs of social policy provision transcend national borders. Across the EU, with its common market and open borders, this is even more the case. Under conditions of only moderate levels of economic growth, fiscal pressures have increased, not least because of greater capital mobility and accelerated European economic integration (Misra, 1999; Genschel, 2004;

Koster, 2009). Countries compete for investments with a view to creating jobs and promoting economic growth. Governments compete for capital. They do so through interest and exchange rates, fiscal policy, tax rates, the competitiveness of their markets, physical infrastructure, and the quality of human capital stock (Hay, 2006).

There are many good arguments on the complementarity of comprehensive welfare provision and accelerated economic internationalization (Cameron, 1978; Garrett, 1998; Rodrik, 1998, 2007). The more generous welfare states of western Europe emerged in line with the growing openness of economies after 1945 (Cameron, 1978, 1984; Katzenstein, 1985; Garrett, 1998; Rieger and Leibfried 1998; Rodrik, 1998, 1997, 2007; Iversen and Cusack, 2000; Iversen, 2001; Busemeyer, 2009). Welfare states are especially large in highly open economies. In addition, historically, there is a strong positive correlation between the size of the welfare state and levels of equality (Pontusson 2005; Atkinson, 2008).

Since the 1970s oil shocks, however, a number of consecutive changes in the international political economy did unsettle the relative 'goodness of fit' between domestic welfare commitments and the international political economy. The oil price shock of 1973 exacerbated the predicament of stagflation, the conjunctive rise of inflation and unemployment. Next, the emergence of a more restrictive international macroeconomic environment, marked by high real interest rates, after the second oil crisis of 1979, pushed up unemployment levels to double digit levels. Low growth, rising social expenditures, and recurrent external disequilibria triggered fiscal crises in many of the European countries. In turn, this made it progressively more difficult for advanced European welfare states to deliver on their core commitments of full employment and social protection over the 1990s (Scharpf and Schmidt, 2000a, b). There is, however, little empirical evidence for the thesis that globalization is leading to a 'race to the bottom' in social policy (Franzese and Mosher, 2002).

Over the past quarter century, there have been a five interrelated international economic impact factors which European welfare states were pressed to come to terms with (Scharpf, 2000; Huber and Stephens, 2001; Reusche- meyer and Glatzer, 2005; Begg, Draxler, and Mortensen, 2008). The first impact factor concerns trade competition. Labour-intensive European industry has over the past two decades moved offshore to central Eastern Europe and South East Asia (Berger, 2000, 2005). As a result, the shrinking manufacturing sector became more exposed. The shift toward high value-added diversified quality production in the exposed sectors of the economy is reflected in an increase in the demand for technical and professional employees, as well as greater skill demands more generally. To be sure, trade integration constitutes a source of growth in the demand for high-skill, high value-added goods and services within the OECD. Moreover, it remains true that the vast majority of trade continues to be among the advanced industrial countries rather than between them and the developing economies. The share of total European trade with the rest of the world is less than 15 per cent, a large part of which concerns trade with Eastern Europe and other OECD countries. Figures 3.1 and 3.2 gives an indication of trade integration in product markets and service integration since the early 1990s.

Second, there is the globalization of finance. Since the late 1980s, domestic financial markets were systematically deregulated, allowing financial innovations to evolve practically unchecked. Many countries began to dismantle controls over cross-border lending and borrowing. In particular the IMF became a strong advocate of capital market liberalization (Rajan, 2010; Rodrik, 2011). It was believed that free capital mobility would increase investment, growth, and prosperity by enabling global savings to flow to their most productive uses. As the financial sector grew and became truly global, insufficient latitude was reserved for domestic government regulation and international supervision (Posner, 2009). In the process, the financial industry acquired the capacity and the licence to make money out of money, generating claims to resources at a pace so rapid that the real economy could not possibly follow (Streeck, 2009).

Trade integration of goods

Figure 3.1. Trade integration of goods.

Source: Eurostat;average value of imports and exports (goods) as percentage of GDP.

Trade integration of services

Figure 3.2. Trade integration of services.

Source: Eurostat;average value of imports and exports (services) as percentage of GDP.

It is important to underline that international capital market liberation is not merely a product of the American or British variety of capitalism. Many European banks invested heavily in large quantities of securitized US mortgages and other innovative financial instruments, such as credit default swaps and collateralized debt obligations. By 2008, European banks ended up being more leveraged than their Anglo-American counterparts. And as European monetary unification brought interest rates down dramatically in the previously high-interest southern tier of the EU together with Ireland, this provided cheap funding to financial speculators, the result of which was a housing boom in Ireland and Spain and lending sprees in the UK and the Netherlands. These European contingencies, combined with the lack of a pan-EU system of financial governance, explain why the instabilities in American financial markets contaminated Europe so easily and swiftly after the downfall of the Lehman Brothers investment bank (Eichengreen, 2009). Real economy globalization and the deregulation of international finance, together, accelerated macro trade imbalances over the past ten to fifteen years. Emerging Asian economies and the oil-exporting countries accumulated large current account surpluses, which were matched by large current account deficits in the US, as well as the UK, Ireland, and Spain. A key driver of these imbalances was the high savings in countries such as China and Germany (Hemerijck, Knapen, and van Doorne, 2009).

Third, liberalization and deregulation have significantly reinforced an austerity bias in macroeconomic policy, by supporting a strong bias to fiscal austerity (Mishra, 1999; Deacon, 2000; Swank, 2001, 2006; Armingeon, 2007). While economic internationalization constrains countercyclical macroeconomic management, increased openness exposes generous welfare states to trade competition, because capital is allowed to cross borders and move to countries with lower social costs. In an environment of international capital mobility, it has therefore become even more costly than before for individual national governments to pursue expansionary monetary and fiscal policies in the effort to stimulate growth and employment. In the shadow of capital mobility domestic policy priorities, such as full employment and income equality, have thus been subordinated to public finance balance of payments and low inflation fiscal and monetary policies. Moreover, under conditions of fully liberalized capital markets, strategic devaluations are practically ruled out as a tool to restore price competitiveness, as this would induce capital flight. Beginning in the 1980s and gathering momentum in the 1990s, macroeconomic doctrines of fiscal discipline, low inflation, financial and trade liberalization, the opening of economies to foreign investment, labour market deregulation, privatization, structural adjustment, and welfare retrenchment gained precedence across advanced OECD market economies, with the objective of making the economies more efficient and competitive, in the hope that economic growth would trickle down to mitigate social needs in the process (Howell, 2006; Glyn, 2006; Busemeyer, 2009).

In this new macroeconomic context, looming tax competition conjures up a fourth critical dimension of intensified economic internationalization (Gang- hof, 2000, 2005; Ganghof and Genschel, 2008). Many observers feared that tax competition would cause the under-financing of the welfare state by driving away taxpayers (Sinn, 1990; Scharpf, 1991; Steinmo, 1993; Tanzi, 1995; Rodrik, 1997). To the extent that financial market globalization limits government policymaking autonomy, market integration constrains the capacity of states to engage in redistributive taxation for fear of tax competition (Genschel, 2002). The reality of tax competition is probably less extensive than some experts claim. Nonetheless, globalization does constrain capital tax autonomy (Hays, 2009). Corporate taxes since the early 1980s have fallen from about 50 per cent in 1981 to 30 per cent in 2009 across the OECD countries (Rodrik, 2011; see Fig. 3.3 for post-1995 developments). In an extensive literature review, Philipp Genschel and Peter Schwarz (2011) conclude that a 'race to bottom' through competitive tax cutting does not stand up to empirical scrutiny. Rate cuts in corporate taxes have been offset by broadening the tax base and the elimination of investment-related allowances, credits,

Adjusted top statutory tax rates on corporate income. Source

Figure 3.3. Adjusted top statutory tax rates on corporate income. Source: Eurostat.

and exemptions (Swank, 1992, 1998; Plumper etal., 2009). Kemmerling (2009) found no effect of openness on individual income taxes and the ratio of the income tax rate to payroll and indirect taxes. Social policy expenditures are by and large financed out of the taxes paid by the recipients of welfare provision (Shaikh, 2003). In Sweden, one of the most generous welfare states, capital taxation is relatively low by international standards, and the overall tax rate from corporate profits is at the EU average. On the other hand, even if corporate tax reforms have not shifted the tax burden onto labour per se, we do observe a significant drop in levels of income taxation on high earnings (see Fig. 3.4).

The final and fifth critical dimension of economic internationalization, closely associated with tax competition and macroeconomic regime change, concerns the 'political logic' of globalization, a concept coined by Duane Swank (Swank, 2002, 2010). Increased international financial integration is said to have strengthened the social and political power of capital—in particular for capitalists with mobile or diversified assets. As such, the relocation threat—a major manifestation of the political logic on globalization—can exert a powerful influence on domestic policy and institutional arrangements,

Top personal income tax rates. Source

Figure 3.4. Top personal income tax rates. Source: Eurostat.

as shown in certain high-regulation European countries where large firms have used it to weaken the power of unions and force concession bargaining. Increased capital mobility has raised the bargaining power of employers, a shift from banks to financial markets as main providers of credit, and a shift from stakeholder to shareholder control with claims for more immediate profit. Multinational companies can use the threat of relocation as a lever to extract concessions on wages, employment relations, and corporate taxation. Powerful economic interests use the opportunities provided by international capital markets and trade liberalization to throw weight behind their ideological opposition to generous social and employment protection. This opposition probably differs across different aspects of social policy, for instance being more modest with respect to active labour-market protections than to more passive income transfers (Burgoon, 2001). Still, the political logic of globalization (Swank, 2002, 2006; see also Streeck, 2009; Trampusch, 2009a) is illustrated by a declining wage share relative to profits since the early 1990s (see Fig. 3.5). Over the past 15 years, while many developed countries saw their GDP increase by up to 25 per cent, median incomes barely rose at all (and in some countries even declined), revealing a highly skewed distribution of growth. Inequality has increased in EU Member States, although the trends are far from uniform: they have grown rapidly in the UK and Italy but are less marked in Germany and France. In a few traditionally low-inequality

Adjusted wage share (as % of GDP at factor costs). Source

Figure 3.5. Adjusted wage share (as % of GDP at factor costs). Source: AMECO.

Scandinavian countries significant increases can also be observed (see Chapter 7). The greatest income disparities have been between those at the very top of the income distribution scale and those in the middle. Also the relationship between labour productivity and wages has been weakened, with labour productivity running ahead of wage increases (ILO, 2011). Absolute poverty has continued to decline across the EU in recent decades, but relative poverty has been on the rise (Forster and d'Ercole, 2005).

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