Race to the bottom

To prevent a race to the bottom, it is often argued that Europe should have influence on social policies. In this section it is investigated of this race to the bottom is a theoretical argument only, or that it really exists in practice.

Swank et al. (2003) present a literature review on economic integration in Europe. The authors argue that labour mobility between countries is theoretically more relevant than capital mobility when considering the optimal decision level for social security.

However, labour mobility between nations is of less importance in the EU (Swank et al., 2003). They state that the movement of workers between member states was limited to 0.1 per cent of the population in 2000, which can be judged as relatively low, both from an economic as well as an international point of view.90

De Giorgi and Pellizari (2006) investigate if social welfare tourism in Europe is a motive for migration. In their investigation from 1994 till 2001, they find –based on the

European Community Household Panel and the OECD data-base on benefit entitlements and replacement rates in the different countries- that this is the case in Europe. However, only a small proportion of the movements can be clarified by this tourism. The authors state e.g. that wages are approximately ten times as important as a motive for migration than social security levels.91

However, De Giorgi and Pellizari also state that the negative effects of migration combined with an adverse shock may outweigh the benefits of efficient migration in a simulation model.92

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PriceWaterhouseCoopers (2002) state in their analysis that the movement of workers between member states is limited to 0.4 per cent of the population per year.

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The authors also state it in this way: when comparing the rise of wages and the rise of welfare benefits in a country by one standard deviation, the rise in welfare benefits induces only 27 per cent of the migration effect of the rise in wages.

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However, these simulations are very stylised. The authors assume two potential migration countries. An exogenous unemployment shock (that differs for both countries) and thereafter a reduction in welfare benefits in the adversely hit country and an increase in these benefits in the other country. Then, the allocative benefits of migration are outweighed by inefficient social welfare tourism.

The low figures for labour mobility suggest that a “race to the bottom” with respect to (redistributive) social security instruments is not a serious problem. However, Swank et al., (2003) show that capital is relatively mobile within the EU, especially on the longer term. Does this induce a social race to the bottom?

Three empirical studies on the convergence of social expenditure ratios confirm the hypothesis that a social race to the bottom in Europe is not manifest. Goudswaard and Caminada (2006) even find an increase in average gross public spending levels (as percentage of GDP) for the EU-15 between 1980-2001 (see table 7).

Table 7: Public social spending for selected countries as % of GDP, 1980-2001

Another analysis of convergence is performed by Bouget (2003). He found convergence, but not to the bottom in the empirical analysis. Bouget suggests that reductions in relative social expenditure ratio’s (social expenditures as percentage of GDP) possibly follow from economic recession rather than from (radical) changes in countries’ social security systems, because of policy competition.

Adelanto and Cuevas (2006) state that although there is no social race to the bottom, there seems to be a relative decline in social expenditure ratio’s in purchasing power parity per head in Europe. Countries with relatively low social security provision increase their expenditures and countries with relatively high social expenditures relatively

decrease their social expenditures between 1995 and 2001, according to their measure. According to the authors, a convergence towards the middle with respect to social security could be seen in this period.

Fiscal pressure

However, mobile labour can lead to pressure on social security systems. The cost of inefficient social welfare tourism may outweigh the gains from efficient migration. This was also reflected in section 8.3 by the direct fiscal impact of immigrants in West Germany and Sweden. Therefore, delayed integration (or the home-country principle for a certain period of time) formed by the national governments with respect to horizontal and vertical redistribution and insurances based on income solidarity seems to be

adequate. Furthermore, with the OMC policy learning and pressures for efficient reforms can occur between member states, without an inefficient transformation of power to the European level.

The low figures for labour mobility suggest that a “race to the bottom” with respect to social security expenditures is not a serious problem. Different empirical studies support the view that a social “race to the bottom” does not occur in Europe. Furthermore, market distortions may be exported when redistribution policies are centralised in the European context. However, low rates of labour mobility may also have (fiscal) consequences on member states, which may require some central (co-ordination) policies.

Capital mobility

Although the assumptions of Perotti (2001) are very specific, Europe’s characteristics seem to fit well to this model. Capital is relatively mobile, while labour is not (Swank et al., 2003). Furthermore, Sapir (2006) showed that there are substantial differences between the efficiency of the economy of the different European countries. Combined with the ageing of the population (and therefore a majority of voters, who will possibly vote for more redistribution) a centralisation of redistribution policies might therefore lead to an export of market distortions from inefficient to efficient countries.

Thereby, capital mobility may lead to the export of negative effects between countries with different pension systems, as was shown in chapter 6. Furthermore, mobile capital may –in very specific circumstances- even lead to a social “race to the top” as was argued in chapter 5. All these analyses lead to a pledge for some central co-ordination to reduce negative external effects to increase welfare. This may be especially important with respect to the diverse pension systems.93

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As was argued, the assumptions to come to a “race to the top” are very demanding. Furthermore, the empirical evidence discussed in this section does not show that the race to the top occurs at present.