'Third Way' Economics: An Evaluation

Third Way Economics Theory and Evaluation

Philip B. Whyman

Third Way Economics

Also by Philip Whyman SWEDEN AND THE ‘THIRD WAY’: A Macroeconomic Evaluation AN ANALYSIS OF THE ECONOMIC DEMOCRACY REFORMS IN SWEDEN: Background, Operation and Future SOCIAL DEMOCRACY AND EMU: Progressive Economic Policy in a Global World IMPLICATIONS OF THE EURO: The Left and EMU (co-edited with M. Baimbridge and B. Burkitt) BRITISH TRADE UNIONS AND ECONOMIC AND MONETARY UNION BRITAIN, THE EURO AND BEYOND (with M. Baimbridge) THE IMPACT OF THE EURO: Debating Britain’s Choice (co-edited with M. Baimbridge and B. Burkitt) EMU IN EUROPE: Theory, Evidence and Practice (co-edited with M. Baimbridge) FISCAL FEDERALISM AND EUROPEAN ECONOMIC INTEGRATION (co-edited with M. Baimbridge)

Third Way Economics Theory and Evaluation Philip B. Whyman

© Philip Whyman 2006 All rights reserved. No reproduction, copy or transmission of this publication may be made without written permission. No paragraph of this publication may be reproduced, copied or transmitted save with written permission or in accordance with the provisions of the Copyright, Designs and Patents Act 1988, or under the terms of any licence permitting limited copying issued by the Copyright Licensing Agency, 90 Tottenham Court Road, London W1T 4LP. Any person who does any unauthorised act in relation to this publication may be liable to criminal prosecution and civil claims for damages. The author has asserted his right to be identified as the author of this work in accordance with the Copyright, Designs and Patents Act 1988. First published 2006 by PALGRAVE MACMILLAN Houndmills, Basingstoke, Hampshire RG21 6XS and 175 Fifth Avenue, New York, N.Y. 10010 Companies and representatives throughout the world PALGRAVE MACMILLAN is the global academic imprint of the Palgrave Macmillan division of St. Martin’s Press, LLC and of Palgrave Macmillan Ltd. Macmillan® is a registered trademark in the United States, United Kingdom and other countries. Palgrave is a registered trademark in the European Union and other countries. ISBN-13: 978–1–4039–2065–2 hardback ISBN-10: 1–4039–2065–6 hardback This book is printed on paper suitable for recycling and made from fully managed and sustained forest sources. A catalogue record for this book is available from the British Library. Library of Congress Cataloging-in-Publication Data Whyman, Philip. Third way economics : theory and evaluation / Philip B. Whyman. p. cm. Includes bibliographical references and index. ISBN 1–4039–2065–6 (cloth) 1. Economic policy. 2. Mixed economy. I. Title. HD87.W49 2005 330.12′6—dc22 2005050354 10 15

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Printed and bound in Great Britain by Antony Rowe Ltd, Chippenham and Eastbourne

To Barbara

I believe that the only important structural obstacles to world prosperity are the obsolete doctrines that clutter the minds of men. – Krugman, 1999: r168 The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influences, are usually the slaves of some defunct economists. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. – Keynes, 1936: 383

Contents Preface

viii

Acknowledgements

ix

Introduction

xi

1 What is the Third Way?

1

2 A Response to Globalisation

26

3 Goodbye Keynes?

55

4 Central Banks and Monetary Policy

89

5 Labour Market Flexibility

112

6 Public Sector Reform: Employability

129

7 Regional Economic Integration

146

8 Evaluation of Third Way Economics in Practice

164

9 ‘Real’ Social Democratic Alternatives

214

Bibliography

240

Index

281

vii

Preface The concept of the Third Way has risen to prominence during the past two decades, with a significant number of progressive-social democratic political movements associating themselves with its general philosophy and/or more detailed policy programme. Indeed, a number of leading figures on the democratic Left have participated in international summits to discuss the ramifications of an evolving Third Way. Consequently, the Third Way has become an issue worthy of study in order to understand its motivations, influences and theoretical foundations. The intent of this book is to seek to outline and evaluate the Third Way. One distinctive feature of this book, however, is that this will be undertaken from an economic rather than political science point of view. There have been a large number of books that have sought to debate the Third Way from a political theory or comparative politics perspective. However, there have been only a handful of previous texts which have sought to analyse the economic policy platform promoted by Third Way supporters – the success or weakness of which will partially determine the potential for realisation of social and other political objectives. The book has been written in a political economy style, so that it should be accessible to non-economics specialists without losing any of the detail. It is intended that the book should be of interest to students following an economics and/or politics course, when understanding of the policies pursued by ‘new’ social democracy governments is an important issue. However, it is anticipated that the subject matter will be of much wider interest across supporters of trade unions, social democratic political parties, policymakers and their advisors.

viii

Acknowledgements There are a large number of people whom I wish to thank for their assistance, directly or indirectly, in the preparation of this book. First, I must thank my family and friends for their forbearance during the endless sunny days locked in my study. In particular, I would like to thank Claire for her patience throughout the completion of this project. I thank Amanda Hamilton, Katie Button and colleagues at Palgrave for their patience during the almost inevitable over-runs. I hope you are pleased with the final product, and agree that it was worth the wait? My appreciation goes to my employer, the Lancashire Business School (University of Central Lancashire), for supporting this project through freeing sufficient time for me to be able to complete the manuscript, despite the myriad of competing demands upon research time. Thanks also go to my colleagues in the Lancashire Business School, together with Mark Baimbridge (University of Bradford), for their guidance and input into this project, particularly in its embryonic state. Furthermore, I offer my thanks for the comments made by two anonymous referees on the initial book proposal – many of which were extremely insightful and have improved the text that you see before you. Lastly, but certainly not least, I would like to offer my deepest gratitude to Barbara Keward for all her help offered during the lifespan of this project. This ranged from assisting in cataloguing the mountains of material I collected through the duration of this research project, to taking charge of quality controlling the bibliography. Without her willingness to offer assistance above and beyond the call of duty, this book would have been less substantial and undoubtedly further delayed. It is, therefore, on this basis that I would like to dedicate this book to Barbara. Despite the help and assistance freely given by all those individuals named, as always, all errors that remain within the text are entirely mine. I hope I have repaid all your kindness with a work that you will enjoy, and which will, in some small way, contribute towards a saner political economy in the future. Philip B. Whyman Heaton Norris, Stockport.

ix

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Introduction The creation of a Third Way between unfettered capitalism, on the one hand, and ‘traditional’ Keynesian-corporatist forms of social democracy, on the other, has proved a potent element of social democratic thought. Indeed, it has become the driving force behind the policy programmes of many left-of-centre political parties in the industrialised nations of the world today. This Third Way is distinct from previous versions of social democracy in that it rejects the Keynesian consensus that aggregate demand management is an essential feature of a successful macroeconomic strategy. In its stead, Third Way theorists concentrate upon reforming social and economic policy to enhance competitiveness within a world dominated by globalisation and technological change, which they believe renders previous forms of social democratic strategy powerless. Thus, the Third Way represents a form of ‘new’ social democracy, occupying a middle path between neo-liberalism and traditional forms of social democracy itself. A practical phenomenon, designed to solve perceived problems from a centre-left perspective, the Third Way has suffered from the absence of a unified theoretical base – particularly when adopting an international comparative perspective. Indeed, it is the multi-faceted nature of the Third Way label that represents both its strength and weakness, since its lack of formal definition facilitates a dialogue between conflicting concepts of social reform, yet the approach suffers from a lack of ideological cohesion. Nevertheless, there are sufficient elements that all variants of the Third Way share, and which therefore enable their association within a common definition that embodies elements of a relatively homogenous strategy. Most notably, the Third Way can be defined according to its strategic reaction to the challenges provided by globalisation, through combining neo-liberal economics with a conception of government activism intent upon realising endowments for all citizens, to improve their opportunities within global markets and not seek to protect them from the consequences of these enhanced market forces. The Third Way has been particularly evident in the USA during the Clinton Presidency and in the UK throughout the Blair Premiership. However, it has had notable influence in many European economies, xi

xii Introduction

for example Schröder’s Germany, the Netherlands and Sweden. It is little exaggeration to suggest that the Third Way approach has had a significant influence upon all of the European social democratic movements, and indeed it has left its mark upon the policies pursued by the European Commission. Furthermore, the phenomenon is not restricted to Europe and North America, since similar strategies were adopted in Australia long before Clinton and Blair came to power. This book develops a workable Third Way model, derived from a synthesis of the most important elements of the programmes pursued by ‘new’ social democratic movements. It explores the theoretical foundations to the Third Way approach, before evaluating its economic strategy against conclusions drawn from contemporary economics literature. It further contrasts the Third Way economic programme from a traditional form of social democratic economics, and comments upon the viability of each approach in adapting to the challenges posed by today’s economy. The book begins with an evaluation of the philosophical and practical determinants of the Third Way approach. It outlines essential elements of the generic Third Way model, formed from elements of ‘new’ social democracy distinct from traditional variants of this type of political economy. Chapter 2 examines what is presented as one of the key defining features of the Third Way, namely its response to the perceived challenges (or threat) provided by globalisation. Third Way theorists share the perception that globalisation has undermined the attempts made by nation states to regulate and tax financial capital, trans-national corporations (TNCs) and mobile, highly skilled employees. Therefore, the Third Way holds that globalisation has imposed limitations upon fiscal redistribution and undermined policies previously forming a central part of a social democratic-Keynesian strategy. The ‘strong state’ is replaced by the ‘competitive state’ as, rather than oppose globalisation, national governments compete for international capital and improve international competitiveness in order to realise and distribute benefits from globalisation to all groups within society. Thus, the Third Way argues that economies should embrace the opportunities provided by greater competition through deregulation, creating a flexible labour market and competing to attract mobile capital through the creation of a superior business environment. At the same time, however, government should empower its citizens through extending human capital investment in education and training, in order to ensure that citizens are better able to compete in the global marketplace. Individuals are equipped to deal with the increase in labour market competition generated by globalisation,

Introduction xiii

rather than seek to protect them from its worst excesses by shielding people from market forces, through social means. Chapter 3 focuses upon Third Way macroeconomic strategy. In particular, it highlights its rejection of the former social democraticKeynesian consensus and its replacement by a synthesis of monetarist and neo-liberal economic precepts. Government no longer uses all tools under its control in order to pursue multiple economic objectives simultaneously, the most important of which being to sustain full employment. Thus, demand management is replaced by supply-side economics, fiscal policy is constrained within orthodox rules, and exchange rate management is rejected as ineffective. The new definition involves the creation of a stable framework for business activity, implying price stability having become the principle goal of economic strategy. Institutional factors are considered of lesser importance to assumptions of economic actors displaying rational expectations which, when combined with the natural rate of unemployment, results in the ineffectiveness of government policy. The Third Way therefore holds that there is no medium- or long-term Phillips-curve trade-off between lower unemployment and higher inflation, and therefore governments should limit their intervention in the economy for fear of worsening the situation. This stance is compatible with the theoretical perspective associated with the New Keynesian and monetarist schools. Fiscal policy becomes a largely passive instrument, concentrating upon reducing public expenditure as a proportion of national GDP, together with reinforcing the budgetary position. Chapter 4 continues where the previous chapter ended, through its examination of Third Way monetary policy. The replacement of full employment by price stability as the prime target for government policy confirms the supremacy of monetarist over Keynesian schools of economic thought, and consequently monetary policy is considerably tighter. Moreover, its operation is increasingly delegated to ‘independent’ central banks, whose insulation from political influence is intended to deliver lower inflation rates, but which suffer from problems of lack of accountability and deflationary tendencies. The evidence supporting this strategy is, however, sparse and contradictory. Chapters 5 and 6 examine Third Way microeconomic policy. Chapter 5 concentrates upon Third Way strategy relating to the labour market. It examines the different approaches to the promotion of labour market flexibility pursued by Anglo-Saxon and ‘Polder’ economies, before evaluating the efficiency of such measures in reducing unemployment and attracting foreign direct investment (FDI) to the national and/or regional

xiv Introduction

economy. The chapter additionally examines the potential for differing patterns of wage formation to facilitating micro- and macro-flexibility. Chapter 6, by contrast, concentrates upon initiatives made to improve the productivity of the public services, together with welfare reforms intended to promote individual incentives for work, savings and investment. In terms of the former, the introduction of New Public Management techniques, the introduction of private sector service provision (through privatisation, the contracting-out of services and/or public–private finance schemes) and introduction of competition within public services are all outlined. Labour market policies and institutional frameworks underpinning industrial relations processes are discussed, before the chapter concludes by evaluating the ability of welfare reforms to promote employability and equip individuals for a more competitive labour market, without having an adverse impact upon social solidarity and income redistribution. Chapter 7 considers the potential for regional economic integration as an alternative means of pursuing Third Way economics. It begins by noting that regional economic integration is a direct reaction to globalisation, as groups of nations – through the creation of larger single, internal markets – seek to maintain an element of control over the integration process and produce a cost-competitive advantage for their firms. In North America, this has resulted in North American Free Trade Agreement (NAFTA); in Europe, this has led to the European Union (EU). However, these models are quite distinct. Whereas in NAFTA, the emphasis is almost entirely upon free trade, the EU approach embodies more far-reaching reforms, such as a common social policy, Economic and Monetary Union (EMU) and potentially ultimate political union. For some, the European ‘project’ is a means of regaining control over trans-national capital, within a larger European super-state, and thereby the creation of a form of Euro-Keynesianism dedicated to traditional social democratic aims. For others, it is a means to further embrace the laissez faire elements of the Third Way and rollback national state regulation. The Stability and Growth Pact (SGP) and European Central Bank (ECB), introduced under EMU, relate to the latter, whilst the demands made for a European Social Model relates to the former. However, the two approaches are fundamentally incompatible and hence one model will ultimately have to prevail, to the detriment of the other. Chapter 8 provides a (necessarily brief ) evaluation of Third Way economics in action. In this regard, it draws upon the experience of ‘Clintonomics’ in the USA, New Labour in Britain, Germany under Schröder, Sweden under Persson, the Olive Tree coalition governments in Italy, the various Dutch governments in which the Labour Party has

Introduction xv

participated, together with precursor administrations including the Spanish Socialist governments led by González and the Australian Labor Party governments under Hawke and Keating. Overall, the evaluation contained within this chapter points to the transience of much of the Third Way economic legacy. It emphasises the importance of fiscal policy as one effective policy instrument to help prevent a deflation of the economy. Moreover, it re-emphasises the necessity to avoid restrictive exchange rate and monetary policy. These are fairly traditional lessons. Indeed, it appears that the most successful policy measures, introduced during the Third Way period, owed more to traditional social democraticKeynesianism than a new style of economic policy. However, the long-term legacy of the Clinton period may be less favourable than the contemporary assessment, due to the unsustainable nature of the ‘engine’ of the economy being private consumption, rather than investment, which itself was largely driven by transient asset bubbles. In the final chapter, alternatives to Third Way (new) social democracy are evaluated. It questions the extent to which the Third Way can accurately claim to represent a legitimate part of the social democratic tradition, and it rejects the assertion that there is no alternative to a choice between the Third Way and neo-liberalism. It presents a number of alternative policy options available to contemporary progressive-social democratic movements, all of which have the potential to make a greater contribution towards ‘traditional’ social democratic goals of full employment, redistribution and social protection. Box 1 Third Way administrations used as case study examples in the remainder of this book • • • • • • • •

Clinton, Democratic Party, USA: 1994–2000 Blair, New Labour, UK: 1997+ Hawke–Keating, Labor Party, Australia: 1983–96 Persson (Sveriges Socialdemokratiska Arbetarpartiet, SAP), Sweden: 1994+ Kök, Labour Party [Partij van de Arbeid, PvdA], Netherlands: 1982–85, 1988+ Schröder (Sozialdemokratizche Partie Deutschlands, SPD), Germany: 1998+ Prodi–D’Alema Olive Tree (I’Ulivo) coalition of the Left, Italy: 1996–2001 González, Socialists, Spain: 1982–96

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1 What is the Third Way?

Introduction The Third Way has been described as arguably ‘one of the most successful theoretical and political strategies’ to have emerged in the contemporary period (Geyer, 2003: 237). Similarly, ‘the debate about the third way has become the most important reform discourse in the European party landscape’ (Merkel, 2001). For supporters, it ‘stands for a modernised social democracy, passionate in its commitment to social justice and the goals of the centre-left, but flexible, innovative and forward-looking in the means to achieve them’ (Blair, 1998d: 1). Moreover, it is portrayed as a form of ‘ethical socialism’ that represents ‘the only serious view of the Left’s future that can remain’ after the substantial changes in the international political economy environment at the cusp of twentieth and twentyfirst centuries (Blair, 1994: 3). However, critics contend that the Third Way is in essence an example of Thatcherite revisionism (Hay, 1994, 1999), where principles are abandoned in a cynical attempt to secure political power – in essence, ‘the great moving nowhere show’ (Hall, 1998). Theorists have described the Third Way as ‘fundamentally vague and elusive’, and may be considered to represent ‘a rhetorically defined space’ rather than an ideology (Lukes, 1999: 3–4; White, 2001: 1). Leading figures associated with the Third Way, including Tony Blair himself, have acknowledged that it should be considered to be a ‘work in progress’, a form of ‘permanent revisionism’ encompassing a perpetual search for improved means to secure ethical goals (Blair, 2001: 2, 4). This emphasises upon the practicality of the Third 1

2 Third Way Economics

Way, but its lack of a well-developed theoretical core, leads Robert Reich to suggest that: Rarely in the history of world politics has a term gone from obscurity to meaninglessness without any intervening period of coherence. (New Statesman, 1 May 1999, cited in Clift, 2004: 36) One measure of the significance of the Third Way is that it developed at least partly in reaction to a number of recent, substantial developments in the international political economy environment. These include the collapse of what passed for communism in the USSR and Eastern Europe, together with the increasing import of globalisation, the development of flexible-specialisation forms of production and the hegemonic position claimed by neo-liberal economics in the industrialised economies. These events provided a temporary period of euphoria for advocates of the neo-liberal ‘new Right’, as it appeared to vindicate their treatises against the dangers of communism, and by inference all forms of progressive policies associated with even the mildest form of democratic socialism and/or social democracy. Despite the triumphalism from the political Right, Fukuyama’s (1992) announcement of the ‘end of history’ and the obituaries written for social democracy by Dahrendorf (1988: 140, 172, 1990: 38) and Gray (1998: 89) were, with the benefit of hindsight, rather premature. A second indication of the importance of the Third Way relates to the electoral success for political parties associating themselves, with varying degrees of enthusiasm, with this form of modernised social democracy. During the five years leading up to 1998, left-of-centre political parties were elected (or re-elected) into government in sixteen out of twenty sets of parliamentary elections held in eighteen westEuropean countries. Moreover, at the turn of the twenty-first century, social democratic parties were in government, either in coalition or governing on their own, in thirteen out of the fifteen EU member states (Lovecy, 2000: 50, 53). Political commentators were discussing the turnaround in the electoral fortunes of European social democratic parties in similar terms to the rise of the neo-liberal ‘new Right’ agenda two decades previously (Clift, 2004: 34). Indeed, European social democracy was even voted the ‘personality of the year’ by the American magazine Newsweek in December 1998 (Leonard, 2000: xi). In Britain, New Labour secured two landslide election victories, whilst Clinton’s two-term presidency in the USA overturned twelve years of Republican incumbents. Moreover, the Australian Labor Party had won

What is the Third Way? 3

five successive General Elections and remained in power between 1983 and 1996. However, whilst this resurgence in democratic left-of-centre electoral fortunes has been described as ‘spectacular and unprecedented’ in terms of the number of governments formed, this was a slightly misleading indication of electoral strength. Indeed, only two social democratic parties polled more than 40 per cent of the vote (UK and Portugal) in 2000, whilst sister parties in five of the fifteen EU member states polled 20 per cent or less (Sassoon, 1999: 19; Giddens, 2001: 20; Favretto, 2003: 12). Relative electoral success for social democratic parties, whether or not this proves to be constructed upon weak popular foundations, has certainly stimulated considerable interest in the development of the Third Way. However, it has simultaneously raised a number of fundamental questions relating to the viability of progressive economic policies, the optimum range of policy instruments to be utilised to secure social democratic goals, together with the very nature of social democracy and what it exists to try to achieve. White (2001: x) explains the significance of the evaluation of the Third Way phenomenon in the following terms: This apparent revival in the fortunes of progressive political parties has generated much excitement. But it has also generated much confusion and debate. In essence, the debate is about the extent to which the electoral success of these notionally progressive political parties really will, or can, translate into a reassertion of progressive values at the societal level. Are we witnessing a political realignment in the advanced capitalist world that will further progressive commitments to social justice (understood in reasonably egalitarian terms) effective freedom, and the extension and deepening of democratic self-government? Or are these new governments of the ‘centre-left’ destined merely to tinker with the terms of established conservative political settlements or to act as reluctant agents of pro-market economic reform?

A new phenomenon? The term ‘third way’ has been used to describe various innovative policy programmes, which occupy middle ground in-between two polarised positions. It may have first been used as long ago as the late nineteenth century by Pope Pius XII as part of his campaign for an alternative to both capitalism and socialism (Gould, 1998: 236). The

4 Third Way Economics

concept of a ‘third way’ has been used interchangeably with the ‘middle way’ popularised by Marcus Childs (1936) when contrasting the full employment and developing welfare state in Sweden in the 1930s with the Great Depression in the orthodox capitalist economies and the repression associated with Stalin’s regime. In Britain, Ramsay MacDonald presented the Labour Party as a ‘third way’ alternative to two other possible forms of socialism, namely syndicalism and state socialism (MacDonald, 1912: 68–69). More recently, the Eurocommunist debate discussed the creation of a ‘third way’ between communism and social democracy, or, as Salvati (2001: 149) explains, ‘between a radical revolutionary programme and the actual experience of social democratic governments in the rest of Europe’. The concept of the ‘third way’ has, however, had a far wider usage. For example, the term has been utilised by Ota šik and advocates of market socialism and has been applied to Yugoslavia, under the communism of Tito, resulting from its pioneering synthesis of elements of worker participation and state ownership (Estrin, 1983). The expression also featured in the Socialist International’s 1951 programme, which marked out a path distinct from both US free-market capitalism and Soviet communism (Green and Wilson, 1999: 69). More embarrassingly, for current adherents, the term was utilised to legitimise anti-democratic variants of extreme right-wing politics in the 1920s, most notably including the fascism of Franco. Indeed, the slogan ‘neither right nor left’ was adopted by the French fascist movement (Bobbio, 1996: 107). Social democracy, itself, has been presented as a ‘third way’ between free-market capitalism and Soviet command socialism–communism (Przeworski, 2001: 312). The tendency to modify policies, strategy, ideology and even values has been a common theme running through democratic socialist and social democratic history, encompassing both Bernstein’s challenge to Marxism and Crosland’s championing of the Keynesian-social democratic mixed economy (Crosland, 1956; Gay, 1962). Social democracy is, in that sense, a political movement and not a fixed doctrine. Its priority is to ‘build and sustain political majorities for reforms of economic and social institutions, which counter injustice and reduce inequality’ (Gamble and Wright, 1999: 2). Consequently, social democratic movements have continually confronted the potential conflict between principles and power (Thomson, 2000: 20). The dynamic nature of capitalism and changes in the international socio-economic environment, together with a range of divergent circumstances produced by different national settings, further complicates matters and has caused social democrats to regularly revise their ideas and programmes

What is the Third Way? 5

to account for new circumstances (Marquand, 1999: 10; Clift, 2001a: 55). As a result, it is perhaps not surprising that each bout of revisionism or renewal (depending upon one’s viewpoint) generates fierce debate – as illustrated by the controversy surrounding discussion of the ‘third way’. The contemporary concept of the Third Way relates to the manifestation of a ‘new’ form of social democracy that is partly defined by contrast to a ‘traditional’ social democracy that has arguably lost its relevance and/ or policy potency. As previously noted, this fact alone is not extraordinary, since all new social democratic strategies share the presumption that new external constraints rendered traditional strategies ineffective, and therefore new policy instruments and/or strategies had to be developed in order to maintain effectiveness and to meet new challenges (Przeworski, 2001: 312). What distinguishes the contemporary identification of Third Way from previous examples is the fact that it involves a middle way between neo-liberalism and social democracy itself, or at least its more traditional forms (Freeden, 1999; Tsakalotos, 2001: 38). The Third Way is, therefore, not seeking a radical middle ground between revolutionary and non-revolutionary forms of transformative socialism, nor even taking a centrist position between the extremes of communism and capitalism, but rather shifting the ‘new’ version of social democracy towards (but not equating with) neo-liberalism. It is important to bear in mind that the Third Way approach is a practical phenomenon, developed to solve perceived problems from a centre-left perspective, and not derived from an established theoretical perspective. As a result, it is not surprising that such approaches vary from country to country, which makes it difficult to develop a unified theory. Nevertheless, there are sufficient elements that all variants share, to enable them to be encompassed within a common definition that embodies elements of a common strategy.

One third way or several? The past decade has witnessed the development of a ‘new’ form of social democracy, which may be distinguished from a more ‘traditional’ version due in part to a number of philosophical differences, but predominantly because of its acceptance of many tenants of neo-liberal economics. This ‘new’ social democracy has perhaps been most notably identified with the fortunes of President Clinton in the USA and New Labour in Britain. In terms of the latter, responding to a devastating electoral defeat in 1983, involving ‘an internationally unprecedented collapse in the popular support for the main left-of-centre party’, a ‘modernising’

6 Third Way Economics

faction sought to re-orientate the Labour Party towards its vision of a European social democratic party (Gould, 1998: 20–22). For the modernisers, the ‘project’ involved the rejection of contemporary support for unilateral nuclear disarmament, withdrawal from the European Community, public ownership and an active fiscal policy associated with a Keynesian strategy rejected as inflationary and problematic to implement due to the consequences of globalisation. The modernisation rationale was based upon a simple thesis: Labour lost the twentieth century and allowed the Conservatives to govern for seventy of the last hundred years because it failed to modernise; it forgot the people that it had been created for. It took the modernisers to save the Labour Party. (Gould, 1998: xii) In its place, New Labour would create ‘a dynamic capitalism’ whose benefits were experienced by all citizens (Rustin, 2001: 15). The remodelling of the British Labour Party borrowed significantly from the changes that had been introduced in other progressive political parties. The primary influence was derived from the experience of the Clinton presidency of the USA, and in particular by his reinvention as a ‘New Democrat’ following the Republican electoral successes in the 1994 congressional elections (Pollin, 2001). Borrowing elements of his analysis from the Republican critique of ‘big government’ and their ‘contract with the people’, Clinton accepted the case that a New Deal social contract, based upon the co-operation of the ‘big institutions’ of state, big business and trade unions, was no longer sustainable (Corera, 1998; Meerpol, 1998; Baer, 2000; Weir, 2001). In its place, government should seek to create the conditions facilitating innovation, investment, education and training, in order to promote growth and productivity, and thereby provide jobs, rising incomes and a degree of security within a global economy (Giddens, 2000: 2). This strategy encompasses the reform of the welfare system, promoting work rather than passive receipt of benefit transfers, together with fiscal conservatism and the abdication of monetary policy to the Federal Reserve and its charismatic chairperson, Alan Greenspan (Green and Wilson, 2000: 428). The interaction between New Democrats and New Labour facilitated the portrayal of their (largely) shared political philosophy as the core elements in a hegemonic shift in international progressive political economy. Ideological similarities were reinforced by personal links, as central British policy advisors (and later MPs) such as David Miliband

What is the Third Way? 7

and Ed Balls had studied at MIT and Harvard respectively, and maintained close relationships with their American counterparts Larry Summers and Lawrence Katz when they were appointed to key positions within the Clinton administration (Arnold, 2000; Purdy, 2000: 184). The Third Way thus became the ‘brand name’ for this type of social democracy (Baer, 2000: 258–259). The Third Way has additionally become linked with the Australian Labor Party (ALP) administrations, which governed between 1983 and 1996 under the leadership of Hawke and Keating. Their programme emphasised the deregulation of the economy in response to the challenges raised by globalisation, the adoption of non-accommodatory fiscal and monetary policies, and targeting of welfare expenditure in the attempt to promote work incentives. Consequently, they may be considered to have been a precursor of the form of ‘new’ social democracy that subsequently developed in North America and Europe. However, unlike the Anglo-Saxon Third Way model, the ALP predicated their approach, at least in its early phases, upon the negotiation of wage restraint via a corporatist ‘Accord’ with organised labour (Harcourt, 2001: 201). This brief overview of distinctive approaches tend to accord with Pierson’s (2001: 129) observation that the Third Way is typically presented with ‘a peculiarly Anglophone provenance’. Nevertheless, this is to downplay the significance of similar changes and debates occurring throughout other social democratic-progressive movements, particularly in Europe. Other examples of social democratic parties adopting elements of Third Way strategy include the Spanish socialist government, 1982–1996, based upon an orthodox economic programme; the Greek Socialist Party (PASOK), whose economic programme shifted from Keynesian to a more orthodox policy stance; and elements of Italian left-of-centre coalition governments in their combination of labour market deregulation, privatisation programmes and orthodox economics (Ferreiro and Serrano, 2001; Graziani, 2001; Skouras, 2001). A Third Way mode of rethinking social democratic strategy is associated with the reform programme championed by German Chancellor Schröder, and which is expressed within the German Social Democratic Party (SPD) ‘Innovation and Justice’ (Innovation und Gerechtigkeit) programme. Moreover, Schröder and Blair published a joint paper entitled Europe: The Third Way – die Neue Mitte, which advanced a general framework for social democratic parties within Europe (Blair and Schröder, 1999, 2000, 2003). Elements of the Third Way are similarly found within the ‘Strong and Caring’ (sterk en sociaal) programme adopted by the Dutch Labour

8 Third Way Economics

Party (PvdA). Finally, the Persson administrations, in Sweden, have been closely associated with Third Way policy innovation. Reich (1999a: 46) views the spread of Third Way ideas as evidence of the evolution of a distinctive, relatively coherent form of social democracy. Clift (2004: 49) contends that a convergence between European social democratic parties has occurred around ‘new’ social democratic approaches. Similarly, Sassoon (1998: 92) finds evidence of ‘an unprecedented, Europe-wide convergence of the parties of the left’. The counter-hypothesis claims that ‘there will never be a single Third Way, but many Third Ways’ (Leonard, 2000: xx). Giddens (2000: 31, 2002: 1) distinguishes between five distinct versions of the Third Way: the market-orientated strategy pursued by New Labour in Britain; the German ‘Rhineland Model’ embodying a reformed version of the social market approach; the Dutch ‘Polder Model’ embracing both market and consensual negotiation; the reformed welfare state route in Sweden, which retains far greater continuity with previous social democratic policy and the traditional state-led programme preferred by the French socialists. Thus, although other centre-left parties tend to approximate in their policies to one or other of these positions, the significance of national contexts ‘engenders enduring and significant differences between these “sister” parties’ (Clift, 2001a: 71). One significant factor underlying continued divergence focuses upon the range of conceptions of the implications of globalisation for the commitment of social democratic movements towards egalitarianism, full employment and the role of the state (Clift, 2004: 49). One indication of this may be found in the fact that, despite a degree of convergence in macroeconomic policies in European nations towards neo-liberalism, a number of key, prominent European social democrats still emphasise the potential role for Keynesian demand management, at both the national and European levels. France and Germany have proposed macroeconomic co-ordination and active aggregate demand manipulation, based upon a form of ‘Euro-Keynesianism’, despite the scepticism of more orthodox governments, including New Labour. Similarly, if social democrats perceive the impact of globalisation as something other than a benign and/or irresistible force, they might become increasingly attracted towards the introduction of innovative forms of the regulation of financial capital, rather than reforming their national economy to adapt to, and promote, the further intensification of international financial integration. The practical expression of Third Way ideas depends upon other ‘deeply embedded national specificities’ (Clift, 2004: 49). One key factor

What is the Third Way? 9

involves the nature of the electoral process, and primarily the propensity for social democratic parties to be able to form governments without the need for coalitions with other parties. Bergounioux and Lazar (1997: 7–8) noted that only the Portuguese socialist party, PASOK (the Greek socialists), and New Labour, out of all of the European social democratic parties, have a realistic expectation to govern without coalition partners. Coalitions involve bargaining processes, where favoured policies are traded-off against one another, and the resultant programme of government represents a compromise solution. Political parties are affected by the nature of competition with potential coalition partners (Clift, 2001a: 58), whether they are located on the Left of the political spectrum, like the Greens (as in Germany and France), former Communists (as in Italy and Sweden) and Communists (as in France), in the Centre (Germany, Italy, Sweden, Netherlands and Belgium) or representing Christian Democratic and/or Conservative viewpoints (Austria and Netherlands). Coalition government in and of itself does not necessarily imply weak government or the dilution of the particular brand of social democracy advocated in each country, as is demonstrated in the relative hegemony that the Swedish social democrats have achieved in their nation despite only having twice gained a majority of the votes in a General Election. Nevertheless, it is a further complicating factor for smaller European social democratic parties. Clift (2004: 36) summarises it thus: ‘continental social democracy’ encompasses a complex reality. Each socialist or social democratic party developed within a specific capitalist society, wedded to nation-states in various stages of democratic development, and conditioned by world wars and the scourge of Fascism. This national setting provides a set of laboratory conditions in which social democracy sought to deliver egalitarian commitments through full employment and extensive welfare states. Factors such as the nature of competition within the national party system, the financial relationship with the unions, the socio-economic structure of society, and the relative openness and competitiveness of the economy, all influence heavily the nature of each national social democratic project. The considerable variance across Europe and the alleged lack of clear principles for key policy areas have triggered a debate on the nature of Third Way politics (Schmidtke, 2002: 4). Nevertheless, it is possible to identify a set of policy initiatives that suggest an emergent core framework associated with Third Way (new) social democracy.

10 Third Way Economics

Although the specific programmes instituted by each of these individual parties are by no means identical, there is enough of a common theme at their heart to identify their distinctive contributions. A reaction to the external economic environment The Third Way, at its heart, is derived from the attempt to develop alternative strategies to pursue many (but not all) social democratic objectives, starting from acceptance of the proposition that a number of changes in the international economic environment, within which progressive programmes must operate, have fundamentally altered the probability of successful implementation of strategies governments can employ (Skouras, 2001: 181). These include, first, the increasing significance of globalisation, secondly, the (albeit contested) conviction that flexible-specialisation forms of production will increasingly supersede Fordism and, thirdly, the replacement of Keynesianism by neo-liberal hegemony. Third Way theorists share the perception that globalisation has undermined the attempts made by nation states to regulate and tax financial capital, trans-national corporations (TNCs), together with mobile, highly educated, managerial and professional employees. Financial market integration limits the ability of national economic autonomy, as perceptions of excessive fiscal expenditure generate fears of inflation and devaluation, and, irrespective of whether these expectations were in line with economic fundamentals, the economy in question would be likely to be penalised by rising interest rate risk premiums – a process likely to undermine economic growth. The perception of the financial markets, and the result of their subsequent actions, is likely to prove to be a self-fulfilling prophesy. The ability of the ‘electronic herd’ to discipline governments, corporations and trade unions is imposed through the cumulative effect of individual movements of physical and financial capital across the world, according to the norms established by the financial markets. Capital has increased its dominance over society due to the ‘disembedding’ of activities from constraints of time and space, whereby financial capital is instantly mobile and corporations can relocate their activities with a minimum of cost, and can therefore undermine the bargaining position of nationally located workers, suppliers and governments. As a consequence, globalisation is therefore viewed as ‘one of the key challenges for social democracy’ due to its limitation of national state autonomy, and is central to the analysis of the Third Way (Giddens, 1998a: 30–32; Arestis and Sawyer, 2001a: 5).

What is the Third Way? 11

This view of globalisation is not universally held, and many theorists propose that most of its supposed consequences are actually caused by other phenomenon, including changes from Fordist to flexible forms of technology (Przeworski, 2001: 330). Post-Fordism implies a shift away from mass production and consumption, machinery producing standardised goods being dedicated to long runs, and unskilled workers performing standardised tasks, and towards diversified markets, multiskilled employees operating flexible technology to produce diversified goods (Ohmae, 1990; Womack et al., 1990; Amoroso, 1998: 96; Driver and Martell, 1998: 43; Scholte, 2000: 222). This view emphasises the increasing importance for business of being able to respond quickly to shifting market conditions and product demand, when operating in a business environment characterised by uncertainty in market demand and technological developments (Piore and Sable, 1984; Gustavsen, 1986; Piore, 1986). Flexible organisation structures are considered to be superior to traditional highly integrated, hierarchical alternatives with the resultant emphasis placed upon micro-level labour market flexibility – that is management autonomy over the deployment of labour within the enterprise – and a lesser concern with macro-level national labour market efficiency. To the extent that such changes have occurred, many theorists have suggested that there is little room remaining for traditional social democratic policies (Taylor-Gooby, 1996; Pierson, 2001a: 127). Consequently, it is suggested that the state should evolve to become either a ‘Schumpeterian workfare state’ (Jessop, 1993, 1994b, 1995) or a ‘competition state’ (Cerny, 1990, 1997). Others, however, suggest that post-Fordism can sustain a variety of different regimes, including traditional forms of social democracy. Thus, the adoption of neoliberalism is not an inevitable consequence of these changes in the productive structure (Hay, 1999: 29). Indeed, many theorists argue that the universality of the mass production regime is questionable, and therefore the transformation in production regimes is overstated (Tolliday and Zeitlin, 1986; Williams et al., 1987, 1992; Hirst and Zeitlin, 1991). Advocates of the hyper-globalisation thesis claim that it has imposed limitation upon fiscal redistribution, whilst the threat of capital flight, in an increasingly integrated international financial system, has limited or ruled out a whole range of policies previously forming a central part of a social democratic-Keynesian economic strategy (Kitschelt, 1994; Arestis and Sawyer, 2001a: 5). It is suggested that two incidents exposed the eroding ability of Keynesianism to resist the wider implications inherent within globalisation, namely the cuts in public expenditure

12 Third Way Economics

imposed upon the British Labour Government in 1976 (Clark, 2001), and the abandonment of a Keynesian-socialist programme pursued by the Mitterand administration in France in 1983 (Hall, 1986; Keeler, 1993; Ross, 1996; Andrews, 2001). However, it is worth noting that Clark (2001) suggests that political rhetoric over-played the significance of this moment as representing a fundamental change in macroeconomic practice. Furthermore, Cameron (1996: 58) argues that the Mitterand government retained considerably greater policy options than suggested by later neo-liberal accounts of the episode, and that it changed policy primarily because of a change in the balance of power within the governing coalition, after protracted political struggle, rather than because it was forced to do so by external constraints. Nevertheless, on occasions, the accurate determination of an event is not necessarily as important as the popular perception of what happened, and in both of these cases the acceptance of the inability to sustain a national, Keynesiansocial democratic strategy certainly eased the rise of neo-liberalism to its present hegemonic status. The Third Way response to globalisation necessitates government intervention to ‘equip people to deal with the travails of the new risk society, in which stable employment and other traditional forms of job security can no longer be taken for granted’ (Corera, 1998: 14). This involves the provision of life-long education and training programmes that facilitate the adaptation of individual skills to a dynamic labour market, together with a modified welfare system providing portable benefits (i.e. pensions, health care) due to the necessity for frequent job changes. In addition, the Third Way strategy requires the creation of a favourable environment for transnational investment, whether through lowering general taxation, generation of a more flexible and highly skilled labour force, deregulation of the economy, providing monetary incentives to encourage inward Foreign direct investment (FDI) and so forth (Arestis and Sawyer, 2001a: 6). The freedom of action governments enjoy may have been reduced by globalisation, but autonomous action remains possible. Most investment is domestically financed, and even where FDI is a significant element of capital formation, it is more closely associated with access to profitable markets, access to skilled labour and the absence of economic and political instability, and is relatively insensitive to government policies in general. Similarly, although financial globalisation has increased the constraint upon economic policy autonomy posed by the likely reaction of investors to government policies, the factors determining capital flows are difficult to determine and often have multiple equilibria

What is the Third Way? 13

(Przeworski, 2001: 330). Under normal circumstances, a rise in interest rates should increase inward capital flows in search of higher returns. However, if it causes increased expectations of an imminent devaluation, it may have the opposite effect, circa the ejection of Sterling and the Swedish krona from the European Exchange Rate Mechanism in 1992. Nation states remain the most powerful actors in the international economy due to their ability to determine the conditions pertaining to economic activity within the boundaries of their territory. TNCs do not control territory, legitimate military force and nor do they have the ability to make laws or design the apparatus needed for their implementation. Governments have the ability to regulate economic activity and introduce taxation, such as a ‘Tobin tax’1, in the attempt to steer the behaviour of private economic agents. As a result, Giddens (1998a: 30–32) accepts the proposition that national government remains strong, has not been rendered impotent by globalisation, and retains the ability to impose its priorities upon global capital through transnational collaboration. However, supporters of the Third Way wish to utilise transnational regulation to maximise gains from increased trade and capital flows, in terms of a predicted enhanced rate of growth, optimum allocation of scarce resources, and facilitating the development of the Asian sub-continent, whilst limiting less palatable consequences such as increased unemployment and rising inequality. Thus, Giddens (2000: 159) argues that, ‘taking globalisation seriously means emphasising that democratisation cannot be confined to the level of the nation state’, thereby reinforcing support for supra-national institutions, such as the EU, to provide a focus for progressive response to globalisation. Rojas emphasises ‘the unparalleled advances of the past 30 years’ to substantiate his belief in the ‘enormous potential’ of the global economy to alleviate underdevelopment, and that therefore government policy should be to ‘transform more and more countries into dynamic parts of this expansive economy’ (Rojas, 1999: 12). Instead of opposing further extension of globalisation, Third Way proponents suggest that supranational authorities could concentrate upon the surveillance of financial transactions, to prevent destabilisation caused by excessive capital flows, together with the provision of international liquidity to facilitate the expansion of the world economy (Giddens, 2000: 126–127). Pro-market philosophy and the restricted role of the state The Third Way takes a markedly different approach to the role and scale of the state than traditional social democracy, which has generally favoured its expansion into social and economic matters in order to

14 Third Way Economics

create new policy instruments and thereby more efficiently enact social democratic strategy. The state has therefore been viewed as the principle instrument for the redistribution of income and power, the regulation and taming of capital, together with the ability to better manage the capitalism to produce full employment, rapid growth economy (Padgett and Paterson, 1991: 49). Neo-liberal critics of the ‘big state’ have argued that it has become too impersonal, threatens individual liberty and is less efficient than market forces. Consequently, state activities should become limited, and its size dramatically reduced, in order to free resources for more efficient market allocation. In this debate, Third Way theorists adopt a position closer to the neo-liberals, in that they favour reconstruction of the state in order to create ‘the state without enemies’ (Giddens, 1998a: 70). This approach shares with the neo-liberals their criticism of an overexpansion in state power leading to moral hazard, dependency, reduction in incentives, bureaucracy, ‘clientism’, fiscal irresponsibility, a tendency towards authoritarianism and a lack of accountability, even potentially corruption and fraud. As a result, Third Way literature promotes the idea of freezing at its present level, or reducing, the scale of the state through engineering a decline in the ratio of public expenditure as a proportion of GDP (Giddens, 2000: 7; Arestis and Sawyer, 2001a: 6). In place of the ‘strong state’, Third Way philosophy relies upon an optimistic conception of the ability of the civil society to act as a ‘self generating mechanism of social solidarity’, and in the process reducing the need for the state to form a conduit for corporatist frameworks (Giddens, 1998a: 11). Nevertheless, this does not imply a total disregard for the state to play a positive role in the new Third Way economy (Rustin, 2001: 22). Indeed, the state is expected to swap its activist Keynesianism for a role as a ‘social investment state’, providing education and training programmes in order to enable individuals to gain the skills and abilities they need to successfully compete in the global labour market. Redefining education and labour market policies as human capital investment narrows conception of the benefits arising from this expenditure, but it does provide a financial case for certain types of increased spending. By inference, however, it condemns other areas of public provision to a continual tightening of resources and cutback in provision in the absence of hard-won productivity gains. Similarly, the reform of the welfare state is intended to strengthen a drive to get people into work, by increasing incentives, and thereby reducing social

What is the Third Way? 15

exclusion (Tsakalotos, 2001: 39). Giddens (2000: 6) describes this change in emphasis as one where ‘the state should not row, but steer: not so much control, as challenge’.

Macroeconomic strategy The economic strategy advocated by Third Way theorists involves a rejection of the Keynesian policies required to pursue full employment, and their replacement with an ‘iron commitment to macroeconomic stability and financial prudence’ (Routledge, 1998: 222). Government no longer utilises all of the economic policy instruments under its control in order to pursue multiple objectives simultaneously, the most important of which being to maintain the full employment of all resources in the economy. One additional feature of the Third Way approach is a marked preference to discuss targets of ‘high’ rather than full employment. Indeed, Giddens (1998a: 126) rather pessimistically suggests that this may be a rational response to his perception that global capitalism no longer generates sufficient work to accommodate a full-employment strategy. Instead, it seeks the creation of a stable framework for business activity, implying price stability having become the new principle goal of economic strategy (Gould, 1998: 244; Tsakalotos, 2001: 33). Government activism is restricted to supply-side policies aimed at improving the ‘employability’ of the unemployed and thereby enhancing their capability to compete for jobs created in the new flexible labour market (Blair, 1998d; Finn, 2000: 386). The Third Way economic programme is built upon the acceptance of a number of theoretical positions, either consciously or in ignorance of the finer points of the economic literature. For example, the replacement of full employment by low inflation as the principle goal of macroeconomic strategy, together with a passive fiscal stance and the detachment of monetary policy from a co-ordinated policy stance, suggests an acceptance of the natural rate of unemployment hypothesis. This holds that unemployment is ultimately determined by structural factors, such as the wage flexibility of the labour market, rather than the result of aggregate demand. Thus, the Phillips curve trade-off between lower unemployment and higher inflation is rejected, with the inference that governments which seek to lower the unemployment rate below the natural rate can do so only temporarily and at the cost of faster rising prices. Hence, the policy solution is for governments to deflate the economy to lower prices, since market clearing theory will have at worst only a temporary impact upon output and prices, because these

16 Third Way Economics

are determined in the labour market, not by aggregate demand. Unemployment should instead be tackled by measures such as reducing the generosity of benefits and the length of time they are paid, introducing inspection regimes upon the economically non-active – to help reduce job search time and deter fraud – reduce the power of unions to push up wages and hence increase unemployment, together with the introduction of tax incentives for low-paid work, and so forth. This is a theoretical and policy stance associated with the monetarist and New Keynesian schools of economics – the latter representing a synthesis of neo-liberalism and elements of Keynesian policy activism in the short run. This is a position that causes most post-Keynesians to regard New Keynesianism as ill-defined and not forming part of the body of thought associated with Keynes, Kaldor, Robinson and Kalecki. Fiscal policy Fiscal policy becomes a largely passive economic instrument under the Third Way, ensuring that a tight control is kept upon public expenditure. This is kept constant in real terms such that it declines as a proportion of national income as the economy grows. There is no concept of the need for management of aggregate demand, either through a process of ‘fine tuning’ or even ‘coarse tuning’. The Third Way approach is therefore based upon the Say’s Law hypothesis, assuming that the economy always tends towards the full employment of its resources because economic activity is set by the supply side of the economy and the level of effective demand adjusts to the appropriate level. This view holds that the economy is relatively stable and any shock, which does cause a temporary deviation from full employment equilibrium, will be self-adjusting through price flexibility rather than via variations in output and employment. Consequently, the budget should be balanced over the economic cycle, and counter-cyclical policy is not required, save for the operation of automatic stabilisers during a temporary downturn in activity. Monetary policy Monetary policy is dedicated to meeting the new prime objective of price stability, rather than undertaking a more balanced role in stabilising the domestic economy, complete with full employment and a favourable rate of growth. Moreover, there is an increasing tendency, particularly within EU member states, to transfer monetary policy into the hands of an independent central bank (CB). The motivation behind this policy initiative was advanced by a relatively new development in the literature

What is the Third Way? 17

which purports to demonstrate that, removed from government control, central bankers can and will be successful in targeting lower inflation (Rogoff, 1985). However, there is a considerable danger in placing one of the most important macroeconomic policy instruments into the hands of central bankers, whose preferences are likely to be more ‘conservative’ in terms of their preference for very low rates of inflation irrespective of the impact upon growth rates and unemployment. The evidence supporting this change is statistically weak, and there is almost as much data to predict that independence would result in relative economic stagnation (Cukierman, 1992; Posen, 1995). Labour market programmes The supply-side orientation of Third Way policy places great emphasis upon the labour market, in terms of reducing unemployment and ensuring that wage formation is consistent with low inflation targets. This approach concentrates upon increasing the incentives to work, through time-constraining benefit entitlement and transferring the emphasis to minimum wages paid in employment, together with enhancing the skills and abilities of individual workers. It ignores the major contribution played by aggregate demand, and the evidence that employment is directly associated with productive capacity. This is due to the adaptation of these policy proposals from within a neo-liberal framework, when the level of employment is assumed to be determined by Say’s Law. This proposes that supply will create its own demand, as opposed to the Keynesian concept of government intervention typically being necessary to prevent demand deficiency resulting in unemployment and productive capacity laying idle. Consequently, the Third Way strategy is based upon a non-Keynesian theoretical base – one that roots all the problems of unemployment, a poor level of investment and industrial growth, low growth rates and social inequality, as originating within the labour market. One Third Way solution involves the re-skilling of the labour force, through an expansion in educational and training programmes to make the unemployed more employable. Much of this analysis is based upon the work of Richard Layard, who argued that the main thing that determines the number of jobs is the number of employable people in the economy rather than adjusting the level of aggregate demand. Furthermore, a more educated pool of labour, better fitted to the job vacancies being advertised, reduces supply bottlenecks in the economy and thereby lessens the inflationary pressure generated by employers raising wages to attract scarce labour. It focuses upon the problems of

18 Third Way Economics

long-term and youth unemployment, in addition to seeking to curb tendencies towards ‘Eurosclerosis’, whereby an overdeveloped welfare state reduces incentives to work and hence is associated with rising unemployment and falling rates of growth (Nickell, 1997; Siebert, 1997). As human capital is regarded as the major driver of economic growth in the information age, this element of Third Way thinking is in line with the new endogenous growth theories, which claim to have found evidence that long-term economic growth rates are closely associated with a nation’s combination of both physical and human capital. Therefore, educational expenditure should make a positive contribution towards enhancing the growth rate (Harcourt, 2001: 215). The welfare state should, then, be reconstituted into a ‘social investment state’ precisely for this purpose (Giddens, 2000: 52). Retraining programmes can help to reduce a skills mismatch, but are powerless to correct demand deficient unemployment, which the European economy has arguably been suffering for over a decade (Arestis and Mariscal, 1997; Stockhammer, 2004a). Thus, Solow (1998: 30–31) claims that, in the absence of near full employment, retraining programmes may result in the retrained unemployed competing with low-skilled workers in employment, leading to a fall in related wages and may, therefore, encourage employers to replace semi-skilled workers with the now more competitive, less skilled alternatives. Industrial relations It is difficult to identify a distinctive Third Way approach to industrial relations. Concertation and wage bargaining co-ordination remain significant features of many European member states. Others have experienced a degree of decentralisation of wage bargaining. Whilst other nations have a markedly firm- or individual-centred approach to wage formation. Moreover, even within specific national programmes, dualistic tendencies can be noted. For example, New Labour emphasises the notion of social partnership between employers and trade unions, together with adopting the EU minimalist social dimension, yet simultaneously they champion the deregulation and flexibilisation of the labour market. This dualism may be at least partly explained by the clash between the remnants of previous ‘old’ Labour policy and a predominantly neo-liberal New Labour programme (Undy, 1999: 333). Thus, the New Labour strategy may be far more neo-liberal than the trace elements of a previous policy stance would make it seem, at first glance.

What is the Third Way? 19

Social policy reform The Third Way approach to social policy centres upon the belief that employment is the only secure and sustainable means to social inclusion (Rustin, 2001: 20). It concentrates upon the expansion of individual opportunities, which can be maximised through work and a programme of continual re-skilling, rather than the redistribution of income and wealth. It promotes equality of opportunity, but says little about the inequality of outcomes and the obstacles within society preventing many from taking full advantage of the opportunities on offer (Faux, 1999). Social policy reform is perceived as providing a potential contribution towards the Third Way work-centred programme through a reduction in the level of payment and duration of unemployment benefits, together with an improvement in take-home income when in work. Layard et al. (1991) found that these features were associated with higher unemployment, through a reduction in work incentives. Moreover, Giddens (1998a: 122) suggested that high levels of unemployment are linked with the provision of ‘generous benefits that run on indefinitely and to poor educational standards at the lower end of the labour market – the phenomenon of exclusion’. Consequently, Third Way policies tend to include an element of benefit reduction – whether through the British government’s practice of uprating in line with prices and not average wages, or through actual cuts in entitlements. Hence, increased reliance upon national minimum wages, together with the introduction of tax credits modelled upon US precedence, has tended to provide greater incentives for individuals and families to seek employment, even if it is low skilled and low paid (Arestis and Sawyer, 2001b: 52–56). Undy (1999: 332) argues that this second element, namely the targeted schemes to boost the disposable income of low-paid workers, distinguishes the Third Way strategy from neo-liberalism. The development of the welfare state was one of the proudest achievements flowing from traditional social democracy. Indeed, utilising a concept most closely associated with T.H. Marshall, the welfare state has been presented as part of a gradual extension of citizenship rights from legal and political rights to social and ultimately economic rights (Marshall, 1963). In this regard, the welfare state decommodified labour and thereby provided individuals with enhanced choices about how to live their lives (Esping-Andersen, 1990). Giddens (2000: 103), however, argues that this approach has become unsustainable, both in terms of cost and fundamental concept. Welfare programmes create dependency and introduce moral hazard through the provision of perverse incentives (Giddens, 1998a: 115). Therefore, instead of seeking to insulate and protect

20 Third Way Economics

individuals from the consequences of market mechanisms, the Third Way aims to enhance the position of individuals within the global market system. Achieving fundamental reform of the welfare system is not easy to achieve due to the reliance of entrenched interest groups upon welfare transfers. However, Giddens (2000: 104) points to the development of new social tensions, including taxpayer resistance to further growth in public expenditure, differences between generations relating to the generosity of the welfare system and conflict between those who benefit from the system and those who are net contributors, all of which increases the possibility of forming coalitions for reform. For example, New Labour Prime Minister, Blair claims that with more than £50 billion currently allocated through social transfers to people of working age, his ‘greatest challenge’ will involve the ‘welfare to work’ programme, which aims to ‘refashion our institutions to bring the new workless class back into society’ (cited in Finn, 2000: 388). One obvious consequence of the Third Way approach to welfare reform relates to the impact this is likely to have upon the distribution of income. Measures to increase employability and the provision of minimum wage legislation have equalising effects upon the national distribution of income, whilst the promotion of low-paid jobs, reduction in benefits relative to average wages and displacement of progressive by indirect forms of taxation, all have regressive effects (Atkinson et al., 1996: 225–256). In the absence of progressive income redistribution, Tobin (1999) states that ‘one generation’s inequality of outcome is the next generation’s inequality of opportunity’. European integration The Third Way strategy amongst European economies is identified closely with the process of European integration. Part of the reason for this is due to the neo-liberal foundation that has been established for the single internal market (SIM) and economic and monetary union (EMU) that are forming the basis for the ‘new’ European economy (Whyman, 2001). In particular, the Stability and Growth Pact (SGP) maintains and reinforces the convergence conditions created to ensure fiscal conservatism amongst potential EMU participants, and which has contributed to a decade or more of economic stagnation across the majority of the European continent (Holland, 1995; UNCTAD, 1996). The policy framework embodies a distrust of politicians to successfully manage economic policy, so that the supranational European Central

What is the Third Way? 21

Bank (ECB) has been created wholly independent of all democratic influence and/or control, and there has been no comparable European Ministry of Finance created to counter its dominance over the European economy. The ECB’s sole policy objective is price stability, which it defines within a range of 0–2 per cent, and the bank is instructed to avoid all consideration of other factors, such as employment and growth, if these detract from meeting this objective. Thus, there is no balanced portfolio of macroeconomic goals established for the new Europe, only the monetarist preoccupation with low inflation, assuming a natural rate of unemployment and the policy ineffectiveness of Keynesian counter-cyclical intervention. Tsakalotos (2001: 38) argues that the EU macroeconomic strategy should not be considered to be a purely neo-liberal approach due to its championing of the social chapter and the fact that social partnership in the industrial relations sphere has been retained in many member states. However, these facts are equally consistent with the proposal that the economic stance is inherently neo-liberal, but that the social policy advocated by the EU Commission enhances the primacy of federal determination over wider areas of formally national policy, and with it the role and importance of the Commission itself. The social chapter is, at best, a minimalist construction, whose operation is in many respects in contradiction to the overall neo-liberal economic structure created at Maastricht (Whyman, 2001). Moreover, the social partnership maintained by many nation states is restricted to ensuring a social consensus for contentious cuts in welfare programmes, due to the requirements of the SGP, and/or the moderation of real wages to facilitate a transition to EMU. Furthermore, suggestions that the EU might provide the necessary economic muscle to introduce a form of EuroKeynesianism is neither very likely within the present institutional arrangements, and nor is this an example of Third Way thinking, because advocates of this initiative are more readily associated with ‘traditional’ forms of social democracy.

Critique of the Third Way The Third Way has attracted a considerable amount of criticism. For example, Faux (1999: 75) describes it as ‘an intellectually amorphous substance’ with parameters ‘so wide that it is more like a political parking lot than a highway to anywhere in particular’. The Economist (1998: 49) remarked upon its ‘fundamental hollowness’, whilst Hall (1998) dismissed it as ‘the great moving nowhere show’. Rustin (2001: 13)

22 Third Way Economics

suggests that the version of the Third Way being developed by New Labour in Britain was initially a concept discussed by political strategists, before only latterly being provided with any theoretical foundation. In practice, he claims that this has provided a political platform, which closely mirrors the failed agenda associated with the now defunct SDP of the 1980s. Marquand (1998: 19) agrees that it is ‘patently not socialist . . . not even social democratic or social liberal’. Ryan (1999) claims that the approach contains little original analysis, as it adopts many ideas from the form of ‘New Liberalism’ that existed in Britain at the beginning of the twentieth century. Furthermore, Green and Wilson (2000: 428) suggest that it is intended to ‘legitimate a seismic shift in social democratic policy towards neo-liberalism’. This viewpoint is disputed by White (1998: 18–21). He claims that, although it is vague in terms of detailed analysis, the Third Way strategy combines individual opportunities and civic responsibility in such a way that it promotes an ‘asset based egalitarianism’. Finally, Giddens (2000: 22–25) cites criticisms that the project is ‘amorphous’, lacking direction, ignores environmental issues and has no effective economic programme apart from an uncritical adoption of neo-liberalism and the promotion of marketisation. Power and social class One powerful criticism of the Third Way approach is that it is too accepting of the existing structures of power within capitalist society, and that it appears to consider that there are few (if any) conflicting interests which cannot be reconciled (Hall, 2003: 84). Marquand (2003: 84) states that ‘. . . the Third Ways discourse . . . is disconcertingly devoid of any sustained reference to power’. For example, Giddens does not allow for the market being a principle means of widening social inequality (Finlayson, 1999: 76). Moreover, the fact that the Third Way prefers to focus upon social exclusion rather than inequality represents a limitation of analysis and a reduction of traditional social democratic objectives (Tsakalotos, 2001: 41). In addition, it also ignores the Kaleckian argument that capitalism may be incompatible with sustained full employment in the absence of corporatist-institutional reform, due to the fact that tight labour markets empowers labour, reduces the impact of industrial discipline and is likely to be opposed by organised capital (Kalecki, 1943; Henley and Tsakalotos, 1993). Giddens’ (2000: 37–38) counter-argument states that ‘the struggle to sustain and extend democratic mechanisms, control corporate power, and protect cultural minorities is fundamental to the third way, as it

What is the Third Way? 23

has been to previous forms of social democracy’. However, this point sits awkwardly with his later argument, that: The division between left and right reflected a world where it was widely believed that capitalism could be transcended, and where class conflict shaped a good deal of political life. Neither of these conditions pertains today. (Giddens, 2000: 39) Wood (2001: 49) argues that the Third Way has adopted a ‘benign view of social organization’ that contrasts with both traditional social democracy and neo-liberalism, because as the former emphasised class conflict and neo-liberalism atomistic individuals, the Third Way is based upon the notion of ‘individuals laden with both rights and responsibilities to communities’. Crouch (2001: 106) suggests that New Labour views concepts of class conflict as ‘old-fashioned’ and claims to have transcended a society stratified by classes, with fundamentally antagonistic interests engaged in zero-sum conflicts over the distribution of resources. Instead, its preference is to visualise society to be comprised of communities of mutual dependence, where consensus can be reached to pursue mutual interests simultaneously. However, this stance is criticised as naive or duplicitous. Hutton (2003: 118) argues that this element of the Third Way has enabled the state to reduce its social obligations and shift burdens onto ‘those least able to bear it’. Similarly, Crouch (2001: 106) notes that the globalised, deregulated economy has facilitated greater capital autonomy, whilst simultaneously organised labour has become increasingly fragmented and lost a degree of coherence. Indeed, Crouch (2001: 106) claims that ‘this is not a transcendence of class conflict but a particular turn in its development: a forceful reassertion of the dominance of one class’. Economic democracy The Third Way places great emphasis upon an active civil society providing a viable constraint upon the power of both markets and governments (Giddens, 2000: 64). However, Marquand (1997: 336–338) suggests that this vision is notably narrower than the traditional social democratic promotion of ‘citizen empowerment’, in that: The citizenship ideal is one of participation, activity and selfdevelopment and, by the same token, of accountability, transparency and scrutiny. Good citizens debate, argue and question; they don’t simply accept what is handed out to them. And they cannot switch

24 Third Way Economics

off their citizen selves when they go to work. That, of course, is what the early social democrats meant by social democracy. A democracy confined to the political sphere was no democracy; it had to embrace the social sphere as well. Citizenship was indivisible. In addition, the Third Way project has little or nothing to say about the traditional social democratic demand for economic democracy; in other words, extension of democratisation from the social to the economic sphere of activity (Tsakalotos, 2001: 41). The promotion of employability as a means of empowerment of individual workers in the global labour market is an individualistic and distinctly different concept to the previous social democratic notion of economic citizenship through collective organisation and labour market institutions. Furthermore, the Third Way is almost completely silent upon the potential of social ownership to further social and economic goals associated with social democracy. Instead, government regulation of private sector corporations is the preferred option, based upon the neo-liberal assumption that private ownership will inevitably lead to greater efficiency. Is it social democracy? Giddens (1998a: 26) claims that the Third Way represents an attempt to ‘transcend’ neo-liberalism and ‘old-style social democracy’ by providing a ‘framework of thinking and policy-making that seeks to adapt social democracy to a world that has changed fundamentally over the past two or three decades’. Indeed, social democracy once provided an alternative to command communism and free-market capitalism, combining a concern for equality, social solidarity, social protection and full employment, with democratisation, economic efficiency, together with the combination of regulated capital and the social ownership and control of resources (Glyn, 2001: 3; Rustin, 2001: 12). However, Dahrendorf has subsequently announced the ‘end of the social democratic century’, whilst Giddens claims ‘the death of socialism’, and therefore that social democracy has lost its ability to transform society because ‘no one any longer has any alternatives to capitalism’ (Giddens, 1998a: 3, 43, 2000: 19–20). The rise of globalisation and subsequent decline of national economic self-management, together with the growth of post-Fordist production and with it the homogenised working class, have weakened the Keynesian-social democratic paradigm. Uncertainty arises concerning whether traditional social democracy methods retain the ability to deliver desired objectives. However, the solution advanced by

What is the Third Way? 25

the Third Way is to reject those traditional goals it cannot in any case achieve because of the inadequate policy instruments instigated according to its neo-liberal foundations. Thus, full employment becomes regulated to a long-term aspiration, equality is restricted to opportunity and not outcome, whilst social policy is defined in terms of reducing social exclusion through the promotion of low-paid employment opportunities. The democratic control over a citizen’s own life has become a non-issue, with even the democratic control over national macroeconomic policy reckoned to be suspect due to acquiescence to capital mobility and acceptance of the EU’s neo-liberal economic regime. Indeed, Arestis and Sawyer (2001b: 58) claim that the macroeconomic stance pursued by leading Third Way regimes, including the New Labour government, can be perceived as the ‘final triumph of (new) monetarism and the defeat of Keynesian economic policies’; at least, if not challenged by a renewal of the post-Keynesian-social democratic synthesis. Therefore, it is an interesting question as to whether the Third Way approach is really a modernised version of social democracy, or a new phenomenon, more closely related to classic political liberalism. This is one of the questions that this book will seek to answer.

Note 1. For further discussion, see Chapter 9.

2 A Response to Globalisation

Introduction One of the most notable features of the Third Way approach relates to its repeated insistence that an increased internationalisation, or globalisation, of the world economy has created a new environment within which progressive-social democratic actors need to adapt traditional programmes to remain relevant and arrest a perceived decline in the efficiency of their preferred policy instruments. Commentators on the future developments in management theory and practice have popularised the perception of the existence of a ‘borderless world’ (Ohmae, 1990; Naisbitt, 1994), within which ‘the stateless corporation’ operates, relocating the location of production facilities with relative ease on the basis of calculations that optimise profits and productivity (Holstein, 1990). For example, in The Work of Nations, Reich (1992: 136–168) argues that the complex inter-connected elements of TNCs make its ‘ownership’ largely irrelevant. This picture is reinforced by those critics of these developments, who claim that global corporations de facto rule the world (Barnett and Cavannagh, 1994; Brecher and Costello, 1994; Korten, 1995). Thus, it is claimed that globalisation has transformed economic activity, through the transformation of the strategic, organisational and operational corporate behaviour (Porter, 1990; Bleeke and Ernst, 1993; Taylor and Weber, 1996). Technological advances that have produced cost reductions in transport and communications have facilitated the development of a light, information-knowledge-based, service-centred economy (Bell, 1973; Katz, 1988; Castells, 1989, 1996: 7; Carnoy et al., 1993; Bryson and Daniels, 1998). This has prompted a number of theorists to make some quite profound claims. For example, that the contemporary period is 26

A Response to Globalisation 27

experiencing a series of ‘new realities’, representing either the ‘first global revolution’ or a ‘third wave’ of human history, whereby the knowledge society is contrasted against ‘first wave’ peasant-agricultural and ‘second wave’ industrial predecessors (Toffler, 1980; Drucker, 1989; King and Scheider, 1991; Toffler and Toffler, 1994). This globalisation thesis involves acceptance that the increasing integration of financial markets, the rising importance of TNCs in global manufacturing production and their use of FDI to expand their control into an increasing number of national markets have created power challenges for those advocating progressive economic and political programmes. Borrowing from the terminology of Marxism Today, these ‘new times’ have, according to this viewpoint, weakened the ability of the nation state to regulate capital and utilise traditional economic policy instruments to secure traditional social democratic policy goals (Hay, 1999: 10). These include full employment, strong rates of economic growth, redistribution of income and power, social solidarity, the development of the welfare state, co-ordination of wage bargaining, regulation of the labour market and provision of public goods through the public sector. In essence, the globalisation thesis suggests that traditional instruments, even traditional progressive goals, are undermined by the free movement of capital, actions of the financial markets and economic realities of an increasingly inter-connected, competitive global economy. Therefore, progressive movements need to develop a new set of policies. The key question relates to whether the attempt is made to oppose and rollback the impact of globalisation or to embrace and adapt to the requirements of the global economy. Third Way theorists are relatively distinctive amongst progressive-Left economists in that they advocate the latter course.

Globalisation: A definition? Globalisation is quite possibly ‘the most contested concept in contemporary social science’ (Grant, 2002: 41), being ‘invariably over-used and under-specified’ (Higgott and Payne, 2000: ix). Indeed, the imprecision that often accompanies debate surrounding globalisation prompted Wiseman (1998: 1) to claim it to be ‘the most slippery, dangerous and important buzzword of the late twentieth century’, and beyond. There are many different definitions of globalisation. At its most fundamental, it refers to an evolving pattern of cross-border activities of firms involving international investment, trade and collaboration for

28 Third Way Economics

purposes of product development, production, sourcing and marketing. It involves an increasing flow of goods, services, technology and capital across national borders. The OECD (1996: 9) describes it as an ‘evolving pattern of cross-border activities of firms involving international investment, trade and collaboration for purposes of product, development, production and sourcing and marketing’. On a ‘micro’ level, Ruigrok and van Tulder (1995) discuss globalisation in terms of corporate strategies to establish a global intra-firm, in addition to inter-firm, division of labour. Hirst and Thompson (1996a) refer to a stronger version of the globalisation concept, involving the development of a new economic structure, where TNCs are the principle actors, and distinct national economies are subsumed into the global system. The fact that the present international system is characterised by a relatively high degree of interdependence among nations and societies, when measured in historical terms, is an insufficient definition of globalisation. The latter is denoted by the combination of the ‘transnationalisation of finance and production at the ideological level’ (Cox, 1993: 259–267; Bieler, 2000: 19). A broad definition of globalisation incorporates both the internationalisation of economic production and capital flows, the growing dominance of FDI and trans-national corporations (TNCs), together with a cultural aspect. It involves ‘the rise of global cultural flows and deterritorialise signs, meanings, and identities’ (Amin and Thrift, 1994: 4). Culture, according to this definition, includes corporate brands such as Nike, MacDonalds and Coca-Cola, alongside the global domination of Hollywood cinema productions. It influences perception and consciousness, modes of life and consumption patterns (Veseth, 1998: 26). It may be presented as a dynamic which facilitates the spread of the ‘structures of modernity’, focused around capitalism and rationalism, and in the process challenging pre-existing local cultures (Scholte, 2000: 16). Very often this aspect of globalisation is equated with ‘Westernisation’ or ‘Americanisation’, thus promoting a global ‘cultural synchronisation’ (Hamelink, 1983: 3; Tomlinson, 1995; Scholte, 2000: 23; Taylor, 2000). Others, however, have associated globalisation with the maintenance of, or an increase in, cultural diversity (Appadurai, 1990; Hannerz, 1992; Cable, 1994). Indeed, Barber (1996) argues that many groups have promoted national, regional and/or religious diversity as a specific reaction to the homogenising influence of ‘McWorld’. Thus, whether through universalisation or provocation of reaction, globalisation may be defined as the intensification of social relations

A Response to Globalisation 29

throughout the world, such that distant localities are linked and local events are influenced by factors occurring in distant lands. Giddens (1994: 4–5) makes the following point: Globalisation does not only concern the creation of large-scale systems, but also the transformation of local, and even personal contexts of social experience. Our day-to-day happenings are increasingly influenced by events happening on the other side of the world. Conversely, local lifestyle habits have become globally consequential. Globalisation is often linked with discussion of an ‘information society’, where the power and cost-effectiveness of communication has increased exponentially, and this facilitates the growth of global markets for products, specialised labour and especially financial assets (Giddens and Hutton, 2000: 1). The ‘dot-com’ revolution is a good example of this practice, whereby the Internet sites provide a new gateway to an existing marketplace, whether relating to the purchase of cut-price airline tickets, CDs or to the selling of shares. Call centres provide a similar service for those less computer literate, but at an equally rapid speed – at least, in so far as site capacity expands as quickly as consumer demand. The low cost of communications and transportation, as a proportion of the total cost of goods and services, facilitates the geographical diversification of corporation production (Rustin, 2001: 18). The ‘weightless economy’ further reduces transaction costs and thereby facilitates an expansion of global trade in commodities, whether products, services or information. Globalisation, then, relates to the multiplicity of interconnections between nations and societies, and describes the means by which phenomena occurring in one area of the globe impact upon the activities of individuals in a geographically distinct region. It therefore involves a spatial linkage, together with an intensification and interdependence between nations and social groupings. Globalisation produces a re-configuration of geography, causing social space to be defined in terms distinct from territorial places and independent of national borders (Scholte, 2000: 16). It incorporates the growth of international consumer markets in cultural, as well as consumer, products. Finally, the globalisation thesis infers a reduced role for national government policy, and an increased potential for surpranational economic regulation (McGrew and Lewis, 1992: 22).

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The evidence for globalisation Between 1970 and 1991, world gross domestic product (GDP) doubled, global exports nearly tripled in real terms and FDI quadrupled, with rates of real increase exceeding 25 per cent per annum during the latter half of the 1980s (UNCTAD, 1993: 17). In 1991, world exports of goods and services were valued at US$4 trillion, one-third of which was intra-firm trade, whilst exports represented approximately 19 per cent of global GDP (Lazar, 1996: 274–275). Furthermore, corporations are increasingly becoming global institutions – adopting strategies which transcend the influence of the small- and medium-sized nations of the world. Indeed, it is estimated that the largest 500 TNCs perform a majority of world trade. UNCTAD (1995) estimates that there are some 40,000 companies with headquarters in more than three countries; the hundred largest being responsible for turnover valued at US$1.4 trillion per annum. The combined output of these TNCs exceeds US$5.5 trillion and their share of international trade rises to two-thirds of the total, with almost half of this amount occurring internally and therefore not being subject to external competitive market pressures (Lazar, 1996: 274–275; Martin and Schumann, 1996: 112). Moreover, it has been estimated that the 15 largest TNCs have each produced annual sales figures exceeding the GDP of over 120 nations (Went, 1996: 18). The largest TNCs dominate many global industries. Thus, the five largest firms control 70 per cent of the consumer durables market, 60 per cent of air travel and the record industry, more than half of electronic components, steel, car and airline production, in excess of 40 per cent of market share in the oil, personal computer and media industries, and 30 per cent market share in insurance and chemicals, whilst the leading five accountancy firms dominate the profession across six continents (Harvey, 1995: 194; Korten, 1995). Global news provision is dominated by a handful of companies, whilst three providers control 95 per cent of the world’s credit card business and 75 per cent of global merger and acquisitions deals (Scholte, 2000: 129–130). Moreover, the top ten companies control 86 per cent of telecommunications, 70 per cent of computer sales and 65 per cent of the world semiconductor industry (Lang and Hines, 1993: 36; UNDP, 1999: 67). TNCs are one of the key driving forces of globalisation, as information technology and low transportation costs facilitate production becoming part of a unified process, co-ordinated across different regions of the globe. The aggregate stock of FDI was estimated to be US$180 billion in 1991 (Lazar, 1996: 274–275). The one hundred largest TNCs control

A Response to Globalisation 31

approximately half of global FDI, whilst the largest three hundred TNCs hold 70 per cent of FDI and up to a third of total corporate assets (Dunning, 1993: 15; Scholte, 2000: 130). However, FDI flows are different from trade flows in that they do not end with the initial transactions, but rather construct long-term relationships between economic agents in different locations. To take one example of this process, Asea Brown Boveri (ABB), the former Swiss-Swedish TNC, is truly trans-national, with one thousand subsidiaries in forty countries. This diverse production matrix enables output to be diverted from one plant to another within a short space of time, and therefore the corporation is less subject to the particular regulations of any one government or affected by instability within isolated parts of the world. Moreover, the fact that subsidiaries occur in more regions of the world is likely to have a depressing effect on the export trade of the ‘home’ nation, as the demand for their produce are fulfilled by the subsidiary in the ‘host’ nation in substitution for the original flow of exports. Thus, the evidence points to capital movements and trade flows evolving in opposite directions (Bairoch, 1996: 183–184). Alongside increases in FDI, there has been a substantial surge in foreign portfolio investment, taking the ratio of foreign assets relative to world GDP from 17.7 per cent in 1980 to 56.8 per cent in 1995 (Crafts, 2000: 27). However, the feature that perhaps most signifies a significant shift towards globalisation relates to the extraordinary expansion in short-term financial capital flows. Helleiner (2000: 54) claims that the globalisation of financial market during the last three decades represents ‘one of the most spectacular developments in the post-war global political economy’. Following the abolition of controls, the volume of international capital movements has increased exponentially. Since 1970, internationally managed money has increased by 1100 per cent globally, relative to other forms of capital (Giddens, 1998a: 36). Thus, disconnected capital has increased in volume and importance to the future stability of the world economy. The daily volume of trading across the major foreign exchange markets rose from around US$18 billion in 1977, at the height of petrodollar recycling, to $83 billion in 1983, $590 billion in 1989 and reached approximately US$2 trillion by 1999 (Cotty, 2000: 283; Watson, 2002: 205). This figure is approaching one hundred times the equivalent value of international trade, seven times the total world expenditure on crude oil and easily exceeds the world’s entire $1.5 trillion official gold and foreign exchange reserves. This represents a value one-third greater than the UK’s annual GDP (Eatwell, 2000: 349). The

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vast majority of financial market transactions are therefore speculative in nature, and have no relation to the real economy (Eatwell, 1995: 277; Watson, 2002: 205). This is a reversal of the situation in 1971, when 90 per cent of all financial transactions were made to facilitate international trade and long-term productive investment. The dominance of international speculation has resulted in a dramatic reduction in the timescale over which financial transactions take place, with less than 1 per cent of net global foreign exchange (FX) transactions have a maturity of longer than one year (Palley, 1998: 178–179). The low cost of undertaking financial transactions of this kind means that they are worthwhile even for very short holding periods and can prove profitable following only negligible fluctuations in exchange rates and/or asset prices. This substantial acceleration in currency trading has increased instability in exchange rates, tripling the monthly volatility of G7 exchange rates and producing far greater increases in volatility for developing nations (Eatwell, 1996: 38). Indeed, Clark (1999: 1) ironically notes that more money is traded on the world financial markets in six hours than has been lent by the World Bank during its entire history. Rapid increases in computer capacity have facilitated the growth of derivatives trading, which has grown so rapidly as to become almost completely autonomous. Derivatives have facilitated an extraordinary increase in potential financial trading through their ability to combine the values of any measure of monetary, actual or potential, and through time via futures markets. Indeed, some estimates calculate the market value of derivatives traded in 1996 at US$41 trillion (Martin and Schumann, 1996: 48–52). Other estimates place the figure to be US$360 trillion in 1997 (Castells, 2000: 54). To place the latter figure in context, it approximates to twelve times global GDP. This statistic illustrates the significance of the change in the nature of financial transactions, as between only 2 per cent and 3 per cent of the total value is intended to provide protection to international trade and industrial production. The remainder of the contracts are effectively a form of gambling between market transactors, with the advantage that only a small amount has to be put up as the original stake; the promised sum is only transferred when the contract is due, and by then most transactors will have limited any potential losses through offsetting contracts. However, the significance of this market lies in the fact that, divorced from the real economy, even small movements of capital lead to large price movements, such that transactors’ expectations become the driving force behind the market and acquire their own momentum. In this process, ‘the financial world has emancipated itself from the real

A Response to Globalisation 33

sphere’ (Martin and Schumann, 1996: 52–53). Futures markets, which were created to reduce the risk farmers and other producers faced when agreeing contracts in advance of delivery, due to fluctuations in currencies, raw materials of other costs, have been transformed itself into the type of ‘casino’ Keynes was so scathing about in his writings. Is globalisation new? The evidence presented in the previous section implies that globalisation is a relatively uncomplicated, empirical phenomenon, and one that has significant implications for social democracy in practice. However, this is not the complete picture. One mild critique of the globalisation thesis concerns the originality of the phenomenon, or whether it represents evidence gathered from one of the many peak periods within a series of periodic fluctuations. There is a growing literature that indicates that, proportionally at least, levels of international trade, migration of labour and international flows of investment capital were higher in the late nineteenth century than the comparable situation at the end of the twentieth century (Zevin, 1992; Hirst and Thompson, 1996b; Wade, 1996). One description of globalisation during the gold standard time period has a number of close similarities with contemporary experience of the phenomenon. Thus: What an extraordinary episode in the economic progress of man that age was which came to an end in August 1914 . . . the inhabitant of London could order by telephone, supping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonable expect their early delivery upon his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprises of any quarter of the world and share, without exertion or even trouble, in their prospective fruits and advantages . . . He could secure forthwith, if he wished it, cheap and comfortable means of transit to any country or climate without passport or other formality, could dispatch his servant to the neighbouring office of a bank for such supply of the precious metals as might seem convenient, and could then proceed abroad to foreign quarters, without knowledge of their religion, language or customs, bearing coined wealth upon his person, and would consider himself most greatly aggrieved and much surprised at the least interference. But, most important of all, he regarded this state of affairs as normal, certain and permanent. (Keynes, 1920: 10–12)

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In terms of international trade, the UK’s trade accounted for 44.7 per cent of GDP in 1913, and after a dramatic decline between 1914 and 1945, it had only risen to 40.5 per cent by 1993. Similarly, France remains beneath its 1913 levels of openness (35.4 per cent), with Germany only narrowly surpassing its 1913 figure of 35.1 per cent by 3.2 per cent in 1993, and with Japan recording a sharp fall from 31.4 per cent per cent in 1913 to 14.4 per cent in 1993 (Bairoch, 1996: 176; Hirst and Thompson, 1996a: 60). Western Europe exported 18.3 per cent of its GDP in 1913, rising only slightly to 21.7 per cent in 1992, whereas the US exported 6.4 per cent of its GDP in 1913 and 7.5 per cent in 1992. The comparable figures for Japan demonstrated a fall in the importance of international trade from 12.5 to 8.8 per cent of its GDP (Bairoch and Kozul-Wright, 1996: 6). Thus, although the volume of trade has increased substantially over the seventy years covered by these statistics, the international economy does not seem demonstrably more open today than during the gold standard era (Hirst and Thompson, 1996a: 37–38). Capital mobility was a feature of the gold standard period, with one estimate calculating that the stock of FDI was around 9 per cent of global output in 1913 (Bairoch and Kozul-Wright, 1996: 10). Moreover, the growth in portfolio investment, particularly from France, Germany and the UK, exceeded expansion in output, and financed the industrial expansion of North America, Argentina, Australia, South Africa and Nordic European nations like Sweden. The UK exported an average 4 per cent of its GDP between 1870 and 1914, with the absolute annual figure having risen to an incredible 9 per cent of GDP by the end of the gold standard epoch (Hirst and Thompson, 1996a: 37–38). Taylor (1996) and Obstfeld and Taylor (1997) have estimated that capital movements represented 5.3 per cent of global GDP at the end of the gold standard epoch, whereas this figure averaged only 2.3 per cent of world GNP between 1989 and 1994. Thus, when compared to relative GDP, capital flows are smaller today than they were seven decades ago, indicating that perhaps capital markets are not as tightly integrated as is typically perceived (Rodrik, 1996: 4). One difference between the two time periods concerns the fact that most capital flows took the form of portfolio investment in 1913, rather than FDI, with the debt typically issued by governments and utilised to finance infrastructure investment, including railway construction, harbour development and telecommunications (O’Rourke and Williamson, 1999: 211–212). It is therefore plausible to describe the process of internationalisation as a recurrent historical trend, complete with alternating phases of globalisation and fragmentation that has been repeated on a number

A Response to Globalisation 35

of occasions in the history of the modern nation state (Clark, 1997). By contrast, other theorists propose the existence of a linear (not cyclical) trend towards increasing globalisation, but locate the emergence of the phenomenon anywhere from 100 to 500 years ago (Porter, 1986: 42; Chase-Dunn, 1989: 2; Robertson, 1992: 58–59). Other critics of the globalisation thesis dismiss much of the apparent evidence of increasing internationalisation, and rather emphasise the continuity of the global economy; either relating to the continued centrality of manufacturing industry (Cohen and Zysman, 1987) or through a Marxist analysis of the unchanging nature of capitalism (Magdoff, 1992; Chesnaid, 1994; Amin, 1996; Marshall, 1996; Burbach et al., 1997; Berger et al., 1998: 9). The preceding analysis is not intended to substantiate a claim that the world economy is essentially similar to the period immediately preceding 1914. It is a profoundly different place. Indeed, one only has to drive to work, spend time accessing the Internet via a laptop computer and respond to urgent faxes and text messages on a mobile phone, to illustrate the point. Nevertheless, Hirst and Thompson (1996a: 37–38) note that the international economy is still dominated by the same handful of nations. Moreover, they point out that, to date, no major international trading and monetary regime has exceeded four decades, and therefore advocates of the globalisation thesis may suffer from a short memory if they do not appreciate the fact that periods of openness and growth have oscillated with periods of closure and decline. Consequently, it would be naïve to project the continuation of current trends as if this were an irreversible inevitability.

Globalisation, the state and progressive economic policy The evidence for an increase in international economic inter-connectedness does not, by itself, prove the globalisation thesis, because much of the available data can arguably sustain distinct claims of internationalisation and/or regionalisation of economies (Vandenbroucke, 1996: 10). In this context, internationalisation may be associated with the documented expansion of international trade and portfolio investment capital flows. However, its distinctive feature is that principal economic units remain essentially national (Hirst and Thompson, 1996a: 8–13; Petrella, 1996). In contrast, globalisation involves the transformation of production, as TNCs lose their former national identity, become truly footloose in terms of location of production and their international management owes no residual allegiance to the interests of any individual nation

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state. Governments find it difficult (if not impossible) to control global TNCs and thus the international economic system becomes relatively autonomous, subject only to minimal international regulation (Hirst and Thompson, 1996a: 1–11). Thus, globalisation should be associated with ‘macroeconomic unification’ (Glyn and Sutcliffe, 1992: 77). Hyper-globalisation The globalisation literature identifies three general reoccurring perspectives on the topic. The first, hyper-globalisation, claims that globalisation has profoundly altered the world economy and with it the potential for national economic policy (Perraton et al., 1997; Held et al., 1999). Theorists claim that markets have been globally integrated to the extent that firms and consumers can source products and services from multiple markets, whilst firms can produce from locations in multiple countries, thereby signifying that the very concept of a national economy is becoming meaningless (Ohmae, 1990: 172, 1993, 1995; Reich, 1992). Strange (2000: 269) claims that the authority of the nation states has ‘leaked away, upwards, sideways, and downwards’. The nation state is being ‘hollowed out’ by the ability for evasion of regulation together with a dramatic increase in capital mobility, particularly financial capital, which governments are powerless to control. Strange (2000: 270) expresses this viewpoint as follows; I am not arguing that states themselves are obsolete. Collectively they are still the most influential and therefore critical sources of authority in the world system. But they are increasingly becoming hollow, or defective, institutions. To outward appearances unchanged, the inner core of their authority in society and over economic transactions within their defined territorial borders is seriously impaired. They are like old trees, hollow in the middle, showing signs of weakness and vulnerability to storm, drought, or disease, yet continuing to grow leaves, new shoots, and branches. Some are clearly more defective in terms of their ability to play their roles in society, further advanced in decrepitude, than others. But the structural forces bringing about the hollowing of state authority are common to all, and it is hard to envisage a reversal of the trends. The implications arising from this perspective for progressive-social democratic strategy is catastrophic, since there remains no room for manoeuvre for discretionary Keynesian policy, and with governments having to conform policy programmes to the dictates of the international

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financial markets (Perraton et al., 2000: 138; Baker et al., 2002: 408). Thus, capital mobility lessens the ability for government to tax mobile resources, therefore forcing down tax rates upon skilled labour and capital, and in the process undermining social policy and welfare state provision (Cerny, 1996; Strange, 1996; Greider, 1997; Gray, 1998; Veseth, 1998: 138). Moreover, capital mobility results in nations engaging in ‘international regime competition’ to secure inward flows of capital investment, thereby further reducing the burden of taxation and regulation upon capital (Cerny, 1990; Jessop, 1996; Watson, 1998). TNCs possess credible exit threats and can use this leverage to bargain with nation states to their advantage (Garrett, 2000: 455). Advocates of hyper-globalisation do not necessarily perceive the withering away of the state to be a problem, due to their faith in the operation of largely unregulated markets (Ohmae, 1995; Hay and Marsh, 2000: 4). Nevertheless, critics argue that this perspective is both undemocratic in terms of its emphasis upon the ineffectiveness of government policy and thereby leaving citizens with little opportunity to express their preferences, in addition to being ‘fatalistic’ because in reality globalisation has not progressed as far, and nor with such dramatic consequences, as many claim (Baker et al., 2002: 409). Regionalism A second perspective relates to the open regionalism that is discussed in more detail in Chapter 7. The most obvious examples of regional integration include the EU, North American Free Trade Agreement (NAFTA) and the Association of South East Asian Nations (ASEAN). However Scholte (2000: 146–147) notes that a total of 109 regional agreements were reported to the GATT between 1948 and 1994. This perspective accepts globalisation to be a real phenomenon and that it has had a significant deterious impact upon the ability of nation states to conduct independent economic policy. Yet, despite this shift, nation states remain powerful political actors on the global stage and, although some policies may no longer be viable, this does not mean that national governments are left without any real choices of alternative policy measures as hyper-globalists claim (Perraton et al., 1997). The open regionalist preference is for traditional goals of economic management to be pursued at a supernational, regional level. The advantage of this approach is that a regional framework of governance could provide an ‘indispensable tier in the search for new and better ways to regulate the economy’ and in the process deal more effectively with the challenges imposed by globalisation than individual nation states (Baker et al., 2002: 414).

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Regionalisation refers to the situation where international economic integration has occurred in certain places, but not globally (Vandenbroucke, 1996: 11). For example, members of the EU have, with different degrees of enthusiasm, been engaged in a process to encourage increasing financial, economic and political integration between participating member states. This process has created (or is in the process of creating) a single European internal market, a single labour market and theoretically a single financial market. However, barriers are maintained between EU and non-member states, and the degree of internal integration is not reflected in the degree of integration with African or Asian nations. According to this viewpoint, it is possible to perceive a ‘triadisation’ of international economic development, with the majority of examples of economic integration being concentrated within three regional groupings, namely Europe, North America and Asia. Regionalisation would appear to contradict the globalisation thesis. It can represent a ‘macro-nationalist’, ‘neo-protectionist’ reaction against the dominance of global market forces (Scholte, 2000: 147). However, it could also represent an intermediate step upon the road towards full globalisation (Tober, 1993: 101; Hettne, 1994). Regional customs unions and/or free trade areas facilitate the development of pan-border production networks and promote product, legal and regulatory standardisation. This tension is inherent within the debates amongst social democrats concerning the future direction of the EU, namely whether it is intended to create a ‘Fortress Europe’, providing a protective environment within which to create a distinctive European Social Market (ESM) economy, or whether EU integration should provide a catalyst for member states to deregulate their economies and reform public provision in order to adapt to the dictates of global markets. Inter-governmentalism A third perspective relates to intergovernmentalism, which holds that the world economy is better characterised as international rather than global, and therefore its consequences upon national economic selfdetermination are not so terminal as suggested by hyper-globalists. Nation states possess different political, economic and institutional characteristics that provide them with differential capacities to overcome the challenges provided by changes in the external environment, and therefore no universal shift whereby nation states are forced to accept the agenda imposed by unfettered economic liberalism. Considerable autonomy remains in economic policymaking and capital can still be

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regulated at national level (Hirst, 1999; Baker et al., 2002: 411). It has, for example, not led to the collapse of the welfare state nor forced tax levels to a common, low level (Vandenbroucke, 1996). Progressive-social democratic macroeconomics remains a viable alternative for any nation to pursue (Baker et al., 2002: 412). Moreover, internationalisation is not an inevitable natural phenomenon, but has been facilitated by a political coalition and therefore a determined attempt to reverse this trend is quite plausible given sufficient determination amongst progressive social and political forces (Cerny, 1990). Glyn and Sutcliffe (1992: 76–77) distinguish between the spread of capitalist relations of production, which they associate with the collapse of central planning in the former Soviet Union sphere of influence, together with the introduction of market forces in China, and an increase in the international interdependence of the world economic system. The former relates to the spread of the capitalist system, whereas it is the latter which relates to globalisation. Careful examination of the data leads a number of theorists to conclude that contemporary phenomenon relates more closely to internationalisation than globalisation (Hirst and Thompson, 1996a; Wade, 1996: 61). One example relates to the fact that the percentage of the global workforce whose livelihoods are determined outside of the allocation determined by market forces has declined from around two-thirds in the 1970s to less than one-tenth two decades later (Diwan and Walton, 1997: 2).

The decline of the nation state? Globalisation has been implicated in a decline in the ability of the nation state to determine its own economic policies. The literature has discussed the variously described ‘decline’ or ‘crisis’ of the nation-state, ‘the retreat of the state’, the phenomenon of the deprivation of the state or all or part of its sovereignty in terms of a ‘diminished nationstate’ and ‘the extinction of nation-states’ (Camilleri and Falk, 1992; Wriston, 1992; Horsman and Marshall, 1994; Cable, 1995; Dunn, 1995; Ohmae, 1995; Schmidt, 1995; Khan, 1996; Strange, 1996; Sassen, 1997; Bauman, 1998). Indeed, Gray (1996: 32) argues that: There is an insoluble contradiction within contemporary social democracy between economic globalisation and egalitarian community . . . The inheritance of neo-liberal deregulation, together with ongoing globalisation . . . make the distributional goals, of social democracy unachievable, at least by traditional social-democratic means.

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One aspect of this postulated weakening of state power relates to the fact that financial deregulation has provided additional exit options for private capital. Corporations can relocate more easily than in the past, and hence governments may not find it as easy to tax more mobile assets as highly as previously. It is not a large step to move towards a system of global tax competition, where corporations threaten to relocate unless governments reduce their tax burdens, or provide them with a variety of subsidies – that is rent rebates, provision of ‘greenfield’ sites for development and infrastructural investment predominantly benefiting the company but financed by tax-payers. Similarly, nation states may use tax competition as one incentive to attract FDI, thereby further driving down tax revenues (e.g. Ireland, Germany). However, when discussing the net benefits to host economies from attracting inward FDI, it is important to realise that, for most industrialised economies, total FDI flows represent only a small proportion of GDP and are exceeded by domestic investment by at least a factor of nine-to-one (Weiss, 1998: 174). Moreover, for many nations, including Britain, outward flows exceed inward investment, such that renewed regulation of long-term investment, in addition to controls over short-term capital flows, might benefit certain nations. Trans-national production additionally provides the opportunity for tax avoidance through the mechanism of transfer pricing, which involves the prices of inter-firm transfers of services and materials being manipulated, so that resources are transferred from subsidiaries located in high tax areas and towards sister companies in lower tax regimes. The US Congress found that half of the forty firms it surveyed had paid virtually no taxation over the previous decade (Dicken, 1992: 391). In the boom year of 1987, 59 per cent of foreign-owned companies reported no profits in the US and therefore paid no taxation, whilst these same firms enjoyed a 50 per cent increase in revenue over the three-year period and yet tax payments rose by only 2 per cent (Barnett and Cavanagh, 1994: 345). This is an important development from a social democratic perspective, because reducing taxation on mobile capital either requires it to be redirected onto less mobile labour, thereby increasing social inequality, or being forced to reduce public expenditure and with it prized welfare programmes. There is a certain amount of evidence of a trend towards lower corporation tax rates has become identifiable across OECD countries, during the last decade. However, Rodrik (1996: 5) notes that comparable tax rates still vary widely across the industrialised nations, whilst the evidence used to predict convergence is, at best, limited. Indeed,

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Eichengreen (1990) points out that the variability of state tax rates remains significant even in an integrated economy such as the US, albeit at a little over half the level between EU nation states. Therefore, it would appear from the available data that capital taxation may be squeezed because of increased mobility, but the potential for significant variation is likely to remain. A second issue concerns the argument that transnationalisation of the economic environment reduces the economic space left to be controlled by the nation state. Strange (1994) discussed this phenomenon in terms of a ‘hollowness’ of state authority and a ‘retreat of the state’. For example, nation states are increasingly being forced to bargain with TNCs over their conditions of operation, rather than regulate their activities (Stopford and Strange, 1991). However, this neglects the fact that markets are not natural phenomena, but are always established in some form of legal and institutional context that defines the conditions under which transactions occur. Ultimately, the power of the nation state creates the conditions for markets to operate, for example, by creating legal protection for most transactions, employing inspection teams to ensure the integrity of the trade (i.e. checking weights and measures, the accuracy of advertising and the safety of the product or service). The intensification in globalisation is closely associated with the rise of neo-liberal economics during the late 1970s and early 1980s, which led to the deregulation of the UK and US economies, and through this process dramatically increased the mobility of international capital. Furthermore, the use of the General Agreement on Tariffs and Trade (GATT), and latterly the World Trade Organization (WTO), has created an international climate receptive to FDI and trade. Consequently, globalisation depends upon the continued acquiescence of nation states in order to expand. Furthermore, Pauly (1995) notes that the international organisations, including the OECD and IMF, have expended considerable energy in promoting the ‘capital mobility norm’, namely the concept that the unrestrained free flow of capital delivers superior economic outcomes, and therefore national regulation of capital is an inefficient practice. The World Bank acknowledges this point, and challenges the ‘overloaded government’ thesis, by calling for states to enlarge their role in protecting and correcting markets. According to this perspective, the state is viewed as a necessary ‘partner, catalyst, facilitator’ to the long-term sustainability of globalisation (World Bank, 1997: 41). Hence, it is possible to portray this shift in viewpoint as a tentative movement towards the social democratisation of globalisation.

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A third topic relates to manner in which global financial markets increase the cost of domestic stabilisation policies (Kapstein, 1994). Globalisation is thus causing a shift away from welfare states to competition states. Deregulation has become a useful indicator for the award of top credit ratings from international agencies. Indeed, Sinclair (1994) argues that Moody’s Investors Service and Standard & Poors Ratings Group have thus become the ‘transmission belts’ of deregulation practice, prompted by the globalisation process. Moreover, financial markets typically prefer mildly deflationary policies as this preserves the value of financial assets (Palley, 1999: 106). Therefore, active fiscal policy is likely to be considered by international financial markets to harbour likely future inflation and/or tax rises, due to a neo-liberal bias, and therefore this approach is likely to trigger capital flight and a currency crisis (Levitt, 1983; Ohmae, 1990, 1995; Reich, 1992; Sachs and Warner, 1995). Thus, governments have little option than to design policy programmes that command confidence in the financial markets (Gill, 1998). A slightly different version of the ‘weakened state’ thesis predicts that globalisation is changing its nature and role. It has been claimed that the Third Way social policy amounts to the creation of a new form of post-welfare state. Jessop (1993: 9, 1994a) postulates a transition from Keynesian welfare state to a ‘Schumpeterian workfare state’. This ‘subordinates social policy to the demands of labour market flexibility and the constraints of international competition’ ( Jessop, 1993: 9, 1994b; Jones and Peck, 1995; Jones, 1996; Ellison, 2003: 168). On a similar theme, Cerny (1990, 1994, 1997) has described the creation of a ‘competition state’, arguing that the nation state is forced to consider the interests of mobile capital in order to increase its attractiveness as a location for production. This gives rise to reduction in business taxes, deregulation and the establishment of a low inflation, market-orientated neo-liberal macroeconomic programme. Cerny described this process as ‘regulatory arbitrage’, where government policy shifts from the development of a welfare state that protects people from the worst features of market determination, to one that seeks to provide citizens with the skills and abilities to be able to compete successfully in the global marketplace. Financial integration has resulted in an increased probability of contagion from financial crises elsewhere in the international community (i.e. Mexico, Russia, South East Asia, Argentina, Brazil, etc.), due largely to a substantial increase in short-term liquidity through financial capital flows, spreading to the domestic economy (Kapstein, 1994). This may weaken state power, but might also caution against closer integration in the absence of sufficiently tight supranational regulation to prevent

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occurrences of this kind and thereby reinforce calls for the re-regulation of national economies. Furthermore, trans-national capital is not a homogeneous class, but contains different fractions, some benefiting from short-term volatility in financial markets and others from longer-term investment in manufacturing. It is a misunderstanding, then, as Panitch (1994) states, that globalisation equals the end of the nation state and the constraints upon national policy are exaggerated. Indeed, it is perhaps worth noting that claims of ‘the end of the nation state’ have coincided with more nation states existing than during any previous historical period of world history. Admittedly, it has become impossible to sustain a policy of fixed exchange rates whilst simultaneously maintaining an independent monetary policy, but the alternatives of a floating currency or a system of adjustable peg, semi-fixed rates, are viable alternatives (Rodrik, 1996: 5). Thus, the state retains substantial capacities to govern global economic activities (Thomson and Krasner, 1989; Krasner, 1993; Boyer and Drache, 1996; Hirst and Thompson, 1996b; Mann, 1997; Weiss, 1998). Crisis of Keynesianism: Three case studies The disassociation of British Labour governments with Keynesianism is not an entirely new phenomenon, and did not arise with the creation of New Labour. Indeed, these issues first arose during the last ‘old’ Labour administration, during the heightened drama caused by the 1976 International Monetary Fund (IMF) crisis (Hall, 1986; Helleiner, 2000: 65). This was the first of the three seminal social democratic government crises that, when taken together, are often alleged to indicate the powerlessness of national Keynesian macroeconomic policy amidst conditions of globalisation, and particularly the free movement of capital (Callaghan, 2000: 102–108; Schmidtke, 2002: 8). The second event relates to the dramatic policy shift undertaken by the 1981 French Mitterand administration, when balance of payment problems and a run on the currency prompted the reversal of expansionary Keynesianism to be replaced by hard currency deflation (Ross et al., 1987; Keegan, 2003: 82). The classic example, often used by supporters of the globalisation thesis, involves the failure of the 1981 Mitterand administration to maintain a radical economic programme, based upon Keynesian reflation and extensive nationalisation, and involving ‘a barrage of reforms without precedent in post-reconstruction Europe’ (Ross and Jenson, 1994: 172; Cameron, 1996). The third crisis related to the defeat of Keynesianism within Sweden. Many theorists place this to have occurred at the 1976 General Election

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defeat that removed the Social Democratic Party from participation in government for the first time since 1932. However, despite the significance of this event, it may equally be argued that the 1976–1982 bourgeois coalition maintained essentially Keynesian policies. Thus, it was the subsequent election defeat for social democracy in 1991 that marked the demise of Sweden’s variant of national Keynesian strategy. Moreover, by the time the social democrats returned to power three years later, their economic stance had shifted far closer to the Third Way approach than it had been previously (Whyman, 2003). Whilst a complete examination of the detailed circumstances relating to each of these three events is beyond the scope of this book, nevertheless there are a number of important similarities. For example, although all three events occurred during periods of economic downturn, the 1976 British Labour government and French Mitterand administration suffered from the twin problems of stagflation, whereby seeking to utilise aggregate demand management as a sole instrument to reconcile simultaneously high inflation and unemployment meant that secondary instruments had to be utilised to prevent expansionary policies from worsening inflation. In Britain, it was the failure to build a sustainable ‘social contract’ that unnecessarily limited alternative policy options. Moreover, both British and French administrations suffered from the preference held by international investors for fiscal and monetary orthodoxy. Therefore, Keynesian expansionary policies, although perhaps correct in terms of economic theory amidst economic recession, resulted in currency crises as investors preferred to withdraw money from sterling and the franc on the assumption that future inflation would be generated and the value of the currency would decline. Worsening balance of payments positions in both countries demonstrated that go-it-alone expansion of one nation state at a time when others were pursuing more deflationary policies would suck in increased imports into the expanding domestic market faster than exporters could increase their sales in relatively static or declining overseas markets. Finally, in both nations, elements from within the social democraticprogressive Left did develop alternative approaches to the orthodoxy eventually introduced by both governments. In Britain, debate focused upon what became known as the ‘Alternative Economic Strategy’ (AES), as devised by the Cambridge Economic Policy Group, supported by key Labour Party figures including Tony Benn, and which advocated increased regulation of finance and trade to prevent leakages from undermining expansionary policies. In France, proposals to expand the nationalisation programme and utilise state assets to stimulate industrial

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investment, together with a substantial devaluation to restore international competitiveness, were rejected in favour of public spending reductions and the imposition of the ‘Fort franc’ hard currency policy which has conspired to keep French unemployment in (or near) double figures for the best part of twenty years (Cameron, 1996: 58). The Swedish case is slightly different as election defeat in 1976 was little to do with the economy and more to do with a number of political factors, whilst by the end of the Keynesian period, in 1991, the SAP had itself lost faith in the Keynesian measures that had sustained full employment for decades and had begun to deregulate the economy in order to stimulate competition within the Swedish market. The end result of the shift towards neo-liberalism was the recurrence of doubledigit unemployment, the loss of one fifth of Swedish manufacturing jobs, substantial FDI overseas, three years of declining national income and the largest budget deficits in Swedish history. Thus, the Swedish example, whilst illustrating the problems governments can have when faced with a large capital strike by international investors, additionally highlights the failure arising from the replacement of Keynesianism by neo-liberal economic policy. The loss of faith in Keynesianism proved to be a feature of all three events. This was famously highlighted by the then British Prime Minister James Callaghan who claimed, in his speech at the Labour Party Conference, that: We used to think that you could spend your way out of a recession and increase employment by cutting taxes and boosting government spending . . . I tell you in all candour that the option no longer exists, and that in so far as it ever did exist, it only worked on each occasion since the war by injecting a bigger dose of inflation into the economy, followed by a higher level of unemployment as the next step. (Callaghan, 1988) Furthermore, Chancellor Dennis Healey ceased considering himself to be a Keynesian a year earlier (Healey, 1989). It has subsequently been suggested that the adoption of monetary targets did not explicitly prove that the Labour government had adopted monetarism (Healey, 1989; Allsopp in Artis and Cobham, 1991; Hill, 2001: 124). Nevertheless, at the very least, just as the combination of a misapplication of economic policy in US and OPEC oil price shock had generated stagflation which, in turn, appeared to cast doubt upon the efficiency of Keynesian macroeconomic management, key figures in

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the British Labour government of the time had already lost faith in demand management techniques. Thus, they found themselves helpless before the challenge caused by the economic circumstances of the day and the rise to prominence of neo-liberal economic ideas. By the time that ‘old’ Labour lost power in 1979, social democracy in Britain had been ‘defeated not only electorally and politically but also intellectually’ (Hill, 2001: 3). It was the political failure to develop a realisable alternative strategy, based upon Keynesian principles but which could restore the confidence of the leading figures in the European social democratic movement, that ultimately undermined ‘Keynesianism in one country’, and with it the prioritisation of traditional social democratic goals of full employment and progressive redistribution (Artis and Cobham, 1991; Kavanagh, 1997; Hay and Watson, 1999a: 152; Finn, 2000: 384). Hay and Watson (1999a: 152) present the circumstances, thus: if ‘Keynesianism in one country’ was an electoral liability and the corporatist-Keynesianism of the late 1970s was no longer possible (especially in the new context created by the Thatcher Government’s programme of trade union reform), then Labour required a new economic paradigm.

The death of national Keynesianism: Has it been exaggerated? A number of theorists have argued, like Drucker, that globalisation has rendered the institutions of the Keynesian and Beveridge revolutions irrelevant (cited in Veseth, 1998: 137). The liberalisation of capital flows, the deregulation of financial markets and technological advance in communications are suggested to have undermined Keynesianism (Levitt, 1983; Ohmae, 1990, 1995; Reich, 1992; Barnett and Cavanagh, 1994; Sachs and Warner, 1995; Vandenbroucke, 1996: 3). It has been suggested that Keynesian social democratic regimes were established during a period of relatively closed economies, with tight regulation of capital, and moreover they depend upon the maintenance of these circumstances (Berger and Neuhaus, 1996; Gray, 1998: 88, 92). Thus, British Chancellor Gordon Brown claims that, in an economy characterised by deregulated, liberalized financial markets . . . the Keynesian fine tuning of the past which worked in relatively sheltered, closed national economies and which tried to exploit a supposed long-term

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trade-off between inflation and unemployment, will simply not work. (Brown, 1998) National Keynesianism has been derided as unfeasible in an open economy (Hall, 1987; Teeple, 1995; Mishra, 1999: 95), whilst the space available for different models of capitalism has so narrowed that institutions are no longer able to make a significant difference, and therefore sustaining alternatives to market-led capitalism are proving extremely difficult, if not impossible (Monbiot, 2000). This implies that ‘luxuries’ such as full employment, redistribution and the development of a universalistic welfare state can no longer be afforded due to greater economic constraints (Hay, 1999: 29). Counter-arguments embrace claims that globalisation is overstated (Berger and Dore, 1996; Boyer and Drache, 1996; Hirst and Thompson, 1996a; Watson, 1999). Moreover, Rodrik (1996) has demonstrated that, far from those economies that are the most integrated into the world economy suffering a ‘shrinkage’ of government, there is actually a positive correlation between openness and the share of government expenditure in GDP, due to the ability of government to act as an insulator against external shocks. Rodrik (1996: 15–16) notes that: The Netherlands, Austria, Norway, Switzerland are all small countries that are, if anything, more exposed to the forces of the global economy than the UK is. If globalisation were a significant counterweight to egalitarian strategies, we would surely expect to see the consequences in these countries. To be sure, each one has had to grapple with the consequences of openness, and in some cases – the Netherlands being the chief example – significant reforms in labor markets and welfare systems had to be undertaken. But the important point is that each of these countries has managed to retain its distributive social institutions. For all its reforms, no one would confuse the Netherlands for the US or even the UK. There is additionally little convincing evidence to indicate that globalisation has undermined the efficiency of institutional frameworks within which economic policy operates (Garrett, 1995). Furthermore, Wade (1996: 108) notes that the vast bulk of a nation’s resources are immobile, including physical and human capital, and therefore governments can invest in education, infrastructure, targeted industrial support and facilitation of the development of business networks in order to enhance the advantages of immobility and proximity for individual companies.

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The literature additionally indicates that globalisation does not have the depressing impact upon taxation and public expenditure that some theorists may claim. Swank (1998) has found that, although governments may have reduced marginal corporation taxes, they have simultaneously broadened the tax base through the closure of loopholes, and therefore overall effective corporate tax burdens have generally remained insulated from the impact of globalisation. Indeed, because most FDI is located in developed economies, Swank (1998) and Kopits (1992) have found a positive and statistic significance associated between capital mobility and the effective tax rate. Furthermore, whilst the top income and corporate tax rates have certainly fallen in most OECD countries over the last two decades, however total tax revenue as a proportion of GDP has remained relatively constant, suggesting a substitution of indirect for direct forms of taxation (Standford et al., 1993: 14–20; OECD, 1998: 159–162). Thus, capital market integration appears to be associated with growing divergence in fiscal policy between nation states, due to the continued influence upon domestic economic policy resulting in large part from the strength of organised labour (Garrett, 1995, 1998, 2000). Examining world trade data, the expansion appears to be slowing as a result of a gradual shift away from manufacturing industry and towards the service sector within the OECD nations, and ultimately leading to lower levels of trade integration in the process (Wade, 1996: 66; Weiss, 1998: 172). Weiss (1998: 173) notes that the majority of FDI occurs for sectors other than manufacturing industry, and is directed towards technically non-productive assets or speculative ventures such as golf courses, property (commercial and residential), hotels and shopping centres. Furthermore, a large swathe of FDI is used to acquire existing assets rather than construct new productive facilities, and is therefore less effective in improving competition and providing additionality to the host economy (Fallows, 1994: 481). The fact that 81 per cent of global FDI stock is located in high wage, high tax OECD nations, indicates that cost reduction is not the overwhelming factor causing the globalisation of production (Weiss, 1998: 186). Furthermore, most TNCs concentrate approximately 70–75 per cent of value-adding activities in their home nation, indicating that they are more accurately ‘national firms which operate internationally while retaining a home base’ (Hirst and Thompson, 1996a: 96; Wade, 1996: 101; Weiss, 1998: 185). Indeed, a study of the world’s largest 100 TNCs reaches the conclusion that ‘not one of these can be dubbed truly “global”, “footloose” or “borderless” ’ because no firm has overcome its dependence upon its

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home base, and consequently ‘globalisation remains a myth’ (Ruigrok and van Tulder, 1995: 168–169; Wade, 1996: 101). The costs of moving resources about the globe to take advantage of differential access to raw materials, markets or investment funds are much lower than at any time prior to 1960, and therefore the physical infrastructure, access to affluent markets and technology, together with the skill and commitment of the workforce have become increasingly important in determining a company or nation’s competitive position, and which as themselves relatively immobile factors (Cantwell, 1989; Caves, 1996; Wade, 1996: 106; Dunning, 1988). Indeed, the ‘embeddedness of companies in national institutions’ provides information and a means of co-ordination between firms to secure common objectives, facilitates the development of a cluster of skilled labour and a technical supply chain specialising in the specific activity of the firm, thereby reducing the uncertainty arising from a dynamic business environment (Hirst and Thompson, 2000: 306; Zysman, 2000: 120–123). A ‘national system of innovation’ can be extremely successful in developing international competitive advantage (Porter, 1990; Patel and Pavitt, 1991). Networks therefore suggest that the advantages of the maintenance of a strong home base may be stronger than ever (Weiss, 1998: 186). These include: • New technologies place a premium on fixed costs (i.e. equipment, machinery, etc.) while reducing the importance of variable costs (wages, raw materials). Indeed certain types of labour (especially knowledge-intensive labour) tend to be treated increasingly as a fixed cost. The general effect of this transformation, most notably in the highly developed countries, is to reduce the cost savings to be gained by moving to low-income sites. • Many new production methods emphasize the growing importance of physical proximity between producers and suppliers (especially in non-assembly operations). Such methods tend to privilege local supplier networks, thus providing a counter-trend towards the constitution of regional rather than global sourcing networks. • Domestic linkages – national institutional frameworks – enmesh business in support relationships with trade associations, training and financial institutions, and national and local governments. Assuming that these arguments are correct, and that globalisation may have imposed minor constraints upon the operation of Keynesian macroeconomic measures but has not fatally undermined the strategy,

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then the obvious question to be asked relates to why progressive-social democratic movements have so easily accepted contrary arguments. The first alternative implies that progressive-social democratic movements have undergone de-radicalisation, either as a result of their belief in the ineffectiveness of policy instruments amidst the new external economic environment, or due to a loss of faith in a democratic socialist vision of society. As such, Grant (2002: 49) argues that globalisation is ‘politically convenient’ in so far as it has facilitated a shift from a traditional social democratic to neo-liberal economic approach, based upon the premise that government room for manoeuvre is limited and that dominant global financial markets need to be continually placated. Thus, ‘globalisation has been used as a rhetorical device to discipline expectations of the limits of fiscal activity’, thereby squeezing tax rates and social expenditures and acting as a ‘convenient post hoc rationalization’ for a neo-liberal policy shift (Watson, 1999). Focusing upon the development of New Labour in Britain, Hay and Watson (1999: 155) suggest that: It is the discursive construction of globalization, rather than globalization per se which is driving political change in contemporary Britain . . . globalization acts as a convenient post hoc rationalization for a logic of tax cutting which the Labour Party has already internalized. In contrast, Hirst and Thompson have claimed that the real effects of globalisation are less consequential than its impact upon the confidence of progressive-social democratic movements. Thus, globalisation’s ‘image is so powerful that it has mesmerized analysts and captured political imaginations’ (Hirst and Thompson, 1996a). Hirst (1999: 88) argues that it has been the ‘fear of globalised capital’ that has led to the retreat of the progressive-Left.

Room for social democracy? Social democracy traditionally places great importance upon the ability of the nation state to manage the capitalist economy efficiently and thereby achieve sustainable full employment consistent with other social and economic objectives. Therefore, the claim that globalisation impairs national macroeconomic strategy undermines this nationalorientated strategy. Indeed, Panitch (2001a: 26) argues that, together with the fall of command communism, globalisation represents one of the two ‘central developments that define our era’ that threaten the

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capacity of the social democratic labour movements to sustain their predominantly national institutional framework and strategies. Przeworski (1985) and Swank (1992) famously claimed that external constraints fatally undermined social democracy due to a structural dependence upon the acquiescence of capital. The threat of radicalism would, he claimed, provoke capital disinvestments and thereby cause modification (or withdrawal) of the distinct progressive policies. Capital mobility weakens Keynesianism, because a rise in fiscal expenditure either implies a rise in taxes, which threatens to cause capital flight, whilst increased borrowing would be viewed by the now powerful international financial markets as leading to future inflationary pressure, and thereby resulting in an increased interest rate risk premium. Thus, Rhodes (1998: 313) feels able to argue that: The lessons of the 1980s is that socialism in one country is no longer possible. All the Social Democrats, like the British Labour Party, can realistically provide is a more humane variant of the neo-liberal state. Deregulated capital flows, it is suggested here, undermined the beneficial impact of social democratic versions of corporatism, which typically included powerful disincentives for domestic enterprises to move their operations abroad, together with restrictions upon foreign firms taking over domestic companies, and thereby encouraging domestic investment in productive capital (Kitschelt, 1994: 4). As Kurzer (1993: 12) notes, ‘the most persistent dilemma for labour is that increased mobility of capital has also increased the power resources of capital’. Indeed, the ability to switch production to low-wage areas of the world, together with the desire to utilise payment as part of strategic management schemes to encourage productivity, improvement of skills and loyalty to the company, has reduced the attraction of nationally co-ordinated collective bargaining as a means of taking wages out of competition ( Jacoby, 1995: 8). Furthermore, Glyn (1998: 14–15) argues that the strategy adopted by capital, empowered by globalisation, echoes the prediction made by Kalecki in 1943, where he claimed that the maintenance of full employment would stimulate the opposition of organised capital, because it weakens industrial discipline and thereby encourage the assertiveness of workers demanding improvements in working conditions. It is additionally claimed that social democracy is too generous by introducing too much equality, security and employment into the capitalist

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economy, and therein undermines incentives to work hard, maintain a high level of private savings and results in inflationary pressures (Lundberg, 1985). Novak even goes so far as to claim that ‘social democracy is based on the same errors as socialism, but in a form that takes a little longer to effect self-destruction’ (cited in Moene and Wallerstein, 1995: 186). Jessop (1994b) suggests that the model of the welfare state has to shift from a centralist-Keynesian to a Schumpetarian framework, orientated towards improving the competitiveness of the economy. Finally, Radice (1999) argues that globalisation represents more than any measured change in the internationalisation of trade, capital flows and cultural exchange, but, more insidiously, it provides ‘a powerful ideological framework within which big business pushes for a redistribution of income, wealth and power towards economic elite’s’. Hence, the decision to deregulate financial markets reflected ‘the policy shift from embedded liberal [neo-Keynesian] to neo-liberal frameworks of thought’ (Helleiner, 1994: 167). Moreover, ‘the neo-liberal concept projected a transition away from the welfare, social compromise state towards the night-watchman state of classical liberalism’ (Van der Pijl, 1989: 66). Thus, Thurow (1996: 180) felt able to declare that ‘capitalists declared class war on their workers – and they have won it’. Over-exaggeration? The globalisation thesis sounds convincing when proclaiming the end of national economic self-determination, and with it the decline of social democracy. However, Vandenbroucke (1996:57) argues that the notion of the emergence of a global economy ‘is largely a myth’, and that, whilst national governments may face tighter constraints upon their capacity to pursue domestic social and economic strategies, a significant degree of autonomy remains. Indeed, it is perhaps a more interesting issue to concern why social democratic nations have responded to changing circumstances by increasing the exposure of their economies to international forces, through deregulation of financial capital and participation in fixed exchange rate regimes, and thereby tightening the constraints upon their own macroeconomic management. This response would seem illogical, when compared to the alternative of endeavouring to reduce the exposure to international pressures, through the strengthening of capital controls, financial regulation and lobbying for a new, decisive trans-national regulation regime. Glyn (1995) may provide one explanation for this apparent contradiction, in his argument that globalisation has been blamed for the inability of nation states to satisfactorily control social conflict and

A Response to Globalisation 53

inflationary pressures. Lundberg (1985: 28) suggests that reliance upon foreign borrowing to finance public expenditure opens the national economy to the dictates of the international financial markets. Alternatively, Hay (1998: 529) suggests that, although internationalisation has caused changes in the world economy, nevertheless, it is: only a distinct absence of political imagination and/or a severe dose of political fatalism’ that causes analyists to conclude that this so narrows the range of potential strategies that traditional social democratic policies are consigned to a nostalgic memory. Thus, the so-called crisis of social democracy is based upon a combination of ‘political fatalism’, a ‘lack of confidence’ and ‘a lack of political imagination . . .’ together with a failure to develop a viable alternative strategy (Hay, 1997, 1998; Whyman, 2003). The only other viable alternative to the re-nationalisation of economic policy involves the construction of supranational regulation of capital. The most visible example of this approach has been in the efforts of social democratic parties within the EU, to replace national with community institutions to promote employment generation and to provide an element of regulation to labour and financial markets. The consequences of this approach are dealt with in Chapter 7. However, for the purposes of this section, suffice it to say that, having embarked upon an EMU based upon monetarist principles, the European social democratic movement is ill-prepared to develop a distinct, social democratic alternative. Indeed, in this regard, Solow (1997) suggests that the process of globalisation should be slowed down ‘until we can be more vigilant in compensating the losers’.

Conclusion The increased incidence of FDI and short-term capital mobility has had a profound impact upon national economic management, causing a re-definition (or rejection) of traditional social democratic strategies, and an adoption of neo-liberal economics. This, in turn, has caused formerly distinctive social democratic states to become ‘normalised’ in terms of rising unemployment, low inflation, regressive income redistribution and underwhelming rates of economic growth. This is not, however, to suggest that globalisation inevitably leads to this eventuality, nor to imply that there are no viable alternatives remaining.

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One of the joint architects of the ‘Swedish Model’, Meidner, argues that ‘full employment can only be regained through a fundamental change of priorities, from price stability to high employment’, involving a ‘well-co-ordinated economic policy which aims at non-inflationary full employment and equality’ (cited in Ginsburg et al., 1997: 14). This may involve the re-imposition of exchange controls, financial re-regulation and/or an industrial policy aimed at providing a combination of incentives and penalties to encourage industrial expansion in the national economy, to provide jobs and pay for the welfare state. However, discussion of such alternatives is postponed until Chapter 9.

3 Goodbye Keynes?

Introduction Traditional variants of social democracy have embraced Keynesian economics as a means for securing objectives of full employment and expanding prosperity. Moreover, Keynesian policy prescriptions have favoured an expansion in public expenditure as a proportion of national income, and this in turn has facilitated traditional social democratic goals to expand the welfare state and use fiscal policy as one means of securing a progressive redistribution of income. The commitment to full employment additionally empowered the trade union movement. Moreover, to ensure that this increase in industrial strength did not become destructive to the economy and society in general, Keynesianism facilitated the development of a progressive form of corporatism amongst many European nations, as collective labour sought an increase in the social wage and/or workplace reforms as an alternative to inflationary wage militancy. Keynesianism advocated government intervention in the economy to correct examples of market failure. At the micro-level, this encouraged the development of active industrial policy, whereas at the macro-level Keynesianism held that government needed to actively manage aggregate demand to ensure that full employment occurred. The development of a social democratic-Keynesian consensus was not without its critics from the political Left, who argued that democratic socialist parties should be concentrating upon advancing public ownership and fundamentally changing capitalist society rather than making it work more efficiently, which was Keynes’ express purpose in developing his theories in the first place. Indeed, many socialists denounced the social democratic-Keynesian consensus as a revisionist ‘sell-out’1, 55

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which is ironic due to the fact that the more recent development of the Third Way has been similarly denounced by supporters of the ‘old’ social democratic-Keynesian approach. Third Way economics starts from the premise that the globalisation (or hyper-globalisation) thesis is essentially correct, and therefore the Third Way is highly sceptical of the ability of national governments to pursue Keynesian policies of managing aggregate demand, together with the regulation of footloose capital (Driver and Martell, 1998: 32, 42). This causes certain theorists to claim that Third Way economics ‘can be seen as the final triumph of monetarism and the defeat of Keynesian economic policies’ (Arestis and Sawyer, 1998: 41). Evidence for this position can be derived from the fact that Third Way economics has substituted price stability for full employment as its prime core objective of macroeconomic policy. Monetary policy has been constrained to act in accordance with the preferences held by the financial markets in the expectation of being ‘rewarded’ for fiscal orthodoxy with lower rates of interest rate risk premium. Demand management is replaced by ‘supply-side socialism’, whereby policies target raising productivity through investment in training and infrastructure projects (Favretto, 2003: 138). Regulation of labour and capital is replaced with the pursuit of labour market flexibility (Blair and Schröder, 2000: 168). Active fiscal policy is replaced by a determination to balance budgets over the business cycle, together with a desire to reduce the size of government spending as a proportion of GDP and introduction of schemes such as the Private Finance Scheme (PFI) which offer to finance public investment projects off the public sector balance sheet (HM Treasury, 2002b: 135–136). Despite this quick review of the differences between Third Way and traditional social democratic-Keynesian policies, certain theorists warn against the adoption of the ‘premature’ judgement that Third Way economics is merely ‘neo-liberalism under another name’. Indeed, whilst accepting the fact that the Third Way is in essence different from ‘old’ social democracy, Gamble and Kelly (2001: 167) suggest that it is not always straightforward to establish an unambiguous judgement relating to the ‘precise character’ of the Third Way approach due to contradictory evidence and a difficulty in ‘distinguishing between rhetoric and reality’. Arestis and Sawyer (1998: 25) recognise the lack of coherence pervading Third Way economics, yet nevertheless they perceive the existence of a ‘set of ideas that lie at the heart of the economic policies’ pursued by Third Way governments, and they further claim that these

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ideas are closely associated with what they describe as ‘new monetarism’. In essence, this involves the creation of a ‘new consensus in macroeconomics’ that synthesises New Keynesian and neo-liberal economic theory to generate a set of distinctive economic policies (Arestis and Sawyer, 2004). This chapter will, therefore, review the evidence relating to the distinctiveness of Third Way economics, its internal coherence and theoretical underpinnings of its macroeconomic stance. Later chapters will examine the emphasis placed upon monetary policy and the development of flexible labour markets. Furthermore, an evaluation of the potential of Keynesianism amidst globalisation will feature in the final chapter.

Critique of Keynesianism Third Way economics rejects Keynesianism, either because it is considered to be irrelevant or at least too dependent upon the conditions of semi-closed economies that it is incapable of operating amidst contemporary conditions of globalisation. Alternatively, Third Way adherents may reject Keynesianism because they accept the historical revisionist critique that Keynesianism was a theoretical dead-end because it never worked in the first place. Examining the second option first, the claim that Keynesianism never worked is, not surprisingly, advanced by those who have adopted a neo-liberal perspective. Neo-classical economists have never accepted the legitimacy of the Keynesian revolution, and have opposed Keynesian economics for a variety of reasons. These included Keynesianism’s supposed lack of microeconomic underpinnings, the claim that it described an exceptional state and was therefore not a general theory, and, more fundamentally, that left to its own devices the market economy would be self-regulating and tend towards the full employment of all the factors of production at least in the medium and long terms (Phelps et al., 1970; Bleaney, 1985). Neo-classical theorists rejected the claim that a deficiency of effective demand, arising from the tendency for individuals and firms to save more from income than it was profitable for business people to invest, would result in an equilibrium for the economy as a whole settling at less than full employment (Stewart, 1993; Galbraith, 2001: 234). Nahan (1998: 406) clearly accepts this basic premise when arguing that Keynesianism has proved to be ‘one of the most serious failings of the modern state’ due to its ‘disastrous’ results in terms of ‘inflation,

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bloated government, high taxes and greater macroeconomic instability’. Moreover, although less damning in his conclusions, Callaghan (2002: 442) states that ‘there is no evidence to support the idea that Keynesian techniques of demand management were decisive in the attainment of full employment’. It is certainly the case that with the possible exception of West Germany, the efficacy of Keynesian economic management was a belief ‘shared by all socialist revisionists throughout Europe in the 1950s and was a necessary part of their new vision’ (Sassoon, 1996: 245). Nevertheless, this is not to say that Keynesianism necessarily fulfilled expectations. The claim that Keynesianism never worked is, however, difficult to maintain in the face of the evidence. Average real GDP per capital growth rates for industrialised nations, between 1950 and 1973, expanded at approximately double the ‘peak’ rates enjoyed during the industrial revolution, whereas labour productivity grew almost three times more rapidly during the ‘Keynesian era’ (Davidson, 1998: 818–819). Unemployment in Britain averaged a mere 1.8 per cent between 1945 and 1968, whilst in Sweden, full employment was sustained from the late 1930s until little over a decade ago – demonstrating quite clearly that full employment could indeed be maintained, with sufficient determination and the correct macroeconomic policy framework, throughout the stagflationary problems of the 1970s and deflationary morass of the first half of the 1980s (Whyman, 2003). Moreover, despite Friedman (1962: 38) claiming that the Great Depression was not caused by any inherent weakness within the capitalist market economy but rather arose from government mismanagement, this analysis does not sit very well with the stylistic facts (Galbraith, 1955; Kindleberger, 1978). Thus, Douglas Jay argues that it is ‘perverse’ to resist the ‘rational and cheering inference that the application of the remedy has had something to do with the cure’ (Jay, 1962: 134). Having dismissed as a minority position amongst Third Way economists, the proposition that Keynesianism was a theoretical and practical dead-end, the second critique remains – circa the argument that Keynesianism has been fatally undermined by globalisation. This is a central tenant of Third Way economics, as detailed in Chapter 2, which is in essence a reaction to the perceived ‘crises of the Keynesian Welfare State’ (Smith, 2001: 261). This aspect of Third Way thought has perhaps been most developed by the New Labour project in the UK, where leading figures Prime Minister Blair and Chancellor Brown have espoused the belief that Keynesian management of aggregate demand would no longer work as effectively as in the past due to the rise in importance of liberalised

Goodbye Keynes? 59

international financial markets. Therefore, a new macroeconomic policy paradigm was needed, comprising a ‘wholly new’ monetary and fiscal policy framework (HM Treasury, 2002b: x). In his 1995 Mais lecture, Blair claimed that globalisation meant that ‘the room for manoeuvre of any government in Britain is already heavily circumscribed’ (Callinicos, 2001: 16). Similarly, Brown (2003: 101) contrasts the New Labour economic strategy with Keynesian and monetarist approaches that he considers to be more suitable to relatively closed economies, thus: In today’s deregulated, liberalized financial markets, the Keynesian fine-tuning of the past, which worked in relatively sheltered, closed national economies and which tried to exploit a supposed long-term trade-off between inflation and unemployment, will simply not work. Neither can stability be delivered in wholly deregulated markets through a rigid application of fixed monetary targets, as was attempted in the 1980s. Hill (2001: 160) suggests that this was partly due to a wider rejection within the labour movement of short-term macroeconomic ‘fine-tuning’ as capable of delivering sustainable full employment. However, it is also because it delivered two political advantages – that is the ability to contrast the new approach with the ‘boom and bust’ characterised by the Lawson chancellorship, whilst the adoption of ‘sound finance’ and the predominance of low inflation as central goal for macroeconomic policy provided a solution to the Labour Party’s inadequate strategy to restrain inflation. Vandenbroucke (1996: 37–38) notes that demand management in open economies is externally constrained to the extent that reflation causes a rise in import ‘leakages’, thereby reducing the impact of the multiplier effect and may eventually result in an unsustainable trade deficit which may require corrective action thereby curbing the initial expansion of demand. Latham (1998: 388–390) points to the example of the Australian economy during the previous two decades as demonstrating that small, open economies with inadequate national savings are constrained from growing more rapidly than their trading partners without a sharp deterioration in its current account of the balance of payments. Attempts to pursue Keynesian ‘fine tuning’ of aggregate demand, under these conditions, is likely to worsen economic instability rather than provide a solution. Thus, Latham (1998: 388) concludes that this explains the scepticism of Third Way economics towards continued use of Keynesian policies

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because of the belief that there is ‘no sense in sacrificing the long-term strength of the economy for the short-term delusions of fine-tuning’. It is, however, simply incorrect to claim that global capital markets have made domestic demand management impossible. If nations operate a floating exchange rate, balance of payment constraints will prove less of a short-term constraint upon demand management. Furthermore, national or supra-national financial regulation limits the negative consequences from an unfavourable reaction from international currency markets to an expansionary policy stance (Krugman, 1999: 163–166). Vandenbroucke (1996: 40–41) argues that external constraints need not prevent Keynesian demand management, assuming ‘co-operative trade unions and employers’, because he identifies internal distributional conflicts as representing the more ‘fundamental long-term constraints on successful demand management’. In the event, the firm commitment to full employment as the central goal of a progressive social democratic-Keynesian government was replaced by the pledge to create ‘economic and employment opportunities for all’, which was presented in terms of being ‘the modern definition of full employment for the twenty-first century’ (HM Treasury, 1999: 49). Utilisation of demand management to stimulate employment growth was overtaken by an ‘iron commitment to macroeconomic stability and financial prudence’ (Routledge, 1998: 222; Finn, 2000: 386). Moreover, claims that the ‘Fordist’ mode of growth had been superseded by flexible specialisation led to discussion of the need for a new progressive political economy to match the demands of the ‘new times’ and the ‘wholesale modernization’ of the party’s economic stance (Smith and Spear, 1992; Hay, 1994). Consensus opinion on the progressive-Left held that ‘the Keynesian welfare state is gone’ and cannot be resurrected, thereby preparing the intellectual ground for the development of the Third Way as the focus of an alternative vision (Hay, 1999: 71). It is, however, ironic that this modernisation of economic policy involved the integration of pre-Keynesian neo-liberal ideas into New Labour thinking. Moreover, the New Labour leadership were fully aware of the fact that their rejection of Keynesianism echoed the stance taken by the Labour leadership during the earlier IMF crisis period, with Brown (2003: 102) making a direct link between Third Way thinking and the IMF crisis period, by stating that: It was controversial in 1976 when one Labour Prime Minister said we could not spend our way out of a recession. I say tonight we cannot simply spend our way through a recovery either.

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It is perhaps surprising and indicative of how far Third Way economics has shifted away from the Keynesianism that used to form a core component of ‘old’ social democratic thinking that this statement did not give rise to spontaneous protest from the labour movement rank and file membership. Indeed, the consequences arising out of this statement and the absence of intellectual opposition within the British labour movement caused Arestis and Sawyer (1998: 41), as previously noted, to suggest that we are witnessing the final triumph of neoliberalism and demise of Keynesianism. If, however, globalisation does indeed necessitate a reconsideration of economic strategy, it is strange that Third Way economic theory is based, to a large extent, upon a continuation of those policies, pursued by Reagan and Thatcher, which failed to deliver sustained periods of economic growth. Indeed, certain commentators find the timing of this conversion to neo-liberalism rather ‘ironic’, since it coincided with Britain suffering from its experience of the European Exchange Rate Mechanism (ERM) crisis and the consequent deepest and most protracted recession since the 1930s (Sanders, 1996; Hay, 1999: 65). Furthermore, Hay (1999: 64) argues that the simplistic conclusion that globalisation undermines national economic management is ‘empirically suspect, theoretically flawed and politically dangerous’. Such a reductionist approach fails to appreciate the myriad of potential economic strategies that might be successfully pursued within a set of globally determined constraints.

Third Way theoretical foundations The rejection of Keynesianism has meant that Third Way economics is largely based upon a synthesis of neo-liberal, ‘new monetarist’ and New Keynesian economics (Arestis and Sawyer, 2001b: 2). Neo-liberalism, in this respect, relates to the doctrine that market forces will produce an optimal allocation of resources, and that governments should refrain from intervention in market determination. Monetarism is one school of thought within neo-liberalism, and is associated with the proposal that the reduction of inflation is secured through control over the money supply. New Keynesian economics is arguably confusingly named because, although it accepts the possibility for active government intervention in the economy in the short run, in most other respects it accepts the neo-liberal consensus. This holds that, in the longer term, government action is unnecessary due to the tendency for the economy to move towards an equilibrium position, at a natural rate of

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unemployment that is determined in the labour market and government demand manipulation is impotent in shifting. Third Way economics is, therefore, located within what has been described as the ‘new consensus’ in macroeconomics (McCallum, 2001; Arestis and Sawyer, 2004). The main foundations of Third Way economics are, therefore: • Acceptance of a supply-side determined equilibrium rate of unemployment. This may relate to the monetarist natural rate of unemployment (NRU) or the New Keynesian non-accelerating inflation rate of unemployment (NAIRU). The significance of supply-side determined equilibrium means that it is the labour market, and not the time path of aggregate demand, that determines the equilibrium position to which the economy would converge. Demand management has the potential to reduce unemployment below the equilibrium rate of unemployment in the short run, but in the long run unemployment tends back towards its supply-determined equilibrium rate, and moreover at the additional cost of higher inflation pressures. • The assumption of the rational expectation hypothesises influences the conduct of both fiscal and monetary policy. The hypothesis proposes that individual economic agents construct their expectations of the future with no systematic errors so that, even though specific individuals may be incorrect in their predictions, in aggregate and on average economic agents are correct. This assumption differs from the earlier theory of adaptive expectations, where it was accepted that individuals base future predictions upon past evidence and therefore they tend to lag actual events. It also differs from the Keynesian viewpoint that conditions marked by uncertainty differ from those that are subject to predictions based upon probabilistic risk, and therefore there is no scientific basis for economic actors to take decisions, leaving them to rely upon convention and unreliable expectations of future developments. Arising from the acceptance of the rational expectations hypothesis, Third Way economics will seek to establish credibility with economic actors, through building a reputation for consistency, based upon elements of pre-commitment of policy objectives, transparency of activities and the establishment of long-term objectives. In this way, it is hoped to resolve the time inconsistency problem. This refers to the potential for governments to surprise economic agents into thinking that economic expansion engineered by government is real and not inflationary – which it can only be if one assumes the natural rate of unemployment hypothesis – and therefore causes them to temporarily act irrationally, until the accurate consequences of government action become clear. Failure to convince

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rational economic actors that a Third Way government would not pursue this course of action might result in a lack of trust in the evidence of a real expansion in demand, and hence firms and workers might not respond only after a hesitant time lag once they believe that the shift in demand is permanent, thereby undermining economic development. These policy factors inform Third Way fiscal and monetary policy. • The inability of Keynesian demand management to shift the supply-side determined equilibrium position in the medium and long run meant that government should focus upon those objectives to which it can contribute, rather than seek to fulfil the multiple objectives pursued during the Keynesian period. Central to Third Way economics, therefore, is the prioritisation of low inflation as the main aim of macroeconomic policy. New Labour in Britain has stated that ‘it is now widely accepted that price stability is an essential precondition for achieving high and stable levels of growth and employment’, and that monetary policy should be targeted towards achieving this end (HM Treasury, 2002b: 10). In Spain, PSOE Finance Minister Solchaga claimed that ‘the problem of macroeconomic policy . . . was not unemployment, since this did not depend on the direction and content of economic policy, but inflation’ (cited in Recio and Roca, 1998: 140; Clift, 2001a: 64). • The pursuit of fewer economic objectives involves the narrowing of the range of economic instruments to achieve policy objectives (Moran and Alexander, 2000: 112–113). Thus, demand management is replaced by supply-side economics, fiscal policy is constrained within orthodox rules, and exchange rate management is rejected as ineffective. Even monetary policy becomes increasingly reliant upon the use of the interest rate alone, as the use of open market operations, reserve asset ratios and credit controls are overlooked on the grounds that they are insufficiently marketconforming. The new definition involves the creation of a stable framework for business activity, implying price stability having become the principle goal of economic strategy. Institutional factors are considered of lesser importance to assumptions of economic actors displaying rational expectations, the natural rate of unemployment and the ineffectiveness of government policy. This element was most notable during the 1997 New Labour election manifesto, when the party committed itself not to raise the top or the basic rate of personal income taxation, and not to exceed the planned public expenditure totals planned for the following two years by the outgoing Conservative administration. In so doing, New Labour had deliberately removed from the hands of its own government those instruments which have traditionally been important in manipulating the total level of economic activity.

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• Fiscal policy has been downgraded to a secondary, largely passive, policy instrument, supporting monetary policy which bears the brunt of efforts taken to reduce inflation. Fine tuning is rejected on the basis that demand management cannot shift the supply-side determined economic equilibrium position, and therefore fiscal policy can no longer play a central role in counter-cyclical policy, excepting natural stabilisers resulting from long-term patterns of public expenditure – that is during a recession, taxes will fall and therefore established expenditure will provide a degree of fiscal boost to the economy. The introduction of fiscal rules will further constrain discretionary fiscal policy, but it is hoped that greater credibility and pre-commitment will lower the risk premium placed upon interest rates by financial markets on the grounds that fiscal policy is less of an inflationary threat. The additional reduction in fiscal expenditure as a proportion of national income, together with repayment of national debt, would further consolidate an anti-inflationary fiscal stance. Fiscal policy becomes a means of securing long-term economic stability. • Monetary authorities seek to establish anti-inflation credibility on the grounds that this will minimise the rational expectations of economic actors of future inflation rates, and therefore make it easier to achieve low inflation objectives. In so doing, Third Way economics had rejected the traditional monetarist form of monetary policy, namely the control over the money supply through its physical stock. It is therefore essentially New Keynesian in nature. However, the fact that the supply-side is the accepted determinant of the equilibrium position for the real economy implies that monetary policy is incapable of affecting this position, and therefore can impact upon the inflation rate with no effect upon the real economy. Monetary policy typically involved the introduction of inflation targeting, CB independence and the concentration upon the rate of interest as prime (and often sole) instrument of monetary policy. Monetary policy is dealt with in greater detail in Chapter 4. • Full employment is achievable in the long run only if it is compatible with the equilibrium rate of unemployment and, since this is supply-side determined, government policies should target product market competition and labour market flexibility to promote more efficient market clearing, and in so doing to shift the equilibrium rate of unemployment to the left (i.e. to facilitate a lower level of unemployment consistent with a given level of inflation). Produce market reforms can include deregulation, competition policies, government contracting-out of activities, privatisation and so on. Labour market reforms can include

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reducing the regulation of the labour market, including job protection rules, promoting numerical and functional flexibility, promotion of non-traditional employment contracts, facilitating the decentralisation of wage bargaining, time-limiting benefits, lowering the wage-benefit replacement ratio and introducing market-orientated industrial relations legislative reforms. These measures are discussed in more detail in Chapter 5.

Supply-determined equilibrium rate of unemployment Dissatisfaction with the ability of Keynesian economic policies to deal with the extraordinary circumstances of the 1970s, where stagflation confounded simple Keynesianism where demand management was the sole economic instrument utilised by government and was tasked to reduce both inflation and unemployment simultaneously – a theoretical impossibility without the aid of supplementary economic policy instruments. This is made explicit by the New Labour administration in Britain, which stated that: The experience of the late 1970s and 1980s – persistent mass unemployment alongside accelerating inflation – serves to make Friedman’s 1968 point: an expansionary monetary and fiscal policy mix cannot, in and of itself, deliver, let alone sustain, full employment’. (HM Treasury, 2002b: 31) In its place, Third Way adherents have adopted Friedman’s adaptive expectations-augmented, vertical long run Phillips Curve (HM Treasury, 2002b: 205). This concept was first developed by Friedman (1968a) and Phelps (1968). Its rationale relies upon the neo-classical view of the labour market, where individuals seek to optimise their satisfaction by determining how much time they allocate to work and leisure at the prevailing real wage rate. If real wages are too low, a number of workers will prefer leisure to work, or will reduce hours spent working. However, government attempts to reduce unemployment through demand stimulus is likely to cause inflation, and therefore nominal wages will increase, causing unemployed workers to mistake this as a rise in real wages and therefore actively seek employment. Once workers realise that the real wage remained unchanged, despite an increased nominal wage (due to a rise in inflation), they will withdraw their labour once again, preferring to substitute leisure for work at the prevailing real wage rate, and

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thereby recreating the original natural rate of unemployment, only corresponding to a higher inflation rate. The intersection of supply and demand curves in a classical, aggregate labour market is assumed to determine a long run equilibrium ‘natural rate’ of unemployment, at a given real wage (Friedman, 1968a: 8). The inflation rate depends upon both unemployment and inflation expectations, and government attempts to reduce unemployment below the natural rate will ultimately end in failure, and at the cost of ratcheting inflation rates higher on every occasion Keynesian stimulation of demand is attempted. Government is, therefore, powerless to reduce unemployment below the supplydetermined long run equilibrium rate. Recently, a new variant of the supply-determined equilibrium rate of unemployment has been developed which, although heavily dependent upon Friedman’s earlier work, has introduced a number of innovations. This concept is the NAIRU. It is defined as that level of unemployment, determined by the interaction between market forces of demand and supply within the labour market, which maintains a steady rate of inflation. If unemployment is pushed below the NAIRU rate, it will result in rising inflation. Therefore, the NAIRU essentially determines the long run level of economic activity, and both monetary and fiscal policy are to be operated to tolerate whatever the rate of unemployment necessary to restrain inflation. Furthermore, the NAIRU is determined in the labour market in the same way as the natural rate. Orthodox policies intended to shift the equilibrium rate of unemployment downwards may involve increasing the supply of labour through lowering reservation wages via reducing marginal taxation and/or tightening the generosity and duration of social security transfer payments. They may equally involve restricting the activities of trade unions, eliminating labour market regulation, lowering job search costs and enhancing the matching of skills between unemployed workers and job vacancies. Thus, the equilibrium natural rate of unemployment depends upon the ability to increase the willingness (and ability) of unemployed workers to fill the stock of job vacancies at a given real wage. Indeed, the increasing interest in labour market flexibility derives from this theoretical proposition. In addition to an orthodox version of NAIRU, based upon neoclassical labour market assumptions, a New Keynesian alternative has been constructed, founded upon assumptions of imperfect competition within product and labour markets, which suggests that inflation arises from incompatible distributional claims on available income, between labour and capital (Layard and Nickell, 1985; Mitchell, 1987; Carlin and

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Soskice, 1990). Unemployment, in this model, acts to discipline the aspirations of collective labour so that they fall to a level compatible with the profit expectations of capital, whilst the lower levels of aggregate demand associated with unemployment constrain firms’ ability to raise prices. Changes in union bargaining power, state incomes policies, variation in taxation and external shocks to the economy may all influence the NAIRU. To the extent that labour market reforms intended to reduce the equilibrium rate of unemployment imply workers’ acceptance of formerly unattractive employment terms and conditions, this approach depends upon reinforcing the existing balance of power in society. Thus, to lower the NAIRU, collective labour power has to be restrained, and workers persuaded or pressured into accepting jobs at lower real wage rates than they would prefer, and/or weaken wage militancy so that smaller wage raises can enable more people to be employed. One feature common to all of these variants of an equilibrium rate of unemployment relates to their view that the level of aggregate demand is forced to adjust to the level of employment established by supply-side factors, whether these be the interaction of market forces and/or the balance of power in a distributional conflict between labour and capital. Moreover, these supply-side factors are not influenced by changes in aggregate demand, but rather are determined within the labour market. But is it useful? The NAIRU has become a widely accepted theoretical tool, not because it accurately describes objective reality, but because it is considered to be a useful aid to policy-making. Indeed, the NAIRU can never be directly observed. The best that can be achieved is to determine whether the rates of inflation and unemployment tend to conform to the predictions of the theory. This need not in and of itself cast doubt upon the theoretical concept. However, the difficulty demonstrated in estimating the NAIRU over time does tend to undermine its usefulness. Indeed, Eller and Gordon (2002) claim that a ‘time-varying’ version of NAIRU is able to explain the decline in inflation rates in the US in the 1990s rather well. Significant factors include changes in the labour market, principally the decline in trade union power, together with a series of beneficial supply shocks; the latter including falling import prices related to food and energy, together with a sharp decline in the prices of computer and medical care products. There is, however, a large literature which highlights the uncertainty and unreliability surrounding NAIRU estimates (Setterfield et al., 1992;

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Staiger et al., 1997; Sawyer, 2003). Estimates of the NAIRU have rather large statistical error terms. For example, Setterfield et al. (1992: 134) suggest that the NAIRU estimates calculated for Canada are so sensitive to model specifications, definition of variables and the time periods selected for analysis that the range of estimates tendered is so large as to encompass almost all actual unemployment rates experienced in Canada since 1956. Moreover, the estimated NAIRU tends to track the actual unemployment rate, although subject to a small but significant time lag. Thus, ‘if the implication is that next year’s NAIRU is a random walk from this year’s, the practical consequence is not much different from that of abandoning NAIRU models altogether’ (Galbraith, 1997: 102). Hence, Arestis and Sawyer (2004: 33) feel able to claim that ‘theorising on the NAIRU has failed to produce any convincing arguments that the NAIRU will be a strong attractor’ for the actual level of unemployment. It is probable that the economy will be operating, for long periods of time, away (and sometimes considerably) from the NAIRU. Therefore, there is little justification to assume that real wages or aggregate demand will simply adjust simply and rapidly to the NAIRU, unless, in the case of the latter, one relies upon the assumption of Say’s Law. Irrespective of the theoretical and practical weaknesses inherent within the utilisation of the NAIRU concept, equilibrium rate estimates are still utilised by most governments and economic analysts to guide economic policy. However, its application tends to be asymmetric, in so far as analysts are associated with an apparent tendency towards raising predicted rates than to lower them, with the consequent bias against expansionary policies (Galbraith, 1997: 102). Consequently, both in its theoretical bias against active government policy, together with its bias in application, the equilibrium concept of unemployment causes policy to be constrained more than it need to be, with the consequence that unemployment is higher as a result (UNCTAD, 1995: 172). Critique: Demand matters There are, however, a number of fundamental weaknesses with reliance upon supply-side determined equilibrium rates of unemployment, such as the natural rate and NAIRU approaches. First, A Keynesian critique reiterates Keynes’ observation that workers are concerned with relative wages in addition to real wages, and yet they can only negotiate for nominal wages, thus undermining the concept of a classical labour supply curve (and hence an aggregate labour market) upon which orthodox variants of equilibrium theories are based. Instead, the PostKeynesian theory of employment arises out of Keynes’ discussion of

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‘the principle of effective demand’ in the General Theory, when he argued that the demand for labour is derived from the equilibrium rate where the aggregate supply function and aggregate demand intersect, at the point where entrepreneurs’ expectations of future profits will be realised, an effective demand point determined in the product markets (Keynes, 1936). Thus, for post-Keynesians, no aggregate demand for labour schedule exists whereby the real wage is capable of determining employment level (Davidson, 1983 and 1998; Galbraith, 1997: 95). Employment is determined in the product market by the aggregate demand for output. Thus, ‘mass unemployment is a macroeconomic phenomenon and can never be a real wage problem’ (Mitchell, 1998: 2). Secondly, contrary to the claims made by neo-liberal commentators, there is little evidence to suggest that wage inflexibility and rigidities associated with labour market institutions have acted as significant factors in the increase in European unemployment (Madsen, 1998; Ball, 1999; OECD, 1999b; Blanchard and Wolfers, 2000; Baker et al., 2002). Instead, a more plausible explanation envisages demand shocks leading to lower rates of capital accumulation; an initial impact which was magnified due to the existence of hysteresis (Rowthorn, 1995). Indeed, this conclusion would appear to be confirmed by the experience of those European nations (i.e. Ireland, Netherlands, Portugal and the UK) which managed to significantly reduce high levels of unemployment, suffered during recession periods in the early 1980s and 1990s, due to expansionary monetary policy pursued during subsequent periods of recovery (Ball, 1994 and 1999). Arestis and Sawyer (2004: 93) suggest that regional variations in levels of unemployment fit poorly with explanations based upon factors such as the NAIRU, labour market institutions, regulations and unemployment benefits, as these typically apply throughout the entire economy, whereas regional variations in industrial structure, productive capacity and aggregate demand may offer a more plausible rationale. Furthermore, there is a large and growing literature that claims that productive capacity has a large, statistically significant impact upon employment (Bean, 1989 and 1994; Rowthorn, 1995 and 1999; Arestis and Mariscal, 1997: 191; Miaouli, 2001: 23; Alexiou and Pitelis, 2003: 628; Baddeley, 2003: 214). In one study, Stockhammer (2004a) contrasted the NAIRU explanation of unemployment with the Keynesian alternative, and found capital accumulation to be a far better explanatory for changes in unemployment than labour market factors. A considerable body of evidence therefore indicates that aggregate demand does in fact have an impact upon the real economy principally

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because it influences, and in turn is influenced by, the rate of investment, which alters the stock of capital and thereby affects productive capacity. A larger capital stock will permit a higher level of aggregate demand – and hence higher output and employment – without resulting in an increase in inflation. Depressed economic conditions result in the deterioration and premature scrapping of productive capital, whilst the accompanying dismissal or underemployment of a firm’s workforce damages a firm’s intangible capital through eroding corporate learning resources, customary working practices and industrial relations. An economic recovery will not immediately rectify this deterioration in economic performance, and thus demand shocks can have a significant impact upon the real economy that are still being experienced several years after the initial event. Major recessions cause a downward shift in the growth path of productivity and hence potential productive capacity, with stable growth paths resuming in the aftermath of the recession, but only from the low point that capacity scrapping first caused (Dow, 1998: 369; Arestis and Mariscal, 2000: 487). As a result, the important finding is that the utilisation of Keynesian measures to prevent the disruption to economic development caused by economic recessions can have a significant impact upon investment rates, industrial capacity, output and productivity. As Rowthorn (1995: 38) states, ‘the problem of unemployment is ultimately one of investment’. The fact that sufficient productive capacity can shift the NAIRU to full employment does not mean that this will necessarily occur, and indeed the existence of high rates of unemployment, together with low levels of capacity, will dissuade investors to finance the construction of such an extension in future capacity. This would leave the economy stuck in deflation, as the necessary increase in aggregate demand, required to raise expectations sufficiently to facilitate an expansion in investment, would, according to the NAIRU theory, result in inflation. The recognition of the importance of aggregate demand upon employment and inflation does not, however, marginalise other factors that have been found to influence macroeconomic variables. Ownership and corporate governance have been found to influence the investment climate and, therefore, productive capacity and employment. For example, Stockhammer (2004b: 19–24) pointed to globalisation leading to liberalised financial markets resulting in a shift in many countries from a bank-based to a market-based financial system, which, in turn, led to increased instability and asset price speculation (Minsky, 1985; Shleifer and Summers, 1990; Shleifer, 2000; Skott, 1995). Furthermore, ‘financialisation’ may have caused a shift in corporate governance, empowering

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shareholders relative to managerial interests, and consequently prioritising profitability at the expense of a decrease in investment and hence productive capacity (Stockhammer, 2004c). One further source of theoretical challenge to a supply-side determined equilibrium rate of unemployment relates to the hysteresis hypothesis. First developed by Phelps in 1972, this approach suggests that the equilibrium rate of unemployment is path-dependent, in that it depends upon the actual history or path of unemployment. Unemployment persistence can be considered to influence future unemployment rates because the skills held by an unemployed individual may deteriorate over time, as can their work discipline, confidence and hence employability in the eyes of the employer. The longer an individual remains unemployed, their search efforts may decline, together with their expectation that they may succeed in securing a new job. The literature relating to hysteresis is split between those who hold a ‘weak’ and a ‘strong’ version of the theory. The former typically adopts the New Keynesian assumption that aggregate demand policies have no impact upon long-term equilibrium unemployment (Layard et al., 1991). Consequently, hysteresis may have a marginal impact upon unemployment rates during the short term, but in the medium and longer term the supply-determined equilibrium rate of unemployment will hold. However, those theorists who advocate a ‘strong’ version of hysteresis believe that it is sufficiently powerful that actual unemployment largely determines equilibrium unemployment, and therefore governments can shift the NAIRU by affecting actual unemployment (Blanchard and Summers, 1988; Ball, 1994). In the latter case, an increase in actual unemployment can, in the medium term, cause the equilibrium rate of unemployment to similarly rise, whereas a reduction in unemployment in the short term may cause a reduction in the equilibrium rate of unemployment. Empirical evidence tends to support this position, as Arestis and Mariscal (1998: 202) identified hysteresis effects in addition to worker militancy and the level of capital stock, as significant determinants of the level of unemployment. The ‘strong’ version of hysteresis, therefore justifies policy activism to reduce unemployment beneath the prevailing equilibrium rate, because by doing so it will enable that equilibrium rate to decline itself in the future. Hysteresis thereby implies that any equilibrium rate is only a temporary phenomenon, since current unemployment remains a significant factor determining future rates. This is tantamount to rejecting the concept of an equilibrium rate at all, and replacing the concept with a disequilibrium

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analysis so favoured by the famous Stockholm School of Economics.2 If an equilibrium rate of unemployment can be altered by every shift in government policy, together with demand and supply shocks to the economy, and is influenced considerably by the actual unemployment rate pertaining at any one moment, it is scarcely of any practical use. It will not provide a fundamental barrier to lowering actual unemployment in the longer term because actual unemployment can be reduced by demand stimulation and, through hysteresis, can itself cause the original equilibrium rate to be reduced. Hence, the practical result is that government might as well operate as though disequilibrium is the natural state of affairs, because even if the economy is ultimately converging to a long-term equilibrium position, it does so slowly. Thus, short-term policy changes can shift the long-term equilibrium so that it is likely to have shifted position long before actual unemployment could ever have converged with the original equilibrium position.

Rational expectations, the time inconsistency problem and credibility The time inconsistency problem is essentially a problem of imperfect information, and therefore the more that economic actors can understand about the underlying health of the economy and the motivation of the policymakers, the lower their degree of uncertainty and suspicion that governments seek to manipulate policy for short-term advantage. This concept was based upon the work by Lucas (1976), who argued that private sector economic agents understand the intentions of policymakers and therefore changes in policy will lead to changes in private sector behaviour. This increases the difficulty in designing optimal policy on the basis of past experience since the introduction of the new policy innovation would be likely to cause changes in patterns of behaviour. Lucas’ work was subsequently further developed by Kydland and Prescott (1977), whose main concern was that government might try to use their information advantage over other economic actors to try to reduce unemployment through demand stimulation even though they privately knew that this would be unable to achieve its goal without allowing inflation to increase over the expected rate. According to the assumption of the NRU, reflation could only be successful if economic actors mistook a rise in nominal wages for a rise in real wages, and therefore secured employment on this basis. In other words, reflation is possible only if economic actors formed adaptive expectations through review of past history and could therefore be surprised for a transitory

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period of time by unanticipated government action. However, the assumption of rational expectations ensures that wage setters would anticipate that government might undertake such behaviour and therefore economic actors would incorporate the expected higher rate of inflation into their nominal wage demands. Thus, monetary surprise would not occur and employment would remain static at a higher rate of inflation. Hence, policy activism is ineffective. One solution to this problem could involve the pre-commitment of the economic authorities to state publicly that they would not attempt to ‘surprise’ other economic actors with such behaviour. However, Barro and Gordon (1983) argued that this might be difficult to achieve in reality because of the incentive for policymakers to renege on this policy stance in order to mislead economic actors and thereby engineer an increase in employment. Thus, a rule, which can be changed relatively easily by government economic authority, lacks credibility and therefore fails to solve the time inconsistent problem. It is therefore important for the government to build its reputation and gain credibility in this regard if it lays considerable emphasis upon its policy rules, or alternatively government could establish an economic agency given policy independence but designated to pursue the policy rules. The New Labour British government has accepted the reality of the time inconsistency problem and has designed a great deal of its policy framework around the ramifications arising from this theoretical problem. In its own words: Global capital markets have intensified the ‘time inconsistency’ problem. In a closed economy, the issue is whether governments can fool their electorates into believing higher growth is sustainable for a while before domestic price inflation rises and the value of their real wages falls. But in an open economy, with capital mobility, discretion also gives the government the ability to fool international investors into believing that growth will be sustained before the exchange rate – and therefore the profitability of their investments – falls. (HM Treasury, 2002b: 35) The New Labour solution is to pursue ‘credibility through sound long term policies’, so that international financial investors are reassured by the pre-commitment of the government to both fiscal and monetary policies that are transparent in their intent, long term in mature and prove to be sustainable over the long term. In its oft-quoted ‘four principles’ that dominate its macroeconomic policy framework, three

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refer to the establishment of credibility through the implementation of policies with long-term objectives, the pre-commitment of policy rules and provision of ‘maximum transparency’ to enable economic actors to evaluate the veracity of government statements and actions (HM Treasury, 2002b: 27). Credibility is intended to be enhanced by the adoption of a long-term approach to policy formation, together with openness and transparency in both policy formulation and application, and accountability for policy activities. This general approach was replicated by most other European social democratic parties (Clift, 2001a: 64). Indeed, it is notable that European social democrats ‘defended enthusiastically’ both the Maastricht convergence criteria (MCC) and the complementary Stability and Growth Pact – both ‘yardstick[s] of credibility’ – as a fundamental element of the design of the European EMU (Recio and Roca, 1998: 143). Critique of rational expectations The theory of rational expectations is, however, based upon a number of unrealistic assumptions, and therefore the predictions made by the theory are suspect. First, for example, the approach overlooks the existence of asymmetries of information in assuming that all individuals possess equal access to information and are equally able to process this complex information in order to make rational and consistent choices. Secondly, the theory assumes consistency, and yet all individuals can make inconsistent decisions, depending upon calculations that are perfectly rational for them at the time. Indeed, Tversky and Kahneman et al. have demonstrated numerous instances of irrationality by individual economic actors (Kahneman et al., 1982; Bell et al., 1988; Shafir, 2004). Moreover, the insufficient availability of information are likely to undermine the concept of all individuals being able to develop a universal, consistent model of the world (Stiglitz, 2003: 151–153). Thus, the unpredictability of the future, due to asymmetric information, the impact of monopolistic competition and unpredictable external shocks may lead to ‘rational ignorance’ where individuals react to a world where most change is essentially unexpected and therefore prefer to concentrate upon short-run actions (Galbraith, 1997). The Keynesian alternative to the rational expectations approach suggests that, during conditions of uncertainty, when insufficient information is available to calculate probabilistic risk, then individuals are likely to utilise all relevant knowledge that is available, even if this is of only tangential relevance to the decision to be made (Davidson, 1995; Lawson, 1995: 93–98). Furthermore, many decisions are not made on the basis

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of objective reality, but on the basis of speculation concerning the anticipation of future outcomes. Thus, speculators do not purchase a stock or currency on the basis of economic fundamentals relating to that company, currency or even its underlying economy, but rather ‘what the market will value it at, under the influence of mass psychology, three months or a year hence’ (Keynes, 1936: 155). The rational expectations approach additionally assumes a market system whereby ‘prices reflect instantaneously everything that is known today, and prices today reflect a consistent set of expectations about what prices will be infinitely far into the future’ (Stiglitz, 2003: 152). The policy conclusion reached is that government intervention is always inefficient and unnecessary. Yet, these conclusions, particularly relating to the supposed efficiency of markets, collapse if economic actors have differential access to information and/or have different beliefs, and there is an overwhelming weight of evidence to suggest it is the real position. Therefore, Stiglitz (2003: 152) is able to claim that ‘unfettered markets, rampant with conflicts of interest, can lead to inefficiency’.

Constrained fiscal policy The traditional Keynesian-social democratic utilisation of fiscal policy focused upon its use as a demand management instrument intended primarily to pursue full employment objectives. Social democrats traditionally preferred an economic doctrine which placed emphasis upon the expansion of government expenditure, and hence the public services and welfare state, on the grounds that a larger state could better control the economy. Counter-cyclical policy, where government sought to expand demand to counter-deflationary consequences arising out of a shortfall of private investment, consumption and/or the balance of payments, would arguably operate with less disruption upon the population through small changes in a large budget as opposed to large changes made in a smaller budget. Thus, fiscal policy came to be used to ‘fine tune’ the economy, seeking to maintain permanent full employment and smooth the business cycle around the long-term rate of growth. For Keynesians, it was usually perceived as the primary macroeconomic instrument. The utilisation of fiscal policy is based upon the premise that no automatic mechanism exists which ensures that aggregate demand is sufficient to facilitate a high level of economic activity (Keynes, 1936; Kalecki, 1939). The Keynesian rejection of Say’s Law means that there remains no reason why ex ante savings should equal ex ante investment,

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either at the full employment level of economic activity, or indeed any other level of national income. Contrary to the pre-Keynesian assertion that investment is constrained by the supply of savings, it in fact generates the savings (in the form of undistributed profits) needed for its own finance. Thus, the greater capitalist profit, the higher savings and accumulation of capital will be, ceteris paribus (Caporaso and Levine, 1992: 117–118; Reynolds, 1987: 199). Budget deficits could stimulate the economy by absorbing excess savings, where this occurred, or provide additional finance for investment if this would otherwise exceed private savings. Indeed, Kalecki (1944: 135) even went so far as to suggest that governments might require a near-continual budget deficit in order to narrow the gap between savings and investment, at the full employment level of activity, or, alternatively, to reduce savings rates through a progressive redistribution of income. Third Way economics has rejected this central role for fiscal policy within macroeconomic strategy and preferred a more limited role for this policy instrument. Part of this new approach has involved a significant reduction in public expenditure as a proportion of national income in all west-European nations (Statskontoret, 1999: 39). Moreover, the US Clinton administration made deficit reduction its top priority (Baker, 2000). This has involved the down-sizing of the state, either to rectify a former tendency for government to over-reach itself and therefore to pursue more realisable objectives, or, alternatively, it has been argued that a fiscal consolidation may protect the future of traditional social democratic programmes from degeneration due to lack of resource in the age of globalisation. Irrespective of the motivation, Third Way economics has drawn from its neo-liberal economic theoretical foundations and imposed rules upon formerly discretionary fiscal policy, in the attempt to promote credibility with economic actors. If achieved, it is argued that this policy would reduce any risk premium added to internationally determined interest rates by the financial markets, hence securing lower interest rates consequent to a given level of inflation and growth in a nation state, which should in turn encourage investment, productivity growth and hence economic growth rates (Baker, 2000: 230). The shift from near-permanent budget deficit to a surplus during boom years might provide the resources and room for manoeuvre from financial market intervention if governments wanted to employ a short-term fiscal stimulus during periods of economic downturn; not to ‘fine tune’ the economy, but perhaps to provide a ‘rough tune’ of a more general type. This approach is described as constrained discretion.

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Fiscal consolidation There are a number of reasons why a degree of fiscal consolidation may have been necessitated by the various nations considered in this book. • The overhang of successive budget deficits has the consequence of increased total public sector debt, and this may increase the economy’s vulnerability to changes in the debt service burden. Interest charges on increased debt had risen as a proportion of budgetary expenditure across most industrialised nations, whether due to increased national debt and/ or the higher levels of real interest rates that have characterised the neoliberal economic period comprising the last two decades. This, in turn, reduces the ability of the government to use fiscal policy to cushion major shocks because of the pre-existence of budget deficits before economic downturns occur. However, this is also due to the potential for financial markets to place a risk premium upon interest rates, to account for anticipated higher future, higher inflation arising from fiscal expansion (a neo-liberal assumption), and therefore blocking the expansionary impact intended to arise from increased fiscal policy. • Globalisation arguably intensifies tax resistance amongst certain mobile groups with key transferable skills within society because these individuals can most easily find alternative employment within a lower tax area and therefore they will be less tolerant of high domestic taxation. In addition, high corporate taxation and/or rates levied upon investment income is difficult to maintain within a deregulated global environment, when differences in tax rates can make a significant cost difference for increasingly mobile companies, potentially leading to significant disinvestment from high tax economies, together with a loss of technological knowledge and employment opportunities. Neoliberal ideology mirrors this concern by highlighting the disincentive aspects related to taxation and high levels of public spending. A series of articles have highlighted the experience of the Swedish economy, which neo-liberals claim has suffered from low growth due to highspending Eurosclerosis (Agell, 1996; Dowrick, 1996; Henrekson, 1996), although such claims tend to be based by selective choice of data and time periods, and conclusions are often reversed when wider factors and different time periods are taken into account (Korpi, 1996; Whyman, 2003: 164). Election defeats of social democratic parties, where opponents have sought to identify them with supporting higher taxation, have caused social democrats to become hesitant to advocate raising taxation, whether temporarily as part of a Keynesian counter-cyclical programme or in order to fund public services. Thus, taxes have largely ceased to be, in

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Franklin Roosevelt’s phrase, ‘the dues we pay for the privileges of living in an organised society’, but rather an unjustified imposition upon individual economic activity. In their joint ‘manifesto’ for the Third Way, Blair and Schröder (2000: 167) advocated the reduction in both income and corporation tax, and with environmental taxation replacing part of this reduced burden upon work and profit. • A well-publicised claim that there exists a ‘crisis’ in the welfare state in many industrialised economies leads to the policy conclusion that these should be reformed, reducing entitlement and generosity of programmes, and possibly promoting privatising provision. Part of this argument arises from extrapolation of the consequences arising from potential future demographic changes within societies, for example an aging population reducing the number of taxpayers per net welfare recipient, whilst enhanced life expectancy resulting in increasing demands upon pension funds and caring facilities. Individual economies are thought to have rather different exposure to such demographic challenges. For example, Italy is characterised by falling fertility rates, high life expectancy and relatively comprehensive public pension provision and is therefore projected to suffer an increase in government spending on health and pensions of some 10 per cent of GDP by 2030. In contrast, the figure for the UK is only 2 per cent, due to factors including higher and more stable fertility rates, a slower rate of growth of life expectancy and less generous public pensions provision (Walker and Maltby, 1997; Hay, 1999: 26). Nonetheless, concern over the future affordability of welfare states has caused reviews in Sweden, the UK, Italy and Germany, where the essence of proposed reforms seeks to replace defined benefit regimes with defined contribution regimes (ISSA, 1995; Scherman, 1995; Walker, 1996; Stephens, 1997; Walker and Maltby, 1997; Campbell, 1998; Hay, 1999: 26). The ‘crisis’ of the welfare state is often linked with the increased importance of globalisation – perhaps leading on from the difficulty in raising taxation upon mobile assets. However, Garrett (1998:150) suggests that: There is no doubt that government budgets throughout the industrial democracies will be put under increasing stress in the coming decades. But globalisation is not the source of these pressures. Rather, the root causes of the looming welfare state crisis are, in the context of stable working-age populations, significant increases in steady state rates of unemployment and, more importantly, the growing ranks of the aged populations entitled to state pensions and health benefits.

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• A slightly different point than the previous one relates to the claim, made most prominently in the discussion of neo-liberal policy in the US, that one element in the strategy devised by radical Republicans to rollback the ‘New Deal’ state programmes involves convincing the American electorate that the programmes are unaffordable and should therefore be reformed or scrapped entirely. One method of doing this is to allow the US budget deficit to rise to unsustainable proportions, and then using the sense of crisis to force through reductions in public provision. Reich claimed that the large budget deficits arising from the combination of tax cuts and military budget expansion under Ronald Reagan were ‘the law of intended consequences’ – in other words, the fiscal programme had been intended to create a budget deficit sufficient to prevent new federal spending initiatives (Klein, 2002: 50; Reich, 2002: 744). To the extent that this argument is correct, it does provide justification for progressive political parties to pursue rather orthodox budgetary measures to try to reduce run-away deficits in order to improve public finances and thereby improve the confidence in the future of the welfare state amongst the citizenry. One weakness with this approach is when budget balance tends to become the goal rather than the means to a different end. This is one criticism that can be levelled at the Clinton administration, namely that balancing the deficit became the centrepoint of the administration and therefore few of the innovative programmes that were discussed in Democrat circles were ever actually realised. • One Euro-centric rationale for improving public finances within a short period of time relates to the determination on behalf of most European social democratic movements for increased regional economic and political integration to lie at the heart of the continental progressive programme. Part of this agenda, therefore, involves participation in EMU, with the consequent implications for fiscal policy inherent within the convergence criteria established by the Maastricht Treaty on European Union, and supplemented by the latter Stability and Growth Pact (SGP). These rules were established to try and ensure that only reasonably comparable economies participated in EMU, and therefore applicant countries were supposed to meet the reference targets of budget deficits not exceeding 3 per cent of GDP and public debt remaining below 60 per cent of GDP (EU Commission, 1992). Moreover, the SGP is a condition of membership and perpetually maintains this degree of budget discipline. Failure to comply, apart from during particularly deep recessionary periods, where national income declines by at least 0.75 per cent in a given year, would invite censure

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from the EU Commission, together with fines of 0.5 per cent of GDP if sanctioned by the Council of Ministers. Thus, those twelve EU member states participating in EMU have been forced to pursue fiscal retrenchment within a relatively short period of time, and irrespective of the place in the business cycle that has meant that much of this fiscal contraction has acted to stymie continental European growth rates, and prolong high levels of unemployment, than would otherwise have been the case. From a neo-liberal perspective, excessive borrowing by the public sector crowded out more productive private sector investment, whilst signalling to the financial markets that taxes might have to rise in the future, thereby reducing the benefits of holding national assets and potentially undermining price stability through exchange rate depreciation. However, there is a progressive, post-Keynesian argument for well-timed fiscal consolidation, namely that increased international indebtedness was a negative phenomenon because it had increased the sensitivity of the national economy to the dictates of international financial money markets. Theoretical arguments against active fiscal policy A theoretical argument proposes a limited role for fiscal policy on the basis that neo-liberal assumptions, explained earlier in this chapter, lead to the natural consequence that monetary policy is a superior policy instrument. Acceptance of the natural rate of unemployment hypothesis, reinforced by assumptions of rational expectations, implies that fiscal policy is incapable of stimulating aggregate demand, the Keynesian multiplier is weak or non-existent. Indeed, critics of active fiscal policy claim that, instead of actually raising aggregate demand, rising government spending would be offset by falling private investment due to a crowding out effect (Meerpol, 1998: 42). Others suggest that time lags inherent within the budgetary and fiscal policy implementation programmes lead to the mistiming of fiscal boosts and reductions, thereby exacerbating business cycles rather than counteracting their fluctuations. Fiscal policy should, therefore, be largely passive in nature and be left to automatic stabilisers, operating alongside budgets balanced over the business cycle (Arestis and Sawyer, 2004: 119).

Time lags There are a number of arguments made against the use of discretionary fiscal policy. One relates to the time lags inherent in the adoption

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and implementation of fiscal policy due to institutional operations (Hemming et al., 2002a). Governments typically have only one (or perhaps two) budget per year, at set times in the calendar, and it is likely that these events will not correspond exactly to the needs of the economy. Parliamentary scrutiny of the proposals and debate leading to eventual approval, or rejection and subsequent renegotiation of budgetary measures, leads to a further time lag. Finally, once approved, implementation may involve an additional time lag, referring to the time duration for fiscal policy to impact upon aggregate demand. As a result, time lags inherent within the policy determination and implementation process may be sufficiently long that fiscal policy becomes pro-cyclical rather than counter-cyclical; this depends upon the length of fiscal policy time lags relative to the duration of the business cycle. Thus, Friedman (1962: 38) felt able to claim that, primarily due to time lags and subsequent mistaken timing of government action, ‘the fact is that the Great Depression, like most other periods of severe unemployment, was produced by government mismanagement rather than by inherent instability of the private economy’. In practice, innovative forms of taxation and capital investment projects may have longer ‘inside’ lags than variations in tax rates and transfer payments, whereas ‘outside’ lags will be more variable and depend to a large degree upon the institutional framework characterising the economy. Moreover, ‘inside’ time lags can be reduced through the adoption of a fiscal policy rule, rather similar in essence to rules discussed in the context of monetary policy – one example could be to establish a rule that prioritises full employment. ‘Outside’ time lags could be shortened through, for example, the introduction of investment funds of the type that were successfully utilised in the Swedish economy during their unequivocal ‘Keynesian period’, where private sector organisations were encouraged, through provision of tax incentives, to develop capital investment plans in advance of an economic downturn, to be financed through deposits held by the central bank and to be withdrawn tax-free if investment occurred and was officially sanctioned during a slowdown in the business cycle.

Crowding out A second set of arguments relates to the claim that fiscal policy will be largely ineffective due to ‘crowding out’. There are a number of different ways in which crowding out could occur. One arises if a fiscal expansion results in rising interest rates which will choke the fledgling

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upturn in the economy (Neville, 2000: 159). Although, if one adopts the post-Keynesian assumption of endogenous money, then this could occur only if the monetary authorities (i.e. perhaps an independent CB) raise rates to presumably prevent the generation of inflationary pressures and therefore deliberately offset the intent informing the original fiscal expansion. A second variant claims that rising fiscal expenditure will result in a larger budget deficit (or smaller surplus) and therefore the government will consume an increasing proportion of private savings and therefore crowd out private investment (Friedman, 1962: 81). This is an old argument that dates back to the 1930s British ‘Treasury view’ which opposed public works schemes on the basis that spending on these initiatives would displace an equal amount of private-sector investment spending, despite ample evidence of resources laying idle due to mass unemployment and underutilisation of productive capacity (Palley, 1998: 141). However, this is based upon the assumption of exogenous money and a resultant given level of savings, whereas post-Keynesian theory holds that an expansion of effective demand will stimulate investment which, in turn, will generate additional income and thereby boost rather than reduce savings. It additionally ignores the potential for a balanced-budget multiplier, where an increase in both government expenditure and revenue provides a stimulus to the economy due to the fact that the marginal propensity to spend public expenditure is higher than the private consumption lost due to the commensurate rise in taxation (Neville, 2000: 159). Although, in most cases, the limited stimulus provided by this mechanism would be insufficient in the fact of recessionary pressures, and therefore the criticism of deficit financing reappears. A final variant suggests that crowding out will occur because the economy tends towards a NAIRU, or natural rate of unemployment, supply-side determined equilibrium in the long run and therefore fiscal policy expansion will be ineffective. The problem here is that, in the absence of market forces sufficiently powerful to ensure a rapid adjustment in aggregate demand to be consistent with the supply-side equilibrium, then fiscal policy can be effective. Not surprisingly, given the importance of this point for the significance attached to active macroeconomic policy, different schools of economic thought fundamentally disagree with one another. New Classical economics starts from the proposition that markets clear instantly, and therefore adjustment to the supply-side equilibrium occurs immediately, leaving no room for fiscal policy or indeed any

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form of expansionary economic policy. By contrast, the New Keynesian– New Monetarist consensus, that dominates contemporary economics, allows for fiscal policy to have an impact in the short run, although not in the long run. The post-Keynesian school, however, emphasises the role that the path of aggregate demand can have upon the real economy through its impact upon investment expenditure and thus upon the size of the capital stock. Therefore, should a supply-side equilibrium of some form exist, the short-run impact that aggregate demand can have upon capital formation therefore can influence employment and output over the long term – leading to the conclusion that fiscal policy can have an influence even in the long run. Of course, if fiscal expansion occurs in a situation of full employment, then it will be far less effective than under circumstances of substantial space capacity in the economy, although it is worth noting that, even here, firms prefer to hold some excess capacity and workers can be persuaded to increase numerical flexibility for relatively limited periods of high demand, although there is an expectation that these circumstances will stimulate demand-pull inflationary pressures. Empirical evidence suggests that fiscal policy multipliers range from 0.1 to 3.1, with expenditure multipliers ranging from 0.6 to 1.4 and tax multipliers from 0.3 to 0.8 (Hemming et al., 2002a and 2002b). Thus, fiscal policy tends to be more effective if expenditure based (rather than tax based), occurs within either a closed economy or open economy combined with a fixed exchange rate regime, and if fiscal expansion is combined with a loosening of monetary policy (Arestis and Sawyer, 2004: 129). Constrained discretion The Third Way approach to fiscal policy draws from both the practical and theoretical arguments arrayed against the use of active fiscal policy. Moreover, Third Way administrations have sought to reduce the burden of taxation upon companies to attract FDI and/or sustain existing domestic production activities. This has required a reduction in the size and scope of government and it equates well to the neo-liberal prescription of low taxation leading to enhanced incentives to work and investment; with anticipated increases in productivity, employment and growth rates as a result. However, Third Way fiscal policy is slightly more sophisticated than simply instituting public sector cutbacks. It has borrowed from the concepts of rational expectations and the time inconsistency problem to result in an attempt to introduce similar reforms for fiscal as monetary policy (Chapter 4). Thus, fiscal policy is

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intended to have long-term objectives that are pre-committed and remain stable over time, are transparently established and implemented. This is intended to create a degree of predictability and credibility amongst economic actors, domestic and overseas (HM Treasury, 2002b: 135). This approach has been termed ‘constrained discretion’ (HM Treasury, 2002a). Part of this process is to establish rules for fiscal policy, and the ability for government to keep to these self-imposed rules over a long period of time is intended to enhance the credibility of the policy framework. However, rather than borrow orthodox rules from the past, such as the old pre-Keynesian ‘Treasury rule’ of balanced budgets, the rules selected have been a little more progressive in their nature. For example, the British New Labour government has set itself two fiscal rules that it has made a key part of its economic credibility; • The golden rule – whereby, over the economic cycle, the government will borrow only to invest and not to fund current expenditure. • The sustainable investment rule – whereby, public sector debt as a proportion of GDP will be held over the economic cycle at a stable and prudent level. Furthermore, ceteris paribus, the government has indicated that it would prefer to reduce net public sector debt below 40 per cent of GDP over the economic cycle, although towards the end of the second New Labour administration, the rate remains closer to 42 per cent of GDP (HM Treasury, 2002b: 135–136). The constrained discretion approach to fiscal policy is openly based upon neo-liberal theoretical assumptions (HM Treasury, 2002b: 27–43). It is intended to circumscribe the freedom of fiscal authorities to act according to their short-term assessment of optimal policy options in order to keep to their pre-commitment to their budgetary rules. In this sense, ‘rules, by their nature, are intended to impose restrictions on behaviour’ (HM Treasury, 2002b: 157). To the extent that economic actors grow to trust the government to keep to its fiscal rules, then the cost of operating economic policy declines because international financiers are willing to reduce risk premiums placed upon interest rates due to the lowered perceived risk of unwise, inflationary fiscal and monetary policy. As a result, this approach provides for a moderate, time-limited opportunity to engage in expansionary discretionary policy, as long as this does not detract from meeting the long-term fiscal rules. In essence, it is based upon the strategy of pleasing the markets, and once achieved they will give the government the benefit

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of the doubt if it engages in short-term expansionary policy because of the belief that it will reverse this quickly and keep to its long-term fiscal rules. Deficit reduction and economic stimulus Traditional economic theory holds that cutting government spending or raising taxes to achieve deficit reduction depresses economic activity in the short term, but, assuming the crowding out theory is accurate, this might additionally lead to an increase in savings, investment and an expansion of the economic productive capacity in the longer term. However, Blanchard (1984) developed an alternative reasoning, during the 1980s, whereby the lowering of current expectations of lower future budget deficits will reduce current long-term interest rates, since borrowers no longer need to demand the type of premium over and above the internationally determined market rate. Lower interest rates can stimulate investment and other forms of interest-sensitive expenditure, thereby offsetting part of the short-term deflationary impact arising from deficit reduction. In other words, lower interest rates are said to ‘crowd in’ private activity (Elmendorf et al., 2002). Note, however, that this new approach depends upon the existence of crowding out for the crowding in effect to work, and this is hotly disputed by Keynesian theorists. Endogenous growth theory One final feature of Third Way economics is in its attraction to the New Keynesian endogenous growth theory (Atkinson, 1999; Kelly, 1999: 103). This proposes that investment in education, health and infrastructure development (i.e. transport and telecommunications) can raise the economy’s underlying growth rate. This provides the ‘new’ social democrats with a positive justification for certain types of public expenditure, in that these may be market-enhancing through raising skills levels, productivity and hence the expansion of output and economic growth. Thus, although fiscal policy constraints remain in terms of public expenditure in aggregate, Third Way economics is particularly interested in how this money is spent, and how growth is enhanced or hindered by supply-side factors, including how institutions foster technological innovation, the skill mix in the labour force and the extent to which economic policies promote investment (Moran and Alexander, 2000: 119). Once again, the focus of Third Way economics can be found in maintaining long-term stability on the demand side of the economy through a strategy of benign neglect of

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fiscal policy, coupled with active, market-orientated intervention on the supply-side of the economy in the attempt to improve market determination. Critique New Labour do at least acknowledge that ‘macroeconomic stability – low and stable inflation and sound public finances – is only a means to an end’ (HM Treasury, 2002b: 28). Yet, their concentration upon these targets makes it more difficult under many circumstances to achieve the ultimate traditional social democratic goals of full employment, high rates of economic development, social solidarity and equality, to which the party claims that it still adheres. Through sidelining policies dedicated to the demand-side of the economy, Arestis and Sawyer (1998: 41) argue that Third Way economics has no realistic strategy to increase investment and create the necessary capacity so that full employment can be restored. The one exception to this relates to the UK government’s promotion of inward investment (Labour Party, 1997: 15). Here, the policy focuses upon enhancing the attractiveness of the UK economy to inward investment, which implies prioritising the pursuit of business-friendly policies ahead of employee-centred reforms, and ultimately promoting enhanced profitability by continuing the shift in the distribution of national income from wages to profits. The Third Way analysis, however, ignores a number of points. First, it neglects the positive potential inherent within an increase in public expenditure, treating this simply as a burden upon the private sector. However, public expenditure has demonstrable beneficial effects upon economic growth, most notably through human capital investment, together with physical and information network infrastructure expenditure, but also through welfare expenditure acting as an automatic stabiliser, thereby preventing the economy from suffering a higher degree of capacity reduction than would otherwise occur during a recession (Korpi, 1985 and 1996; Barr, 1992). Secondly, Krugman (1999: 155) criticises the short memories of the adherents to the Third Way doctrines, due to the fact that, ‘for the first time in two generations, failures on the demand side of the economy – insufficient private spending to make use of the available productive capacity – have become the clear and present limitation on prosperity for a large part of the world’. Indeed, he asserts that an overt concentration upon ‘supply-side economics’ is ‘a crank doctrine’ which achieves influence only because it appeals to the interests of wealthy and opinion setters.

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The generalisation that occurs from the initial observation of changes in the international economy to the end prediction of the contemporary weakness of governments and traditional Keynesian policies has been overdone. However, acceptance that ‘something’ has indeed changed does not equate acceptance of the hyper-globalisation thesis. Indeed, an active debate continues amongst progressive theorists and political movements over the strategic options available to social democratic governments (Hirst and Thompson, 1996a; Vandenbroucke, 1996; Clift, 2001a: 63; Whyman, 2003). The Third Way is simply one outcome of this debate and its policy conclusions are not necessarily the best available. Nor, indeed, do all governments that might be associated with the Third Way approach, concur on all of these matters. For example, there is unquestionably a significant difference in emphasis between New Labour, the Swedish SAP and large sections of the German SPD.

Conclusion Third Way macroeconomics differs from the traditional social democratic approach in that it rejects Keynesian demand management on the basis that a supply-determined equilibrium rate of unemployment implies the ineffectiveness of government intervention in the economy to lower unemployment below this fundamental rate. The end result, it predicts, would be greater inflation. Moreover, the assumptions of rational expectations and implications derived from the inconsistency problem have caused the development of constrained fiscal policy. This involves a straightforward consolidation of public expenditure, together with reductions of taxation (particularly for mobile capital), and the pre-commitment to long-term, transparent fiscal policy targets, in the intention that the credibility established with economic actors will contribute towards the achievement of these goals. In particular, the focus upon creating a business friendly economic environment, through prioritising low inflation rather than full employment, redistributing national income towards profits in the attempt to attract inward investment, and tailoring economic policies towards those preferred by international financial markets, all leaves little room for distinctive, progressive national policies. Instead, Third Way economists have developed what they term a ‘new paradigm’ (HM Treasury, 2002b: x). This is further explored in the Chapter 4, with emphasis given to monetary policy.

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Notes 1. Two notable examples concern the German SPD’s shift away from its former Marxist analysis through adoption of the 1959 Bad Godesberg Programme, together with the Gaitskell-Crosland axis in the British Labour Party. The marked social democratic nature of the new programmes downplayed the importance of public ownership as a central feature of democratic socialist-social democratic analysis, to secure macroeconomic management and progressive redistribution. The adoption of Keynesianism meant that this could be achieved through monetary and fiscal policy. In theory, there is no reason why the two approaches need be exclusive and contradictory, but in practice acceptance of the social democratic-Keynesian consensus tended to result in a de-prioritisation of public ownership. 2. First coined by Ohlin in a paper in the Economic Journal in 1937, the ‘Stockholm School’ included Dag Hammarskjöld, Alf Johansson, Erik Lindahl, Erik Lundberg, Gunnar Myrdal and Bertil Ohlin (Hansson, 1991: 168–213). Their analysis was developed in parallel to Keynesianism but with greater emphasis upon disequilibrium analysis, derived from assumptions of irrational factors influencing economic actors and uncertainty of expectations in a dynamic economy, inferring that static theory is an inaccurate approximation of dynamic reality (Myrdal, 1927; Winch, 1966: 170). They argued that market economies contain a large element of cyclical instability and therefore governments should control the business cycle via fiscal policy.

4 Central Banks and Monetary Policy

Introduction Monetary policy is the dominant element within Third Way macroeconomic policy. Starting from the proposition that, in a globalised world, national economic policy has lost much of its former potency, the Keynesian approach to monetary policy is rejected. Thus, government no longer seeks to maintain tight regulation upon financial capital to facilitate macroeconomic management of the economy to secure full employment. Instead, it is assumed that governments need to retain the confidence of investors (domestic and overseas) to avoid capital flowing out of the country and undermining economic and social policy objectives (Driver and Martell, 1998: 61). The viability of reflation in one nation state, that occurs out of synch with other large industrialised economies, is called into question. The significance of international financial markets has had a significant impact upon the development of Third Way monetary policy strategy, which is designed with their preferences in mind. Thus, the long-term policy pre-commitment to prioritise price stability (or similar inflation target) is intended to generate an anti-inflation reputation for the monetary authority. This credibility is thought to be sufficient to minimise the costs of pursuing the low inflation strategy, as wage bargainers exercise their rational expectations and base their future expectations of monetary policy and inflation rates upon the transparent objectives and policy intervention explained by the monetary authorities. Full employment is therefore replaced by low inflation as the primary objective of macroeconomic policy. There is, moreover, a movement towards granting operational independence to national CBs in order to try and increase the credibility of 89

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non-inflationary policy as the insulation of independent CBs from political influence is assumed to deliver lower inflation rates. Together with fiscal constraint, this tighter monetary policy is intended to reduce the risk premium placed upon internationally determined interest rates according to predicted future inflation, devaluation and other risks posed by investment in economies in conditions of imperfect information. Pre-commitment to a low inflation agenda, together with transparency of government objectives and activities, is hoped to contribute towards lower real interest rates, thereby reducing the cost associated with the low inflation strategy and boosting investment, and thereby productivity and growth rates (Meerpol, 1998: 230, 255).

The essence of monetary policy Third Way economics accepts the proposition, derived from the work of Friedman (1963a), that inflation is ‘always and everywhere a monetary phenomenon’. The Governor of the Bank of England King (1997: 6) claimed that, in the long run, ‘there is no trade off between inflation and output’ and therefore ‘there is no point using monetary policy to target output’. Instead, inflation targeting is ‘the only sensible objective of monetary policy in the long run’ (King, 1997: 6). Gordon (1997: 17) argues that: In the long run inflation is always and everywhere an excess nominal GDP phenomenon. Supply shocks will come and go. What remains to sustain long-run inflation is steady growth of nominal GDP in excess of the growth of natural or potential real output. Greenspan (2004a) feels able to claim that ‘the notion, advanced by Milton Friedman more than thirty years ago, that inflation is everywhere and always a monetary phenomenon is no longer a controversial proposition in the profession’. Cost-push inflation is either ignored, or is assumed that this should be accommodated, or else that the shocks perfectly offset each other over time and therefore are of no real consequence. The pre-Keynesian consensus held that the equilibrium rate of interest, termed by Wicksell as the ‘natural rate of interest’, equated savings and investment at a supply-side equilibrium level of income. However, Keynes (1936: 242–243) rejected the concepts of a unique ‘natural’ rate of interest, and rather suggests that there is a ‘different natural rate of interest for each hypothetical level of employment’. This

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is because there will be a different rate of interest that corresponds to each level of effective demand which equates savings and investment, but does not necessarily do so at a unique level of full employment (Arestis and Sawyer, 2004: 101–102). According to the monetarist approach, money is assumed to be exogenous in so far as variation in the stock of money is perceived to have a casual impact upon the price level, and that the money supply is controllable by monetary authorities. Thus, the monetarist prescription for maintaining a low inflation rate is to limit the expansion of the money supply to the growth rate of productivity in the economy as a whole, so that demand expands exactly at the same rate as output and the real economy. By contrast, Keynesian economics starts from the assumption that money is endogenous, in so far as it is largely created by the banking sector and cannot be controlled by the monetary authorities. Money supply is no longer primarily notes and coins (M0), but is predominantly comprised of bank accounts, credit, mortgages, credit card balances and other easily liquidised financial assets. Thus, in the Keynesian view, causation runs from nominal income to the demand for money to the stock of money, as the availability of loans facilitates the expansion of investment, which leads to an expansion of savings and bank deposits. In practice, Keynesians argue that the CB establishes the rate of interest on the basis of its repo-rate – that is the rate at which it loans money to commercial banks – and the commercial banks provide loans at a higher rate of interest. The mark-up over the CB repo-rate depends upon a number of factors, including the degree of competition and market power of the banking sector, their liquidity preference and degree of risk aversion. Loans are forthcoming as a result of the demand for credit, and the money is transferred to borrowers through bank accounts, thereby increasing the supply of money circulating in the economy. The repayment of loans, by contrast, reduces the money supply. Thus, money is created within the inflationary process and, although the rate of inflation is closely associated with the growth in the stock of money, the causation runs from inflation to money. In other words, the money supply does not cause inflation, but rather rising prices lead to a commensurate rise in the money supply (Arestis and Sawyer, 2004: 107–109). Consideration of the difference in approach to monetary policy design, between neo-liberal and Keynesian economists, highlights an interesting contradiction at the heart of Third Way monetary policy, at least as implemented in the UK. Inflation targeting is the preferred

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strategy because of the general acceptance of Friedman’s claim that inflation is always a monetary phenomenon, and that the long run equilibrium unemployment rate is determined by supply-side factors and not demand. Hence, the Bank of England Monetary Policy Committee states its belief that ‘monetary policy works largely via its influence on aggregate demand in the economy’, having no direct impact upon supply capacity but rather determining the general price level in the long run (MPC, 1999: 3). Interest rates are, therefore, not viewed as a means of influencing the demand for, or supply of, money, but rather are treated as the main instrument to manipulate aggregate demand. Hence, monetary policy is the new fiscal policy! However, the most obvious way in which interest rates can influence aggregate demand is through its effects upon the rate of investment, and this, in turn, has a direct impact upon the size of the future stock of capital, productivity rates and hence rate of economic growth. Therefore, monetary policy has a real and durable influence over real economic variables (Arestis and Sawyer, 2004: 45–51).

Rules, pre-commitment and credibility Third Way monetary policy accepts the proposition that the money supply is the main instrument to be used to tackle inflation, and that this is the prime (or sole) objective facing macroeconomic policy. Moreover, due to the influence of the international financial markets, previous attempts to isolate domestic financial markets, and thereby impose administrative-determined interest rates upon the national economy, have been fatally weakened by deregulation and the freedom of movement of international capital flows. Thus, if a nation attempts to operate a ‘cheap money’ policy by causing interest rates to remain below the international norm, short-term capital will flow out of the economy in search of better returns, thereby causing a run on the national currency and potentially leading to a reversal in the policy. The resulting Third Way strategy is founded upon the recognition of the importance of international financial markets, and it seeks to utilise monetary policy to convince international traders, together with other significant economic actors, that pursuit of low inflation is credible and will be pursued consistently in the long term. To the extent that monetary authorities can build up an anti-inflationary reputation, economic actors will not need to build in a high risk premium into their activities because it is less likely that they will be surprised by unanticipated inflation or currency devaluation. In the same way as

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with fiscal policy, credibility can best be achieved by pre-commitment, transparency, long termism and consistency in approach. The adoption of monetary rules is advocated as another means to enhance the credibility of monetary policy by reducing the autonomy of the monetary authorities. The ‘k-percent rule’ advocated by Friedman (1960 and 1968a) is a good example of seeking to maximise the restraint placed upon policymakers through the imposition of binding rules on their actions. For Friedman, this was as much to prevent the skewing of monetary policy due to its dependence upon dominant personalities together with control by individuals who did not share the preferences of the population as a whole (Friedman, 1968b). A monetary rule which would leave monetary authorities with zero discretion. According to Friedman (1972: 227): A monetary rule would insulate monetary policy both from the arbitrary power of a small group of men not subject to control by the electorate and from the short-run pressures of partisan politics. According to this viewpoint, CBs should therefore be given the sole objective of ensuring a fixed growth rate of the money supply, preferably sufficient to facilitate the long-term growth trend of the economy, and thereby preventing inflation, which monetarists define as a monetary phenomenon. This strategy was intended at ‘tying central bankers’ hands in chains’ through neutralising its capacity for autonomous action (Friedman 1960 and 1968a). The monetarist position can be contrasted with that of Keynes, who possessed great faith in the ability and integrity of expert technicians to design and implement economic strategies capable of stabilising the economy and running it closer to maximum capacity. Economic authorities needed to use their judgement and possess the ability for autonomous action, in order to respond to variable shocks to the economy. There are, however, a number of problems with the use of monetary rules in practice. First, the deregulation of the financial sector, together with technological advance and extended consumer choice, has contributed towards unstable money demand functions. Hence, fixed monetary policy rules have proved to be too inflexible in practice (HM Treasury, 2002b: 32). Secondly, Greenspan (2003) states that ‘uncertainty is not just an important feature of the monetary policy landscape; it is the defining characteristics of that landscape’. Uncertainty in this instance is intended to embody both ‘risk’, where uncertainty of

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outcomes can be represented by a known probability distribution, and more general ‘uncertainty’, when the probability distribution itself is unknown. Thus, Greenspan acknowledges that monetary policy involves elements of ‘risk management’, seeking to quantify risk wherever possible but realising that, however perceptive economic theory and accurate the predictions made by resulting economic models, knowledge remains incomplete in an ever-changing economy. Thus, policymakers have to resort to judgement about the probable results of actions, costs and benefits associated with various possible outcomes resulting from different policy options. Moreover, Greenspan (2003) notes that: A policy action that is calculated to be optimal based on a simulation of one particular model may not, in fact, be optimal once the full extent of the risks surrounding the most likely path is taken into account. In general, different policies will exhibit different degrees of robustness with respect to the true underlying structure of the economy. Thus, he argues that any rule capable of encompassing every possible contingency would lose a key aspect of its attractiveness: simplicity. On the other hand, no simple rule could possibly describe the policy action to be taken in every contingency and thus provide a satisfactory substitute for an approach based on the principles of risk management.

Central bank independence If the establishment of monetary rules is too inflexible a means of improving the anti-inflationary credibility of the monetary authorities, a second proposal concerns making the national CB operationally independent. This has become one of the central precepts of orthodox monetary theory within a relatively short space of time. It is advanced as a means to secure a lower rate of inflation, in the medium to long term, than would otherwise prove possible with monetary policy remaining under a variant of political control. Lower inflation would facilitate a reduction in long-term interest rates, according to this scenario, thus producing an optimal climate for increased business investment, employment and economic growth. Thus, the notion of CB independence has taken on the character of an institutional panacea, capable of producing desirable macroeconomic results in a wide variety

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of national contexts. CB independence is, therefore, considered by many to be a ‘free lunch’ in so far as a country can thereby secure a lower inflation rate without suffering higher output variability (Grilli et al., 1991). This position is not, however, universally accepted. Critics point to the absence of convincing theoretical foundations and a paucity of supportive rigorous empirical data (Stiglitz, 2002: 45). Independent CBs are accused of having a deflationary bias, thereby undermining the effectiveness of policy co-ordination and democratic accountability. Indeed, Carvalho (1995: 161) memorably argues that the literature supporting central bank independence consists almost entirely of empirical propositions perfunctorily supported by fragmentary references to theoretical concepts, such as the natural rate of unemployment and the neutrality of money. This feature is particularly striking, since it seems counterintuitive that the very same theoretical arguments used to support the adoption of nondiscretionary rules of monetary policy appear now to justify what could be seen as a means to maximise the discretionary power of the monetary authorities. Moreover, the assumptions underpinning the case for an independent central bank are questionable. Nevertheless, circumstances appear to have combined to create an optimal climate for CB independence to be readily accepted by both the economic profession and, perhaps more surprisingly, the government representatives. The popularity of neo-liberal1 economic perspectives, together with the establishment of EMU between a majority of EU member states, based upon these principles, have provided much of the impetus behind the acceptance of CB independence from government. The newly established ECB drew much of its inspiration from the former Bundesbank, with its statutes being framed to create the most independent of all major CBs (Jabko, 1999). Eagerness on the part of many EU nation states to participate in EMU necessitated an acceptance of the principle of CB autonomy from all government influence and control. Supporters of CB independence can point to the fact that Keynes supported a form of CB independence, where economists, rather than bankers, were given policy autonomy to meet objectives established externally for the monetary authority. Milton Friedman, by contrast, categorically rejected the proposition, preferring to impose a monetary

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rule to prevent central bankers from exercising any significant degree of independence (Bibow, 2004: 554). As a result, Keynes opposed the proposal made by the then Labour Party leadership to make the CB governor subject to the general direction of a Cabinet Minister, as he believed that economic management should remain in the hands of experts (Keynes, 1982: 131). Keynes, however, only supported instrument and not goal independence for the CB. He believed that Parliament should determine the basic policy objective, for example an exchange rate or inflation rate target, before government established detailed policy objectives for the CB to pursue exercising its expert judgement in autonomy. The CB should therefore be unhindered to pursue the objectives established for it by democratic government, subject to requirements for transparency and accountability to Parliament. Nevertheless, Keynes stated that ‘the less direct the democratic control and the more remote the opportunities for parliamentary interference with banking policy the better it will be’ (Keynes, 1982: 131). The differences between Friedman and Keynes, on this issue, therefore, resolved around perceptions of the inherent qualities of monetary policy specialists and the degree to which central bankers’ discretion should be constrained. Keynes favoured ‘independent technicians’ exercising discretion in monetary policy, subject to checks and balances imposed by a supervising democratic authority, whereas Friedman preferred to ensure that monetary policy became ‘pure technique’, through the imposition of an absolute constraint in the form of an unchanging monetary rule (Bibow, 2004: 555). What type of independence? Central bank independence relates to the creation of a particular form of relationship between the CB and the government, whereby a degree of responsibility for monetary policy is delegated to the CB, which is intended to act as an autonomous agency. The concept of ‘independence’ is generally perceived to be obvious; it means simply that the government possesses no formal mechanism to influence central bank decisions over monetary policy (Wood, 1993). The form and degree of this independence can vary considerably depending upon the particular model selected. For example, the CB could be responsible for the selection of monetary policy targets, strategies and the instruments available to realise these objectives, or it could have discretion for the timing and content of monetary policy, once goals and instruments had been determined by the government economic authority.

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The term ‘independence’ is frequently employed as a convenient, if not potentially inaccurate, shorthand to describe a central bank’s status. As the Treasury and Civil Service Committee (1993: vi) indicated ‘so far as we are aware, there are no wholly independent central banks existent in the world today’. Thus, an alternative is to compare the degree of autonomy or dependence that a CB possesses. Hetzel (1990), for example, adopts a terminology of CB autonomy or ‘autonomy with discretion’ because of the risk that independence could be taken to imply a lack of constraints. Similarly Fair (1979) referred to ‘independence within government’ rather than ‘independence from government’ and even equates this preferred definition to the provision of independent, professional advice by the CB, possibly combined with the ability to publicise or at least signal a policy disagreement with government. Nevertheless, the terms independent and autonomy have become synonymous, with the latter generally omitted in both governmental, EU and academic literature. One of the earliest analyses of the various possible dimensions covered by such a concept was made by Friedman (1968b), who suggested that a possible definition could simply be that monetary policy is entrusted to a separate organisation which is subject to the head of that agency. Thus, interest rates will be determined by a CB monetary committee in a process completely independent of government. However, to the extent that the appointment of the governor and senior members of this monetary committee are appointed by the prime minister, or other senior government representative, the CB is not entirely free from political influence. The power of appointment normally carries with it the power to dismiss. Governors could therefore find their position untenable, if they pursued policies of which the government disapproved, even when they enjoyed the statutory freedom to do so. Consequently, the longer the period of tenure given to CB appointees, the more independent they are assumed to be from outside influences. The establishment of the European System of Central Banks (ESCB) feeding onto the ECB, created to manage exchange rate and monetary policy within EMU established by a number of EU member states, was established as the world’s most independent CB, under the terms of the 1991 Maastricht Treaty (EU Commission, 1992), whose Article 107 states that: When exercising the powers and carrying out the tasks and duties conferred upon them by this Treaty and the Statute of the ESCB, neither the ECB, nor a national central bank, nor any member of

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their decision-making bodies shall seek or take instructions from Community institutions or bodies, from any Government of a Member State or from any other body. The Community institutions and bodies and the governments of the Member States undertake to respect this principle and not to seek to influence the members of the decision-making bodies of the ECB and of the national central banks in the performance of their tasks. Arguments for central bank independence There are essentially three arguments that are utilised to support the concept of CB independence. All share the assumption that the market economy is essentially efficient, and will tend towards producing pricing decisions that will clear each individual market, balancing the demands of buyers and sellers, such that, in the absence of undue interference (from government, trade unions, etc.), it tends towards full employment of all resources in the economy. In pursuing their selfinterest, private agents are assumed to make (Pareto) optimum use of scarce resources. Thus, at any moment in time, market forces will produce the most efficient allocation of resources and distribution of market-determined income, and government intervention in this process is both unnecessary, and indeed counter-productive. • The assumption of a supply-determined long run equilibrium rate of unemployment, whether the monetarist natural rate or the New Keynesian NAIRU, implies the ineffectiveness of monetary policy since variations in money stock cannot influence the preferences held by efficient economic agents. As discussed in more detail in the previous chapter, if an assumption of adaptive expectations is made, then economic agents can be surprised by an increase in money supply into believing that real wages and prices had risen, and therefore increase their work and trading. Once they realise that this is simply the result of an inflation caused by expansionary money supply, the economic agents will resume previous patterns of work and trading. Thus, the assumption of the neutrality of money means that monetary policy can only generate oscillations in economic activity around the economy’s natural position, but cannot cause it to shift. Acceptance of the proposition that policy activism simply generates inflation, and has no permanent effect upon the real economy, leads to the conclusion that CBs should not try to influence employment and growth, but rather target price stability. In so far as independent CBs offer a superior institutional setting to secure this sole policy goal, the force of the

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argument generated by the natural rate hypothesis is that this framework should be adopted. • The assumption of time inconsistency, as discussed in the previous chapter, holds that a monetary authority might attempt to lower employment, even if temporarily, through increasing money supply as in the previous example. However the further assumption of rational expectations involves economic actors internalising the potential for government action in their future expectations. Thus, economic actors cannot be surprised by monetary policy. Hence, monetary policy is ineffective relative to the real economy, even in the short run. Monetary policy can, however, affect the rate of inflation, and therefore the optimal sustainable outcome policy authorities can achieve is price stability (Goodhart, 1994: 1427). One means of increasing the efficiency of monetary policy could involve the pre-commitment of the CB to a monetary rule, or otherwise seek to build an anti-inflationary reputation for the monetary authority, thereby making its chosen monetary objectives appear more credible (Barro and Gordon, 1983). To the extent that an independent CB is trusted to pursue low inflation objectives more consistently, and with more vigour than could be secured within other monetary policy institutional frameworks, the greater CB independence adds to the credibility of the approach. • An alternative accommodation to the problems identified by the theory of time-inconsistent behaviour is for the selection of monetary authorities to be predisposed towards concentration upon securing price stability but to do so in the absence of a fixed rule. Rogoff (1985) argued that the imposition of a fixed policy rule was dangerous given the persistence of supply shocks, and therefore a similar response to a demand shock would not be appropriate. One solution to this tension between the credibility established by adherence to rules and the occasional necessity to vary policy objectives in the face of supply shocks, could, Rogoff argued, be resolved through the transfer of monetary policy to a conservative central banker, because their preference for lower inflation would be more strongly held than for government and society taken as a whole. Consequently, trade unions and other economic actors would expect a tighter monetary policy, focused upon reducing inflation, and would therefore incorporate a lower expected inflation rate into their wage claims and pricing decisions. Thus, the expected and actual rate of inflation would decline. In effect, the conservative CB would act as a kind of guarantor of trade union wage moderation, although its means are based upon imposing a credible threat upon wage negotiators rather than promoting social partnership. Failure of

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the negotiation system to produce non-inflationary wage settlements would result in the Central bank imposing monetary restraint, thereby increasing unemployment and weakening trade union bargaining power. • A final argument in favour of CB independence relates to public choice theory, and the suggestion that politicians will seek to maximise their own utility at the expense of the national interest, by manipulating economic instruments to maximise their chances of re-election. According to this approach, political business cycles are the result of governments seeking to increase demand (through cutting taxes, lowering interest rates) immediately prior to elections, and thereby increasing voter support (Nordhaus, 1975). Johnson argued that ‘democratic sovereignty over monetary policy has furthered the electoral ends of politicians, not the public interest in keeping inflation down’. Moreover, Cukierman (1994: 1443) claims that ‘the inflationary bias of policy arises precisely because of the way politicians operate’. Issing (2002: 9), lead economist for the ECB, claims that: There is today a broad consensus that stable money is too important to be left to the day-to-day political process . . . it makes sense for society to create an independent institution that stands above the fray of day-to-day politics and can pursue this objective [price stability] with minimum distraction. Consequently, long-term economic efficiency requires the removal of monetary policy from the sphere of democratically accountable politics. Such a move will also enhance the credibility of declared antiinflationary strategies. Indeed, although not personally supporting the policy, Friedman (1968b) conceded that CB independence was appealing due to its removal of monetary policy from ‘being a day-to-day plaything at the mercy of every whim of the current political authorities’. Thus, one might conclude that a proven track record should be one of the main components of a credible monetary policy. Counter-arguments Central bank independence has been widely adopted by a large number of nations across the globe on the basis of less than perfect theoretical and empirical evidence. As such, there are few other examples of economic propositions, which have been so eagerly accepted, amidst imprudent claims of the reform leading to a ‘free lunch’, based upon contested theoretical assumptions and the flimsiest empirical support. Criticisms of the policy include:

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• The case for CB independence rests, to a considerable degree, upon the twin propositions of continual market clearing and the neutrality of money. According to this approach, monetary policy cannot affect the real economy, and the only conceivable policy objective is price stability. However, Keynesianism disputes both of these propositions. The Keynesian revolution was based upon the fact that economies can not only suffer from market failure, where markets fail to achieve continual full employment of all resources, but can become stuck in demand deficient equilibria where mass unemployment can persist in the absence of stimulus from government or some external phenomenon. Furthermore, Keynesian monetary theory is based upon the non-neutrality of money. This is one of the key areas of dispute between Keynesian and monetarist schools of thought. Keynes considered money to influence real variables through its impact upon the motives and decisions made by economic actors. Indeed, Keynes argued that ‘there is no unique long-period position of equilibrium equally valid regardless of the character of the policy of the monetary authority’ (Keynes, 1979: 55). • A second critique relates to the underlying assumption of a supplyside determined long run equilibrium rate of unemployment as itself having weak theoretical and empirical foundations. Post-Keynesian economics holds that employment is determined in the product market by the aggregate demand for output. Moreover, aggregate demand influences the real economy through its impact upon, and in turn is influenced by, the rate of investment, which in turn changes the stock of capital and thereby effects productive capacity. Hysteresis means that the future unemployment rate is path-dependent, in that it depends upon the actual history or path of unemployment, and therefore it justifies policy activism to reduce actual unemployment beneath the prevailing equilibrium rate, because by doing so it will enable that equilibrium rate to decline itself in the future (Blanchard and Summers, 1988). Hysteresis implies that any equilibrium rate is only a temporary phenomenon, since current unemployment remains a significant factor determining future rates – a concept tantamount to replacing the concept of an equilibrium rate with a disequilibrium analysis. Thus, ‘the problem of unemployment is ultimately one of investment’ (Rowthorn, 1995: 38). Active monetary policy can facilitate an increase in aggregate demand, through reducing interest rates (or otherwise), thereby increasing output and potentially influencing growth rates, through negating hysteresis and encouraging the principle of cumulative causation. • The actions and preferences held by a ‘conservative’ central banker, appointed to deal with the time inconsistency problem are not as

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costless as the theory suggests (Bibow, 2004: 566). A conservative CB may establish its own targets, or seek to intensify efforts to meet externally determined goals as soon as it is practicable, irrespective of the state of the business cycle or the health of the real economy, so as to build its anti-inflationary reputation and policy credibility as rapidly as possible. Such anti-inflation credibility is ‘painstakingly’ constructed through a long process of ‘matching deeds to words’ (Blinder, 1998: 65). Therefore, conservative CBs are likely to have an asymmetric reaction function when responding to problems of inflation and unemployment; being far more likely to react quickly and decisively to deal with the former rather than the latter. Thus, a greater stabilisation of prices would only arise at the expense of a greater instability of output and employment, resulting in a deadweight loss caused by sub-optimal output stabilisation (Rogoff, 1985; Bibow, 2004: 564). Although neoliberal economic theory would suggest otherwise, the costs associated with higher unemployment have been calculated as far exceeding the cost of inflation (Dawson, 1992). Suggestions that independent, conservative central bankers can reduce the costs of disinflation can be dismissed as the ‘power of wishful thinking’ (Blinder, 1998: 63). Furthermore, the proposition that a conservative CB is the only or even optimal means of guaranteeing trade union co-operation in designing and operating a non-inflationary wage bargaining system ignores the evidence produced by the sizeable corporatist literature. This suggests that unions may modify wage claims as part of a bargain with the economic authorities to facilitate a prioritisation of full employment – a bargain which a conservative CB would not, by its nature, facilitate (Edgren et al., 1970; Cameron, 1984; Bruno and Sachs, 1985; Calmfors and Driffill, 1988; Amoroso and Jespersen, 1992: 79–80). This latter point may be of more importance in nations where trade union density is high (i.e. Sweden, Norway, Denmark, Austria, Germany) rather than those where wage setting occurs on a more individual basis (i.e. US, UK, Canada, Spain). • CB independence may imperil the efficiency of co-ordination between monetary and fiscal policies (Blake and Weale, 1998; Bibow, 2004: 569). This might lead to circumstances, for example encountered in post-unification Germany, where fiscal expansion was deliberately offset by the independent Bundesbank tightening monetary policy, due to its fear of future inflation. Moreover, the inability to co-ordinate macroeconomic policy across all economic instruments might lead to mis-timed policy, and potentially an unsatisfactory policy mix (Doyle

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and Weale, 1994). New Labour economists dispute this interpretation, arguing that co-ordination is achieved because government sets the targets for both fiscal and monetary policies (HM Treasury, 2002b: 50). However, even where government establishes tight rules or contracts for autonomous monetary authorities to pursue, this arrangement still falls foul of the principal-agent problem. Here, the agent has their own interests, preferences and will operate as close to their own agenda as they can, circumscribed by contract, the prospect of discipline, the potential for constant surveillance and/or provision of an incentive scheme intended to cause divergent interests to move more closely together. Yet, monitoring and provision of incentives is costly and remains an imperfect means of securing behaviour close to that preferred by the principal. • The insulation of CBs from political interference creates a ‘democratic deficit’. There are clear risks involved in the insulation of conservative central bankers from democratic influence, reinforced by the reward of long-term contracts, when they hold opinions which, by definition, diverge from the majority of society and are likely to do so from the expressed economic strategy devised by the democratically elected government (Lohmann, 1992). Posen (1993) suggests that the financial sector has a vested interest in low inflation, as banks typically borrow short and lend long, their profits are vulnerable to changes in interest rate spreads and the squeeze on corporate clients which result from the resultant deflation. Moreover, inflation tends to undermine confidence in, and use of, the financial system and threatens the stability of institutions through potential capital flight. Thus, although the CB may be a government institution, it retains close organic linkages with the wider financial sector through a high degree of mobility of staff, complementary interests and ideology. Hence, greater CB independence is attractive to finance because it brings about an institutionalised reallocation of state power in its favour and thereby against the interests of industrial capital and labour. • In terms of the political business cycle theory, Forder (2004: 156–157) points out that policymaking is an imprecise art and, therefore, there will be examples of instances that conform to the predictions of this theory. One example relates to the 1972 US presidential election, despite the policy independence of the Federal Reserve. Similarly, there have been a number of well-documented cases when policy has been too tight at election time – that is 1970 and 1992 UK General Elections. Overall, studies have found remarkably little evidence of a political business

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cycle effect (Alt and Chrystal, 1983; Alesina and Roubini, 1992; Hadri et al., 1998). Furthermore, the claim by advocates of CB independence that politicians are self-serving may be contrasted with their belief that non-elected policymakers are immune from similar expressions of self-interest. Chant and Acheson (1973) argued that central bankers could be viewed as any other bureaucracy, having its own distinctive objectives which may include maximising its own influence and resources. Moreover, there are instances where individual, independent CBs have been accused of manipulating policy in order to remove critical politicians or governments from office (Goodman, 1992: 63; Kennedy, 1991). Democratic control therefore enables the protection of citizens from continual misrule through the ability to replace its leaders. Empirical evidence Central bank independence, more than most other currently popular policy stances, relies more upon econometric evidence than theoretical foundations, as the latter are rather contentious. However, the evidence is not as rigorous as the popularity of this reform would suggest. A number of studies have discovered a statistical relationship between low levels of inflation and the degree of CB independence, at least within developed, industrialised economies (Alesina, 1988; Cukierman, 1992; Alesina and Summers, 1993). However, this statistical relationship collapses once developing countries are included in the analysis (Cukierman, 1992). For those economies undergoing transition from command to market mechanisms, the greater the degree of CB independence that occurs, the higher the observed rate of inflation (Hillman, 1999). Furthermore, whilst the IMF (1996b: 129) found a close inverse relationship between inflation and an index of CB independence during the 1970s and 1980s, it found no such relationship during the 1960s and 1990s. Thus, the oft-mentioned link between CB independence and price stability can hardly be an immutable economic law! Berger et al. (2001) concludes that CB independence is neither necessary nor sufficient for achieving monetary stability. It is merely one institutional arrangement amongst many alternative means of reaching the same objective. Central bank autonomy may additionally result in lower and more volatile rates of economic growth. Although Grilli et al. (1991) and Alesina and Summers (1993) found no association between CB independence and variability of output, Debelle and Fischer (1994), Posen (1995), Fischer (1996), and Jordan (1997 and 1999) found that CB independence resulted in deeper recessions and a higher sacrifice ratio, relating to the ratio of output lost associated with a reduction in inflation. Thus, CB

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independence does not appear to be costless. Moreover, there additionally appears to be little evidence for a monetary policy-induced political business cycle in the OECD countries. There are, additionally, a number of methodological weaknesses with many of the studies into this area. One criticism relates to the simplistic view of the relationship between CB and government generated by indexes of CB independence. For example, the German Bundesbank is typically presented as entirely independent, but has nevertheless accommodated the policy of the government on occasions when it has perceived it to be advantageous so to do (Vaubel, 1997). The second criticism relates to the existence of a certain degree of circularity of argument in some research designs. For example, Cukierman adopts, as one measurement of its independence, the degree to which a CB views price stability as its sole objective, and discounts pursuit of growth and employment objectives. However, this results in the study measuring independence according to the degree that the bank adheres to their price stability target, and then correlates measures of independence with observed rates of inflation! The third criticism suggests that some studies draw their inspiration from economy-specific factors, such as the experience of the US economy complete with its experience of weak unionisation. European economies, by contrast, tend to have a far greater interaction between strong trade unions and economic policy authorities and the impact of changes in monetary policy will therefore be affected by the strength, organisation and objectives of trade unions (Iversen, 1999). Additional methodological concerns relate to problems with control variables and choice of countries (Cukierman, 1992; Posen, 1995; Campillo and Miron, 1997); a divergence between measurement of legal CB independence and the existence of real independence; and, finally, the fact that causality is not expressed by single-equation regression techniques (Forder, 1996 and 1998; Magano, 1988).

Inflation targeting One possible solution to the divergence of preferences between central banker and society would be to impose a detailed contract upon the CB, in which a deflationary bias could be corrected through the establishment of detailed operational goals, together with designated penalties if these are not met. Thus, the CB and/or its governor might have to explain itself to government or parliament if goals remained elusive, and either fines or the threat of redundancy could be introduced. This proposal is unlikely to prove workable in practice, however, since it would require

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perfect information in order to correct certain preferences held by the central banker and to satisfactorily define those shocks which would be within the remit of stabilisation policy. The introduction of an inflation target may provide a less complex alternative, and this might explain why it has been adopted by the UK, New Zealand, Sweden, Switzerland, Australia, Israel and Canada. Indeed, fears over a non-symmetric response to episodes of inflation and deflation might encourage government to establish unemployment and growth targets to complement inflation objectives. There are a number of features associated with inflation targeting (Bernanke et al., 1999): • Precommitment to publicly announced inflation targets (or target ranges), intended to combine the flexibility of policy actions on behalf of the monetary authorities with the discipline of having to adhere to a set target, together with providing accountability and transparency to economic agents. • Through its combination of discretionary policymaking within the constraints imposed by having to meet an unambiguous long-term objective, inflation targeting provides an example of what has become known as constrained discretion (Bernanke and Mishkin, 1997: 104). • Inflation targeting acts as a nominal anchor for monetary policy, rather than alternative forms of discipline associated with monetary base control and/or using an exchange rate anchor for monetary policy. • Monetary policy is the main instrument of macroeconomic policy, due to its advantage of greater flexibility and speed of adjustment relative to fiscal policy. Thus, ‘monetary policy moves first and dominates, forcing fiscal policy to align with monetary policy’ (Mishkin, 2000: 4). • Assuming the level of economic activity fluctuates around a supplyside equilibrium, based upon the natural rate of unemployment (or NAIRU), it follows that monetary policy cannot affect the real economy in the long run, and it is the most direct determinant of inflation, leads to the conclusion that monetary policy should, therefore, be targeted at securing price stability at minimum cost (HM Treasury, 2003). • It is assumed that Say’s Law holds, such that economic activity in the long run is determined by the supply-side, and not influenced by the level of effective demand – the latter passively adjusting to facilitate the natural rate equilibrium. Therefore, monetary policy cannot have a permanent effect upon the level of economic activity.

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A good example of inflation targeting relates to the reforms introduced immediately upon the election of the New Labour government in the UK, where the operational responsibility for monetary policy was transferred to the Monetary Policy Committee (MPC) of an independent Bank of England. These arrangements were formalised by the Bank of England Act which came into force in June 1998, and involved government maintaining control over the setting of long-term objectives for monetary policy, but thereafter the responsibility to achieve these targets falls upon the MPC, which can act with policy autonomy from political interference, except in exceptional circumstances. The New Labour administration argued that, once the inflation target is set, the level at which interest rates must be set is a ‘technical issue’ and ‘technical decisions are best made by independent but fully accountable experts’ (HM Treasury, 2002b: 49). The specific details are as follows: • The inflation target is 2 per cent (±1 per cent) of the Harmonised Index of Consumer Prices (HICP), calculated on a monthly basis. This is a modification of the original target of 2.5 per cent of the retail price index minus mortgage interest payments, the latter having been omitted because of the instability in inflation caused by changes in the interest rate itself. The adoption of the HICP index is at least in part driven by the requirement to move towards increased economic harmonisation with other EU member states relating to the operation of EMU and, in this case, the institutional and policy practice developed by the ECB. • The inflation rate is intended to be symmetrical in so far as deviations of 1 per cent below and above the target are treated equally. In practice, the governor of the Bank of England is required to write to the Chancellor to explain the reason for inflation missing its target by more than (±) 1 per cent, to justify its actions taken to return inflation to its target rate and predict the time lag until this occurs. • The government has designed the framework for monetary policy, established the inflation target, monitors the effectiveness of policy implementation and provides one means of ensuring accountability for the Bank of England’s actions, whereas the MPC has sole operational responsibility for meeting the inflation target. Inflation targeting is not, however, universally advocated. For example, it is claimed that this approach is insufficient for the requirements of a modern industrial economy, because it fails to consider the impact that may be caused by financial market innovation, speculation

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and resultant asset price and/or debt bubbles. These imbalances in financial markets are more likely to occur due to the widespread deregulation that has occurred in the last three decades. Yet, the manipulation of the sole policy instrument, the interest rate, is insufficient to deal with the causes of these phenomena. Additional policy measures are required. For example, the current UK housing asset price bubble might require a combination of restrictions upon mortgage demand, such as the re-imposition of credit controls, reserve asset ratios, borrowing ceilings calculated as a fixed proportion of income and minimum deposit requirements. Measures intended to stimulate the supply of houses could include fiscal incentives to restore uninhabited housing stock, reconsideration of planning restrictions relating to the building of new houses and/or facilitating the development of new council house building, the collapse of which over the past two decades is the largest single cause of the current housing shortage. Studies have, furthermore, found little evidence to suggest the existence of an optimal rate of inflation, which facilitates an optimal rate of growth (Akerlof et al., 1996; Sepehri and Moshiri, 2004: 191). Ball and Sheridan (2003) found little evidence that inflation targeting nations fared better in terms of inflation, output and employment, than other OECD countries pursuing other forms of monetary policy during the last decade. Moreover, Stiglitz2 questions whether inflation targeting actually reduces the trade-off between inflation and unemployment. Arestis and Sawyer (2004: 53–54) point out that in many of the inflation targeting countries, high rates of inflation had already been reduced prior to the introduction of this type of monetary policy, thus limiting the force of many of the claims made about the superiority of this type of policy approach. Bernanke et al. (1999: 288) suggests that, at best, advocates of inflation targeting may more accurately claim that this type of monetary policy may have helped to ‘lock in’ low inflation rates in the face of inflationary shocks.

An alternative view of money and inflation In contrast to the view of money and inflation that informs the Third Way approach to monetary policy, alternative propositions do exist. For example, the post-Keynesian position is that inflation arises from real factors in the economy and not the level of the money supply. It notes that firms appear to set their prices in a variety of different ways, arising from such factors as their own objectives, the size and governance

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structure of the company and the degree of competition in the product markets in which they operate. Generally speaking, prices appear to be based upon a mark-up over average costs, with the size of this mark-up determined by the industry norm, the firm’s market power and the buoyancy of demand in the economy – perhaps associated with the rate of change of capacity utilisation. Inflation occurs when demand exceeds productive capacity, and so firms face rising unit costs and there is likely to be an intensification in conflict over the distribution of income will arise from one group intending to increase their share of national income and taking advantage of an enhanced opportunity to do so. Wage determination depends upon the expected inflation rate, workers’ desire to move towards a target real wage, which is derived from the aspirations and expectations of workers and their trade unions including notions of fair wages. Therefore, buoyant economic conditions may increase workers’ aspirations, thereby leading to enhanced demands for rising real wages. On the money side, money is assumed to be endogenous credit money – that is it is created by the banking system – rather than comprising physical notes and coins. Hence, monetary base control, even if justified, would prove impossible in practice in a sophisticated modern economy. Furthermore, the stock of money expands alongside the rise in prices; it responds to inflation and does not cause rising prices. One conclusion, drawn from this general approach, is that inflation will itself at least partly depend upon the size and composition of the capital stock (Arestis and Sawyer, 2004). The larger the productive capital stock in the industry, the larger the number of employees and higher the real wage that should be compatible with a low level of inflation. Moreover, since investment is influenced by current and expected profitability, together with the degree of capacity utilisation – all of which are effected by the level of aggregate demand – the evolution of capital stock depends upon the time path of aggregate demand. In so far as monetary policy impacts upon investment, it will therefore have a significant and durable effect upon the real economy, and it is in this way that it can additionally impact upon inflation. Keynesian policy perceives fluctuations in private investment as one significant source of macroeconomic instability, and thus utilises both fiscal and monetary policy to stabilise aggregate investment. The former may involve the maintenance of a long-term public investment programme, intended to ‘balance and stabilise the Investment Budget for the national economy as a whole’, reinforcing a strategy of low and

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stable interest rates, designed to facilitate sufficient capital formation to maintain full employment (Keynes, 1971–83, XXVII: 409). Keynes certainly would have refuted the current practice of utilising the interest rate as the main (or sole) macroeconomic instrument aimed at fine-tuning the economy. He argued that: It is a fatal mistake to use a high rate of interest as a means of damping down the boom . . . the long-term rate of interest must be kept continuously as near as possible to what we believe to be the long-term optimum. It is not suitable to be used as a short-period weapon. (Keynes, 1971–83, XXI: 389) Indeed, empirical evidence suggests that interest rates are a weaker determinant of investment than other factors, including corporate profitability, cash flow and capacity utilisation (Fazzari et al., 1988; Hubbard et al., 1995; Hubbard, 1998; Baddeley, 2003). This neatly dovetails with the Keynesian approach, which hypothecates that businesses invest on the basis of expected future profitability, fund much of this through retained profits (Keynes, 1936: 135–141; Kalecki, 1971; Arestis, 1989: 614; Caporaso and Levine, 1992: 107). The degree of capacity utilisation is a proxy in this instance of the buoyancy of demand, and can be taken to reinforce expectations of future profitability, whilst indicating supply-constraints to maintain future market share without additional investment and the creation of extra capacity. Monetary policy, for Keynes, should be focused upon maintaining the conditions for full employment in the national economy, rather than concentrate more narrowly upon an inflation target and the maintenance of a notional fixed exchange rate anchor (Skidelsky, 1999: 10). The expansion of public credit allocation could play an important role in a reinvigorated active industrial policy, financing innovation, new areas of production, together with productivity-enhancement of existing technological applications, in order to promote economic growth, productivity and thereby facilitating a high wage economy compatible with continued international competitiveness (Pollin, 1993).

Conclusion The monetary policy approach incorporated within Third Way economics is largely consistent with the neo-liberal New Keynesian theoretical foundations to its fiscal policy programme. Inflation is identified as the central goal for monetary policy, and is defined as a

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monetary phenomenon so that control over the money supply should target inflation directly. Moreover, in order to increase the efficiency of monetary policy amidst assumptions of rational expectations and perceived problems of time inconsistency, the Third Way monetary strategy adopts the mechanisms of pre-commitment to monetary rules. Albeit, these are often of the inflation targeting variety, it looks favourably upon the creation of independent CBs as a means of enhancing the reputation and credibility of the monetary policy process and objectives. This approach to monetary policy is not, however, universally shared across the economics profession, with post-Keynesians advancing a quite different alternative, emphasising the importance of capacity utilisation and aggregate demand in creating a non-inflationary environment for production to occur. If the assumptions are made of that money is endogenous credit money, and that the natural rate of unemployment does not apply, then monetary policy can be seen to have effects upon the real economy in addition to inflation. In which case, it can and should be used, together with fiscal policy and a myriad of other policy instruments, to pursue macroeconomic goals of full employment, economic growth, a sustainable balance of payments and low inflation. Once again, therefore, evaluation of the appropriate nature of Third Way monetary policy design revolves around analysis of the theoretical foundations and empirical evidence for the diverse approaches outlined in this chapter.

Notes 1. In this instance, this broad category includes a wide variety of approaches within the neo-classical and new classical traditions. Monetarism would normally be included under this label, despite the preference for rule-bound monetary policy. 2. The Guardian, 10 June 2003.

5 Labour Market Flexibility

Introduction Acceptance of the existence of a supply-side determined equilibrium rate of unemployment by Third Way economists implies both a rejection of Keynesian macroeconomic policies and a renewed emphasis upon supply-side interventions intended to promote market clearing through reducing imperfections, whilst modifying institutions and policies to promote productivity growth and higher rates of employment consistent with a low rate of inflation. Whereas ‘old monetarism’ perceived market imperfections as being associated with the activity of trade unions, the generosity of social security benefits and labour regulation (i.e. minimum wages, employment protection legislation), for ‘new monetarism’ the market failure is a lack of training and skills (Arestis and Sawyer, 1998: 37). In this scenario, the rate of employment is determined through the interaction of market forces in the labour market, and therefore the attempt to reduce unemployment should be located in this micro-market. Policy reforms intended to promote employment and productivity could include active labour market policy, the promotion of a flexible labour market and trade union industrial relations legislation. This can be complimented by reforms to welfare benefit systems which are intended to promote work incentives, and educational reforms designed to encourage investment in human capital and the creation of a ‘learning society’.

Labour market flexibility Labour market flexibility has been identified as one means of advancing a number of economic goals, including the achievement of superior 112

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financial performance and higher levels of productivity at firm level (Ichniowski et al., 1996), together with favourable macroeconomic benefits including lower levels of unemployment and reducing inflationary bottlenecks in the labour market. Studies indicate that labour market flexibility might be able to shift a supply-determined long run equilibrium rate of unemployment to the left, thereby reducing unemployment consistent with retaining a low rate of inflation (Layard et al., 1991; OECD, 1994a; Nickell, 1997; Siebert, 1997; Elzmeskov et al., 1998; Nickell and Layard, 1999). These conclusions are not, however, universally shared as other studies have found no significant impact arising from labour market deregulation (Nickell, 1988; OECD, 1999b: 88; Blanchard and Wolfers, 2000; Baker et al., 2002; Schettkat, 2003; Arestis and Sawyer, 2004: 93). One reason for this might derive from a tendency to downplay the importance of demand-side factors influencing unemployment, together with the fact that characteristics of labour market flexibility can themselves be influenced by the impact of aggregate demand upon investment, capacity utilisation and indirect effects upon the viability of regulatory and institutional arrangements (Palley, 2001: 3; Alexiou and Pitelis, 2003; Schettkat, 2003; Stockhammer, 2004d; Arestis and Sawyer, 2004: 93). Nevertheless, the UK government’s position is that ‘flexible and dynamic markets’ are considered to be ‘a precondition for economic strength’ (HM Treasury, 2003: 239). There is a reasonable degree of consensus throughout industrialised nations that labour markets should be more flexible and that this would enhance national competitiveness (Sassoon, 1999: 28). This applies in social democratic as well as bourgeois administrations. However, not all governments have embraced this approach as enthusiastically as others. For example, short-term contracts have become a very significant factor in Spain, whereas they have not generally been adopted by German firms. Similarly, whilst Belgium, France, Britain and Spain weakened dismissal laws, and the Netherlands reduced its minimum wage, Britain first removed its minimum wage regulation before subsequently reintroducing a new form. Most nations observed a general decentralisation in wage formation, whether prompted by government, as in Italy where wage indexation was eliminated, or in Sweden where the shift from centralised wage bargaining was led by the powerful employers’ federation against (often lacklustre) union and social democratic government opposition (Gahan and Harcourt, 1999). The introduction of labour market flexibility reforms has proven more difficult in Germany, where the social democratic administration has experienced great difficulties

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getting its reform agenda through its own party and the parliamentary process. It has also been pursued in different ways in different countries, so that in Sweden the attempt has been made that where deregulation has occurred this has been implemented in such a way as to retain maximum co-ordination by the social partners to prevent instability, whereas in the UK no such consideration has been given. Furthermore, the labour market flexibility agenda has been largely accepted by the EU Commission, following concerted pressure from Blair and Conservative governments in Spain and Italy, thus marking a significant shift in policy emphasis from the former quasi-Euro-Keynesianism of the Delors period (Black, 2002; Annesley, 2003). Characteristics of labour market flexibility Labour market flexibility derives from the degree to which labour market outcomes are determined by the operation of market forces free from rigidities and/or restrictions imposed by powerful actors such as monopsony employers, trade unions and government. A perfectly flexible labour market would imply the absence of all hindrances to the free operation of market forces. This not only includes examples of labour market regulation, such as job protection legislation, and institutional arrangements, such as systems of sectoral wage bargaining, but also unorganised forms of market imperfection – for example, resulting from insider–outsider power imbalances and/or irrational employment practices arising from labour market segmentation or discrimination. Furthermore, there is a sizeable literature pointing to the existence of labour market inflexibility due to various factors, including implicit contracts, efficiency wages, transaction costs in the renegotiation of contracts and incentives provided due to the principal-agent problem (Bosworth et al., 1996; Lindbeck and Snower, 1988). Clearly, certain types of labour market inflexibility are more easily subject to corrective government policy reforms, whilst others appear more intractable. The literature on labour market flexibility denotes a range of different factors that, in aggregate, determine the extent to which the labour market is comparatively more or less flexible. At any one moment, it is possible that a number of these characteristics of flexibility are moving towards greater flexibilisation whereas others are indicating increasing rigidities. This can explain why labour markets generally considered as exhibiting a high degree of flexibility nevertheless contain features that depart quite significantly from this norm. For example, the fact that US and UK labour markets have a relatively low incidence of temporary workers as a proportion of the total workforce does not necessarily

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imply labour market rigidity. Instead, it reflects the fact that employers are comparatively unencumbered by labour market regulation and are therefore more able to hire and fire core workers without having to resort to other forms of non-standard employment contract to avoid regulation and pursue the flexibility agenda through a core-periphery split (Robinson, 2000: 36). There are a number of different typologies that run throughout the literature. One emphasises the fact that labour market flexibility is concerned with both micro and macro issues. For example, whereas the pay structure for an individual firm would have considerable significance for micro-flexibility, it would have little influence upon the macro-flexibility of the economy as a whole; the latter would be more concerned with matters such as national wage bargaining institutions and the resultant real wage flexibility. Similarly, micro-flexibility would focus upon the impact of increasing self-employment and growth in temporary employment at firm level, whereas macro-flexibility would be concerned with deregulation of the regulation of working time, together with various labour market programmes (Beatson, 1995). Flexibility characteristics can be further identified with the concepts of numerical and functional flexibility (Burchell et al., 1999; Weiss, 2001). The former concerns the capacity to adapt the quantity of labour inputs to changes in patterns of demand. This could relate to a shift in the numbers of potential workers willing to work at the going wage rate, perhaps due to a reduction in reservation wages, change in the value or duration of social benefit entitlements, active labour market policies, a shift in relative trade union bargaining power, and/or changing employment regulations which impinge upon the cost of hiring and firing workers (and hence firm demand for new labour). It might similarly involve temporal flexibility, namely the capacity to introduce variability in working time, whether through changes in holidays, the length of the working week, shift working patterns and overtime working. Alternatively, numerical flexibility might be enhanced through shifts towards non-standard employment, through an increase in part-time working, temporary employment contracts, sub-contracting job tasks outside the core organisation, home-working and consultancy. Functional flexibility, by contrast, embraces work reorganisation initiatives in the attempt to increase efficiency and/or adapt to changing patterns of product demand. Examples include the introduction of multi-skilling (or multi-tasking) and reduction in job demarcation, the enhancement of employee participation within the workplace, and measures to sub-contract elements of production to external actors.

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Inspired by the philosophies of lean production, just-in-time-production and total quality management (Berggren, 1993; Hackman and Wageman, 1995), functional flexibility may encompass initiatives designed to flatten organisational hierarchies and thereby reduce bureaucratic overheads (Hudson, 2002: 44). Objectives included both the enhancement of skills and the competences of individual employees, together with the advancement of teamworking. Monastiriotis (2003) extended this basic framework by adding a third category, namely labour costs (i.e. flexibility in pay and non-wage costs). Wage flexibility is perceived to be a central element in achieving labour market flexibility through its adjustment to maintain the balance between demand for, and supply of, labour, hence the initiative introduced by the UK government to promote regional variations in those areas of the public sector currently utilising national pay bargaining (HM Treasury, 2003: 244–247). Wage flexibility can be affected by the development of industrial relations legislation and governments, acting as large-scale employers in their own right, relating to promotion or restriction of trade union activity. The synthesis of the literature, illustrated in Figure 5.1, highlights the multi-faceted nature of a flexible labour market, together with the potential for conflict between the different types of flexibility, thereby potentially, partially offsetting reform objectives. For example, deregulating employee-training regimes to workplace level might improve firm micro-flexibility, but if the result is a decline in aggregate training, as competitive pressures squeeze individual training budgets, then aggregate macro-flexibility may be reduced over time (ILO, 2004: 191–220). Similarly, the decentralisation of wage formation may facilitate pay structures best suited to the incentive structures sought by individual managers, yet the rise in pay diversity in the labour market as a whole, together with the removal of the moderating effect of peak level bargaining partners, might provoke increased industrial unrest and hence damage macro-flexibility. Labour market flexibility and foreign direct investment One additional feature ascribed to LMF relates to its ability to attract FDI (Dunning, 1979). In a world characterised by the free flow of capital, nation states have sought to compete with each other to attract FDI as a means of attracting inward flows of capital and technology, innovation in management techniques, the organisation of work and distributional networks. FDI may therefore raise aggregate productivity, thereby facilitating the rising skill level of the workforce through the provision of high-skill employment opportunities (OECD, 1991). TNCs

LMF

LABOUR COSTS (Unit Costs)

SUPPLY-SIDE

Numerical flexibility

Skills & quality

- Fiscal policy - Education & training

- Training - Education

FUNCTIONAL

- Working time regulation - Employement regulation - Labour market Policy (Public work) - Labour mobility (national, regional)

- Work time - Holidays - Non-standard employement - Labour Market Policy (Job subsidles) - Job Search Costs - Labour mobility (sector, occupation)

- Minimum wage - Aggregate wage flexibility - Institutions & patterns of wage bargains

Social Policy (Impact of benifits upon reservation wages & seach costs)

- Job demarcation - Multi-skills - Teamwork - Employee participation - Subcontracting - HRM intiative

- Incentive pay - Workplace & wage flexibility

Trade Union Flexibility

- TU Density - TU Coverage - TU Power

Key:

MACRO MICRO

Labour market flexibility

Aggregate Demand

117

Figure 5.1

TU Strategy (partnership vis conflict)

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are estimated to account for more than one-fifth of global employment in the non-agricultural sectors, with global sales of US$19 trillion worth double the value of world exports (Dunning, 1993: 15; Scholte, 2000: 130; UNCTAD, 2002). Thus, FDI has therefore become an increasingly significant factor in influencing the level of economic activity in developed, in addition to developing, nations. For example, as early as 1989, TNCs employed 40 per cent of the manufacturing sector (Ladipo and Wilkinson, 2002: 12–13), and FDI accounts for approximately 30 per cent of UK manufacturing productivity growth (Barrell and Pain, 1997). Indeed, attracting inward investment has acted as ‘the chief instrument of industrial policy in the UK over the past 20 years’ (Driffield and Taylor, 2000: 93; Wren and Taylor, 1999). The ability to attract FDI depends upon many different factors, including the relative development of physical and informational infrastructure, wealth and growth rates of national (and/or regional) markets, factor endowments, skill levels and quality of training, political stability and possession of raw materials, in addition to policy measures favouring business development. Policy factors include relative tax rates, levels of regulation, provision of location incentives and the existence of labour market rigidities. The evidence of the effects of flexible labour markets is mixed, since studies tend to associate high labour costs negatively with FDI flows (Schneider and Frey, 1985; Culem, 1988; Friedman et al., 1992; Wheeler and Mody, 1992; Karier, 1995; Head et al., 1999; OECD, 2000). Yet four-fifths of the world stock of FDI is located in high-wage and relatively high-tax nations, primarily the US, UK, Germany and Canada, whilst this proportion has increased by 12 per cent over two decades (Weiss, 1998: 186). Similarly, regulation of the labour market is generally perceived to be a disadvantage for a nation seeking to attract FDI (Bentolila and Bertola, 1990; Cooke, 1997; Cooke and Noble, 1998; Haaland and Wooton, 2003). However, other studies found no statistical significance (Leonard and Schettkat, 1991), and it is a stylistic fact that FDI tends to be higher in countries with stronger employment rights (Kucera, 2002: 63). Trade union activity and the institutional arrangements facilitating wage bargaining tend to be insignificant (Floyd, 2003). Hence, the evidence indicates that labour factors are not ranked amongst the leading determinants of FDI (Erickson and Kuruvilla, 1994; Marginson et al., 1996; Traxler and Woitech, 2000). Inter-labour movement splits Support for the creation of a flexible labour market would not seem to be the natural territory for social democratic labour movements.

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However, Hall (2002: 37–39) argues that, whilst the industrial age enabled the redistribution of part of the high growth rates associated with manufacturing industry to expand the public sector, and where trade unions could secure the rising wages which, in turn, fed aggregate demand, under globalisation the expansion of the service sector has driven a wedge through its traditional constituency because its lower rate of productivity creates a distributional problem. Government could redistribute a greater proportion of industrial growth to maintain pay levels in service and public sectors at a similar level to those in private manufacturing industry, and thereby promote social solidarity, but higher taxes may provoke capital flight. Alternatively, it could tolerate lower wages in the service sector in order to facilitate employment growth in this area, but at the cost of increasing social inequality (Iversen and Wren, 1998). The latter strategy would create divisions within the labour movement, as a core labour force composed of ‘insiders’ with high skills and high wages resist initiatives to lower labour costs and/or deregulate labour markets, because this is likely to intensify wage competition without adequate social protection, whilst ‘outsiders’ composed of those who are unemployed or workers on the margins of the labour force prefer employment expansion even if this involves the creation of a low wage service sector (Hall, 2002: 38). Critique There are a number of criticisms of the labour market flexibility thesis. First, increased labour market flexibility may compound market failure in firms’ provision of training (Appelbaum, 1989; Crouch, 1997). Streeck’s (1991: 23–24) thesis is that specific institutional conditions can best facilitate different patterns of production. Specifically, employee participation is crucial to generating the consensus and understanding of production matters – particularly, the introduction and use of new technology. Employment regulation makes redundancies expensive and limits non-traditional employment contracts, and thereby encourages employers to treat employees as quasi-fixed factors of production. As a result, employers have a greater incentive to invest in employee training and, reinforced by enhanced job security, employees are more likely to accept the necessity to be functionally flexible (Streeck, 1987: 293–294). Centralised wage bargaining, in addition to producing superior macroeconomic trade-offs between inflation and employment, limits the opportunity and attractiveness for employers to adopt a cost-minimisation production strategy, and therefore further reinforces the incentives provided to firms for human capital investment (Streeck, 1992b: 264).

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Kleinknecht (1998: 388) argues that ‘policies aiming at a greater degree of labour market flexibility may be successful in the short run, but harmful to innovation and economic performance in the longer run’ because ‘attempts at removing labour market rigidities are likely to discourage productivity growth and product innovation’. Adopting a neoSchumpeterian perspective, Kleinknecht (1998: 394) argues that the creation of a flexible labour market ‘give an extra competitive option to non-innovating firms’, resulting in a vicious circle where deregulation, work intensification and wage flexibility lead to lower incomes and fewer jobs, which in turn stimulates further demands for lower wage, enhanced managerial control and further labour market flexibility. In this regard, the efficiency-wage hypothesis proposes that firms and industries may find it profitable to pay wages exceeding those that clear the labour market because the wage, or total compensation, stimulates productivity (Leibenstein, 1957; Solow, 1979). This effect may occur due to increased effort or human capital investment by labour, but could also occur because high wage pressure encourages increased capital investment which stimulates productivity (Perelman, 1995: 145). Therefore, one straightforward solution to breaking a low wage–low productivity cycle would be for trade unions to make higher wage demands, thereby providing the moderate cost pressure that acts as an incentive for firms to invest in capital equipment, innovate and introduce functional flexibility. This model can be criticised on the basis that it is less applicable to service provision, which constitutes the majority of employment in contemporary industrialised economies, but also because it overlooks the possibility that capital flight could occur if the conditions placed on capital by labour prove to be too onerous. However, it does question the efficacy of uncoordinated market economies, like the US, UK and Australia, seeking to emulate German or Japanese occupational training and manufacturing strategies, because they do not possess the prerequisite institutional conditions, and are most unlikely to be able to construct such an institutional framework (Soskice, 1996). A second concern relates to the means by which flexibilisation is pursued, since research indicates that the erosion of traditional job demarcations, work intensification, downsizing, flattening hierarchies and giving employees greater responsibility are all associated with heightened feelings of anxiety and stress, which, in turn, may result in demoralisation and demotivation of concerned employees, thereby impairing productivity (Wichert, 2002). If the association and motivation of labour is intrinsically linked with employment security, then the high labour turnover associated with labour market flexibility could

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deprive firms of valuable skills and is likely to reduce firm-based investments in training (Gasteen et al., 1999: 92). Similarly, the OCED acknowledged potential costs associated with an expansion in ‘nonregular’ forms of employment, including potential conflict between certain forms of greater flexibility of working hours and family life responsibilities (OECD, 2004: 12–13). Thus, the extraction of functional, numerical and labour-cost flexibility may be secured at the expense of attitudinal and/or behavioural inflexibility, thereby reducing the net value of potential gains (Mankelow, 2002: 137). A third, distinctive feature of this synthesis concerns the theoretical limitations demonstrated by much of the existing literature relating to the assumption that employment is determined by supply-side factors in the labour market and is not therefore influenced by aggregate demand. This is an error, because it is well established that the level of demand impacts upon many of the other variables outlined in this paper. For example, the literature indicates that the level of aggregate demand has a significant impact upon trade union membership, strike activity and wage bargaining power (Ashenfelter and Pencavel, 1969; Bain and Elsheikh, 1976; Booth, 1983; Carruth and Disney, 1988). Aggregate demand management may similarly impact upon the continued optimality of the wage bargaining institutions and patterns of bargaining (Calmfors and Driffill, 1988; Iversen, 1999). Aggregate demand is closely related to the degree of capacity pertaining in an economy at any given time, and this, in turn, is associated with encouraging industrial investment, enhancing productivity and acting as a significant determinant of the level of unemployment (Rowthorn, 1995; Arestis and Mariscal, 1997: 191, 2000: 487; Dow, 1998: 369; Arestis and Sawyer, 2003: 11; Baddeley, 2003). Therefore aggregate demand is a major factor influencing the supply curve of available labour, itself affecting numerical flexibility, whilst the buoyancy of the economy may influence the replacement ratio, degree of wage flexibility, willingness of employees to accept certain types of non-standard employment and so forth. Solow (1997: 3, 29), for example, argues that weakness in job creation is most likely the result of excessive and anti-competitive product-market regulation, restrictive macroeconomic policy, especially monetary policy, and inadequate discipline from the capital markets, and not the inflexibility of labour market. The results of studies examining the impact of labour market flexibilisation have been pretty consistent, in that they found ‘little evidence that labour market flexibility is substantially affected by the presence of social protection programs, nor is there any evidence that the speed of labour

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market adjustment can be enhanced by limiting these programs’ (Blank 1994; Blank and Freeman, 1994; Solow, 1997). Likewise, Jackman (1998: 6) finds ‘no conclusive evidence that economies where governments intervene a lot in the labour market have higher unemployment rates than economies where the role of government is minimal’. Moreover, the OECD finds that labour standards do not play a determining role in the investment decisions of multinational enterprises (OECD, 1996: 123–124). Furthermore, the significance of the failure to consider the interaction of labour markets with the institutional framework and macroeconomic policy can be seen by consideration of economies like Austria. Here, a nation with one of the least flexible labour markets in Europe, a large public sector, amongst the highest wage costs and a low average retirement age, has consistently maintained one of the lowest unemployment rates in Europe over several decades, has attracted huge inward investment and has very low rates of inflation (Sassoon, 1999: 28).

Active labour market policy Labour market policies offer one means of reducing unemployment through increasing the efficiency of the job search process, increasing the employability of the unemployed and creating temporary work placements. They offer the possibility of enhancing labour market flexibility. They can also potentially shift any supply-determined long-term equilibrium rate of unemployment to the left, thereby creating the conditions to achieve lower unemployment consistent with low rates of inflation. Active labour market policies incorporate both demand- and supplyside measures (Meidner, 1985:3; Trehörning, 1993: 14) (Table 5.1). The former reinforce counter-cyclical stabilisation, whilst the latter ease market adjustment by achieving a higher employment level at a given rate of inflation and promote structural change by reducing structural rigidities, search and transaction costs (LO, 1951: 92–93; Layard et al., Table 5.1

Different types of labour market policies

Matching

Supply

Demand

Public employment services • Information • Job placement

Subsidised geographical mobility Free labour market training Subsidised in-house labour training

Public relief work

•

Counselling

Recruitment wage subsidies Youth teams Sheltered employment

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1991: 64). Examples of demand measures include public works schemes, employment subsidies to individual firms, control over the release of tax-exempt private investment funds and state purchases placed with firms and in localities where unemployment would otherwise increase. Supply-side measures, in contrast, ease the market adjustment process by achieving a higher employment level at a given rate of inflation whilst simultaneously accommodating structural change (Johannesson and Niklasson, 1974: 4). The dynamic nature of the labour market gives rise to constantly changing stocks and flows of vacancies and workers, whilst adjustment processes are weakened by job heterogeneity and segmentation of the labour market. Supply-side measures include reducing transaction costs through the provision of comprehensive information, alleviating the job-search process through an efficient labour exchange service, providing incentives for workers transferring to activities or localities where they are most required, and providing extensive training and retraining services to facilitate voluntary movement to new activities. Third Way economics focuses upon supply-side labour market measures, utilising intensified job search measures to enhance matching between the skills and experience already held by unemployed individual and the existing job vacancies, together with educational and training schemes to enhance existing skills or create new ones and in this way to increase matching with vacancies. Demand-side policies, whilst once representing a majority of manpower expenditure, are more recently overlooked and considered ineffective to reduce unemployment, due to assumptions of the existence of a supply-side determined long run unemployment rate, rational expectations and other key assumptions derived from neo-liberal economics. Criticisms of manpower policies focus upon displacement and deadweight effects. It is argued that employment creation measures displace labour elsewhere in the economy or substitute for other workers in the same firm or sector. This assumes demand for labour is limited and Layard et al. (1991: 64) reject this assumption as ‘almost totally misconceived’. Manpower policy is applied in the belief that structural rigidities, rather than deficiencies in aggregate demand, are the main problems in targeted areas. Furthermore, Layard et al. (1991: 65) estimated deadweight effects – that is when money is spent on employment which would have occurred anyway – to be a ‘smallish issue in the overall social cost-benefit calculus of most active labour market policies’. Moreover, Piggott and Chapman (1995) claim that many labour market programmes pay for themselves in the long term.

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Labour market policies increase flexibility, facilitating adaptation to structural and industrial change. Without comparable promotion of structural mobility, a commitment to preserve jobs at all costs could result in economic stagnation and prevent adjustments necessary to maintain international competitiveness. Labour mobility moderates the high pay rises otherwise necessary to attract scarce labour to sectors experiencing high demand and bottlenecks in the supply of skilled labour. Therefore, it should create an inflation-dampening effect. However, as labour market policy also prevents unemployment from rising, it may thereby limit wage reductions during recession periods. The overall impact of labour market policy upon inflation is, therefore, indeterminate and depends upon which one of these two effects predominates in practice (Erixon, 2001: 20).

The new deal The New Deal, established in Britain in 1998 by the New Labour administration, is a good example of a supply-side orientated strategy, initially targeted at those groups most at risk to suffer long-term unemployment (i.e. the young, older workers, single parents). The New Deal aims to ‘build security through employability’ through skill enhancement and enabling individuals to adapt to changing needs of the labour market (DfEE, 1997). It utilises intensive job search techniques, combined with the introduction of new benefit rules to reinforce active job search, together with education and training schemes, placements with an environmental taskforce and/or the provision of a subsidised job (Purdy, 2000: 186–187). As Bonoli et al. (2000: 137) put it, the New Deal is a policy preference common to EU nations, since it: favours a shift from a largely passive welfare state, intended to meet people’s needs when these were not met through the market, to an active welfare state, which enhances the competitive position of the country. [It] puts much emphasis on spending on education and active labour market policies, which constitute investment, as opposed to mere compensation. In the absence of complimentary shifts in aggregate demand, the New Deal programme is based upon the premise that ‘the main thing that determines the number of jobs is the number of “employable” people in the economy’ (Annesley, 2003: 158; Finn, 2000: 387). Indeed, Peck (1998) states that, without complementary demand stimulation,

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the New Deal lacks credibility in areas of high unemployment even if the national economy is near full employment. A number of studies have been commissioned to ascertain the effectiveness of the New Deal active labour market programme. An early study by the National Institute for Economic and Social Research (NISER) estimated that the New Deal had reduced youth unemployment by 40 per cent in its first year of operation and that the policies were self-financing as they reduced benefit payments, and taxes increased as a result of higher employment rates. However, it predicted that the overall future net impact of the programme on the economy was likely to be small (Anderton et al., 2000; Finn, 2001: 83, 396). Other studies tended to confirm that New Deal programmes tended to have a positive impact upon employment prospects and potential earnings which lasted well beyond the programme duration, but that, once again, such results were ‘selective, small-scale and resource-intensive’ (Payne, 1991; White and Lakey, 1992: Payne et al., 1996: White et al., 1997). In the absence of sufficient job opportunities available in the economy, retraining programmes suffer deadweight costs as the unemployed move from one temporary project to another with minimal consequent reduction in unemployment (Turok and Webster, 1998: 325). Active labour market policies, therefore, are useful complements to demand-side policies, but are not sufficiently strong instruments to secure high and sustainable rates of employment in a depressed economy.

Industrial relations and wage formation The final element of the Third Way approach to the labour market relates to industrial relations and the institutional framework associated with wage formation. This is an area where the Third Way economic framework is perhaps the most differentiated in terms of national practice. The logic of much of the Third Way economic project would suggest that ‘new’ social democratic administrations would prefer decentralised wage bargaining and flexible labour markets to more corporatist arrangements. Thus, Blair has claimed that the New Labour ‘fairness not favours’ policy ‘would leave British law the most restrictive on trade unions in the Western world’ (cited in Panitch and Leys 1997: 254). Moreover, Third Way literature largely overlooks trade unions and industrial relations, for example Blair’s Third Way pamphlet has only two (critical) mentions of trade unions whilst Giddens’ Third Way failed to even mention Thatcher’s assault on trade unionism (Blair, 1998c: 1, 8; Giddens, 1998a; Ludlam, 2001: 116).

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Even the introduction of the minimum wage, the signing of the European Social Charter and introduction of trade union recognition legislation, comprised the remnant of ‘old’ Labour policy rather than New Labour initiatives. Nevertheless, this is not the case throughout Europe. Indeed, a number of nations – that is Belgium, Italy, Finland, Ireland, Norway, Portugal and Spain – have negotiated social pacts between governments, employers and trade unions as ‘a major tool of economic management in several European countries in the late 1980s and early 1990s’ (Fajertag and Pochet, 1997; Pochet and Fajertag, 1997: 10; French, 1999: 99). Thus, even though trade unions are generally in a much weaker position in the 1990s than two decades previously, the contemporary form of corporatism is characterised by the willingness of trade unions to make concessions – primarily by accepting pay restraint – in exchange for employment security and where possible, job creation (Pochet and Fajertag, 1997). Furthermore, European social democratic movements remain committed to the creation of a European Social Model (ESM) within the European Union, as an alternative to the market-orientated alternative (Ludlam, 2001: 116). This proves attractive, not least to the British trade union movement (McIlroy, 1995: 313–348; Monks, 1998). However, certain leading social democrats, most notably Blair, insist ‘that we need to reform the European social model, not play around with it’ (Blair, 1998a, c). Co-ordinated wage bargaining The main alternative to a market-orientated, flexible approach to industrial relations and wage formation concerns the establishment of a system of concertation, incorporating a co-ordinated wage bargaining initiative. Giddens (2002: 97) argues that, due to the globalisation of capital, macroeconomic policy is weakened and therefore ‘wages policy remains the one autonomous macro-policy tool still available to national governments’. Glyn (1995: 55) agrees that employees are required to facilitate full employment through wage moderation, otherwise social democratic-Keynesianism will fail and distributional conflict will continue to be settled through mass unemployment. The sizeable corporatist literature demonstrates that macro, as opposed to micro, flexibility can be secured through co-ordinated, centralised wage bargaining, and has the potential to secure a slower rate of growth in aggregate real wages, reduce labour turnover (with associated reduction in recruitment costs and possible productivity impact) and industrial conflict (Cameron, 1984; Bruno and Sachs, 1985;

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Calmfors and Driffill 1988; Rowthorn and Glyn, 1990; Amoroso and Jespersen, 1992: 79–80). Furthermore, through negotiation of wages independent of productivity in individual workplaces, centralised wage bargaining may promote structural change, as high productivity plants are able to create jobs due to paying a lower wage rate than the marginal productivity of labour, whilst a low productivity plant will shed labour for the opposite reason (Salvanes, 1997). Solidarity wage policy promotes economic efficiency in three ways. First, Holmlund (1988) argues that a comprehensive union organisation, capable of influencing the entire economy, has a greater vested interest in achieving efficient wage settlements. Unlike a fragmented wage bargaining framework containing multiple small unions, each only bargaining for a small proportion of an industry or craft-skill base, a monopoly union organisation cannot ignore the impact on jobs and inflation resulting from its wage bargaining demands. Therefore centralised wage bargaining is more likely to be associated with a superior trade-off between inflation and unemployment. This conclusion is consistent with the findings made by the influential Calmfors and Driffill (1988) study. Secondly, it reinforces active labour market policy by promoting structural change and labour market mobility. Basing his remarks upon experience designing the ‘Swedish Model’, Meidner states that solidarity wage policy will ‘not function unless the government is willing and able to carry out an active labour market policy’ and manage aggregate demand (Meidner, 1983: 15, 1987). Elimination of ‘wage dumping’ means inefficient firms are not subsidised by paying lower wages to their employees for equivalent work to higher-waged posts in other firms in the industry. Moreover, as discussed earlier in this chapter, moderate wage-cost pressure increases the substitution of capital for labour, accelerating business restructuring and rapid introduction of new technology; thereby stimulating greater labour and capital productivity (Bergström, 1980: 6). Solidaristic wages would thus encourage structural change and economic growth (Erixon, 2001: 18). It is further argued that narrow wage differentials can aid labour mobility by minimising any loss of earnings if workers transfer from a high to low wage sector (Rehn, 1987: 76). Finally, solidaristic wages were considered to be less inflationary than the alternative, namely reliance upon wage differentials to encourage labour to transfer to areas of skill shortage. Inertia in job preferences, and time lags involved in training programmes, contributes to the fact that wage differentials must be quite large in order to

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successfully attract employees from other sectors of production or to re-join the labour market from education, childcare and/or retirement. However, such large differentials would cause greater social inequality, and hence may create additional inflationary pressures due to the resultant distributional conflict between groups of workers. Rehn and Meidner both considered that the development of ‘fair wages’ would minimise such inflationary wage-price spirals. The solidarity wages policy should therefore be a constraint upon inflation (Erixon, 2001: 18–19). Traxler (1997: 30) suggests that attempts to re-establish corporatist arrangements will be opposed by employer desire to pursue a marketdriven variant of industrial relations, because a cost minimisation strategy is less demanding than negotiating reform and offers short-term advantages, whilst the deregulation and decentralisation of industrial relations increases the power of employers in relation to workers. Therefore, whilst macroeconomic policy remains characterised by neoliberalism, concertation will be regarded as dysfunctional.

Conclusion The approach of Third Way economics towards the labour market is one of the areas of greatest diversity between the approaches adopted by ‘new’ social democratic parties. Third Way theory, discussed in earlier chapters, holds that the rate of employment is determined in the labour market and not, as the Keynesians would propose, the result of effective demand and its impact upon the product market. The majority Third Way consensus is that the achievement of a more flexible labour market will facilitate lower unemployment rates at no cost in terms of higher inflation, and is likely to attract inward investment into the economy. However, whilst certain nations have made significant progress in deregulating most aspects of the labour market and employment practice, others have found this to be more difficult to achieve. In contrast, Streeck et al. have outlined a coherent case that a more regulated and organised institutional framework is likely to produce a high skill, high wage, high rate of human capital investment economy, as opposed to a low wage, low skill alternative. Thus, other social democratic parties have resorted to innovative forms of corporatist social pacts in search of welfare and employment regulation reform.

6 Public Sector Reform: Employability

Introduction The Third Way economics strategy places great emphasis upon enhancing the supply-side of the economy. In the previous chapter, the utilisation of active labour market policy, combined with initiatives designed to increase the flexibility of the labour market, were examined in terms of their contribution towards their impact upon reducing unemployment. This would be achieved through shifting the supply-side determined long run equilibrium rate of unemployment to the right, together with their ability to attract FDI and thereby enhance technologically advanced production. In contrast, this chapter concentrates upon a second variant of supply-side policy, notably one targeted upon reform to the public sector in general, and specifically to the welfare state. This includes the introduction of New Public Management (NPM) techniques into public service provision, complete with a greater emphasis placed upon contracting, instituting a purchaser–provider split, strategic management and the introduction of quasi-marketisation as a mechanism to introduce competition and deliver structural change. The economic rationale behind these supply-side reform programmes relates to the Third Way’s adoption of the endogenous growth theory as a means of raising the economy’s long-term growth potential (Gamble and Kelly, 2001: 176). This approach is based upon the hypothesis that investment in knowledge, when added to physical capital, produces increasing returns. Therefore, investment in human capital and/or research and development has the potential effect of significantly increasing labour productivity (Romer, 1986, 1990; Lucas, 1988; Solow, 1994: 50; Skott and Auerbach, 1995). Government expenditure in the areas of education and training is acceptable as a means of raising productivity 129

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and economic growth rates, whereas expenditure in other areas is viewed more of a drain upon the dynamism of the economy (Hutton, 1999: 101; Altman, 2001: 126; Mosley, 2003: 9). The endogenous growth theory, therefore justifies a limited and targeted pump-priming role for public expenditure as a means of public investment, undertaken in the expectation to secure exponentially greater future returns in economic productivity and growth.

Public sector reform: Managerialism and marketisation The 1980s was a difficult decade for the public sector throughout the industrialised nations. Public services were initially constructed upon technical or rational planning models that emphasised uniform services and centralised command-and-control decision-making – that is adopting many of the elements of the Fordist mode of production. However, publicly operated systems faced insistent pressures to differentiate services to heterogeneous client groups and to decentralise administrative decision-making to local institutions. Moreover, a simultaneous squeeze upon public expenditure contributed to the cash-rationing of some services. A growing lobby began to suggest that the system was producer orientated, responding to the interests of public sector professionals rather than the recipients of the services. Service delivery was criticised as being incoherent, bureaucratic and inadequate (Massey, 2001: 27; Newman and de Zoysa, 2001: 39). Moreover, requirement to provide an increasing volume of differentiated service, whilst budgets remained constrained, increased the pressure upon service provision and demanded consideration of new methods of enhancing efficiency without abandoning traditional values and objectives. The fact that public services tend to be labour-intensive activities and have historically experienced lower productivity rates than manufacturing industry, whilst consumers tend to disproportionally increase their demand for merit goods (i.e. education, healthcare, training, sport and leisure activities) as their incomes rise, all implies that costs tend to rise disproportionately quickly in these industries (Holtham, 1999: 60). The cost of providing these services will therefore tend to rise relative to income, and if they continue to be financed through general taxation, the share of tax in GDP must rise over time. This is politically difficult to sustain. Moreover, as Western economies are becoming increasingly service based rather than manufacturing based, continued economic growth increasingly depends upon whether these services can achieve significant productivity gains.

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The acceptance by Third Way economics of the hyper-globalisation thesis leads to the policy conclusion that taxation should be kept as low as possible, at least for mobile assets. This is reinforced by the reluctance to provoke a tax revolt by middle-class and skilled working-class taxpayers, as occurred in Denmark in 1973 and 1989–90, and in the UK between 1979 and 1987 (Blair, 1998d: 15; Callaghan, 2000: 220). This does not mean that Third Way governments have not raised taxes to sustain public services. Indeed, Sweden did this most successfully in 1994 and even in Britain the New Labour administration won the 2001 General Election on the basis that indirect taxation would be slightly raised to restore public services (Ludlam, 2004: 3). However, in both cases, generosity in funding was combined with insistence that ‘modernisation’ or the radical reform of public services was a condition of providing these additional resources (Labour Party, 2001; Blair, 2003; Prabhakar, 2004: 161). Third Way economics, therefore, requires the introduction of reforms that can increase the efficiency of the public services in order to increase service provision, given a relatively consistent level of funding. The two mechanisms selected involved reforms to the structure of public service provision, with a particular emphasis upon the introduction of market forces into areas of public provision, whilst the other relates to initiatives to achieve internal modernisation through the widespread introduction of NPM.

New public management Developed in the UK, NPM has influenced Third Way administrations in the US, Australia, Scandinavia and, to a lesser extent, continental Europe (Lane, 2000: 3). NPM is a means of empowering managers within the public sector through the introduction of contracting within the public services, the establishment of formal targets to be achieved and, by utilising structural change to loosen up the former bureaucratic regimes, to facilitate greater decentralisation of initiative and activity (Osborne and Gabler, 1992; Massey, 2001). Institutional and individual objectives are clearly defined and include the establishment of key performance indicators against which to measure delivered outputs (Hughes, 1998: 52; Horton and Farnham, 1999). Benchmarking is used to spread best practice (Samuels, 1998). Accountability of results is therefore central to the NPM approach. Reconsideration of traditional public sector governance leads to the conclusion that government has traditionally performed three different

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functions, namely purchaser, service provider and monitor or regulator of the service provision activity. However, there is no reason why government need to retain responsibility for each of these activities at all times and in all circumstances. NPM utilises this observation to promote the idea that government should manage the public sector via a set of contracts (Alford and O’Neill, 1994). Contracts define service objectives, minimum levels of quality and so forth. Each contract can run to hundreds of pages due to the complexity of specifying all eventualities to be covered by the agreement. The intention is to empower the principal by providing them the right to hold the agent to account if the contract is breached in any way. Therefore, unwritten, implicit contracts undertaken between members of the bureaucracy are replaced by formal contracts that can be enforceable. NPM is associated with a move from tall hierarchies to flatter, more devolved management structures, with flexible terms of employment (Horton and Farnham, 1999). The former public sector organisation is criticised as being technically inefficient, allowing too much organisational slack in its performance – that is it is arguably X-inefficient (Borcherding et al., 1982; Boyne, 1998; Lane, 2000: 72–75). Remuneration and working conditions are decentralised to increase their flexibilisation and enhance accountability for individual and/or group performance (Naschold and von Otter, 1996: 41). Advanced information technology is typically utilised to improve access to government and facilitate the flow of information to citizens from the many public sector organisations with which they have contact (Massey, 2001: 25). It is notable that NPM in Germany, for example, concentrates upon increasing co-operation between individual elements of the public sector and social organisations, rather than establishing a customer-orientated approach (Naschold and von Otter, 1996: 63). NPM is also associated with structural change to the public sector. This can involve a commitment to reducing the role of the state in the provision of services in favour of privatised companies and the establishment of a market in areas previously viewed as the preserve of natural monopolies or public adminstrators (Massey, 1993; Hughes, 1998). It may additionally facilitate the development of quasi-markets to encourage competition between providers – whether publicly or privately owned (Naschold and von Otter, 1996: 42). Marketisation The case for the introduction of market-based competition within the public sector is that it will lead to greater efficiency, provide incentives

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to secure productivity gains, encourage proficient management and produce a higher quality of service at lower cost. In other words, marketisation will produce an increase in welfare for consumers who will receive additional service for a given level of public financial support, and will therefore experience a gain in utility. For the government, the service will be improved by this additional service provision and achievement of optimum output at lowest possible cost. Flexible markets are adopted as a modern social democratic aim (Blair and Schröder, 2000: 168). One failing associated with the traditional model of public service provision relates to the fact that, unlike the private sector, there are few penalties attached to economic inefficiency. Public bodies do not generally go out of business however poor their relative performance. Indeed, before the NPM agenda began to be implemented, there were few reliable publicly available statistics by which to measure the relative efficiency of various service providers. Performance indicators and related ‘league tables’ of providers can empower consumer choice within complex areas of service delivery. Moreover, salaries and the job security of staff did not depend upon the success of the organisation in lowering costs or attracting consumers of their services. Therefore, neither staff nor management had any incentive to struggle to reduce costs or dramatically improve services. The introduction of competition between different service providers, where money follows people rather than being distributed to each hospital in a block grant, introduces such missing incentives. The purchaser–provider split enables government to contract agents to provide services in addition to monitoring the progress of each of these agents. Diversity can be promoted, in both funding and provision. In terms of funding, this has meant the expansion of public–private partnerships (i.e. the Private Finance Initiative, PFI), where the public sector contracts the private sector to finance, build and potentially run public services, paid for through general taxation, and contracted to continue at a minimum rate of usage for perhaps 15 years duration. Thereafter, depending upon the nature of the PFI contract, the asset may revert to public sector ownership or remain the property of the private sector company (Prabhakar, 2004: 169). In terms of provision, diversity is promoted through the creation of primary health care trusts, commissioning occurring through GP fund holding and the treatment of individual hospitals as self-managing entities, together with the local management of schools and introduction of specialist schools (Driver and Martell, 1998: 94; McCaig, 2001: 200; Prabhakar, 2004: 169–170).

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Service providers can remain entirely within the public sector or involve an element of private sector entry into the market, through either privatisation of a formerly public owned entity or through the contracting-out of specific areas of service provision (Elcock, 1991; Hughes, 1998). Critique of NPM One limitation of the NPM approach is that the concentration upon contracts reduces the flexibility of action and relationship necessitated by complex organisations and changing needs of service recipients, thereby requiring repeated re-negotiation of contracts and consequent high transaction costs. A second problem relates to the weakness in separating purchaser and provider. No longer does the public service seamlessly internalise all aspects of this relationship, but instead this causes organisational fragmentation and the development of divergent interests between each of the different groups. This can cause considerable dynamic inefficiency in a small organisation. Moreover, contractual obligations can break the democratic accountability link between elected representatives and the citizenry. Agents may be unwilling to allow their business sensitive data to be distributed to the population at large. Furthermore, performance management can work well within a homogeneous, Fordist service provider, but since one of the arguments for public service reform argued that consumers increasingly demanded differentiated services, the setting of easily defined and measured targets will be less effective. Finally, the introduction of a commercial culture and stress upon entrepreneurialism may undermine the public service ethos (Naschold and von Otter, 1996: 47). Market failure may additionally weaken public sector reforms. For example, in many geographical areas, competition between providers is extremely limited, thus the limited degree of competition between a few alternative suppliers weakens incentives intended to force producers to improve their cost effectiveness. A market characterised by oligopoly may result in collusion between service providers, or at least the realisation that their joint interests are best served by non-price competition rather than a price war – hence, explaining the high cost, high quality status of much of the US private health service. Furthermore, despite publicly available data, consumers may have insufficient technical knowledge to be able to correctly interpret this information (i.e. in health and education sectors), and therefore the market will not display consumer sovereignty as decisions will often be influenced by advice given by professionals within the sector. Transaction costs resulting

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from changing service provider may additionally lead to inertia and a reduction in anticipated allocative gains, whilst the presence of sunk costs may prevent institutions from fully exploiting demand for their services through expansion. Competition may, additionally, cause service providers to specialise in those areas in which they hold a competitive advantage. However, this may reduce effective choice available to service recipients who may not be able to travel large distances to receive a specific service – that is a heart attack victim would prefer for a local accident and emergency department, and a woman in labour would prefer a local maternity unit. It would be of little comfort for either individual to discover that their local hospital had determined to specialise in geriatric treatment and, due to their rural location, the nearest alternative was fifty miles away. Similarly, the closure of individual university departments may make financial sense to each autonomous organisation, but the aggregate consequence will be to reduce the range of provision, variety of research output and breadth of student choice.

Welfare reform The social democratic welfare state is a remarkable achievement by historic standards (Mishra, 1999: 29). Moreover, the development and protection of the welfare state lies at the very core of traditional social democracy. Social security, education, health, housing and social care are all essential elements of the social democratic project, and as such, the welfare state lies at the core of social democracy (Le Grand, 1999: 142). Consequently, it is natural that any fundamental re-evaluation of social democracy, such as that which has been undertaken by Third Way theorists, must involve a reassessment of the welfare state, in terms of its objectives, methods of finance and means of service delivery (Funk, 1999: 11; Meyer, 1999: 300). Critique of the passive welfare state The fiscal crisis of the welfare state, due to pressures created by globalisation and tax resistance from mobile groups of citizens, has exacerbated demographic changes in society, at a time of higher unemployment rates than were typical during the ‘Keynesian era’, and has led to increased interest in how the burden of welfare expenditure can be reduced (Callaghan, 2000: 220; Hombach, 2000: 136; Vaughan-Whitehead, 2003: 499). In their joint ‘manifesto’ The Third Way, Blair and Schröder suggested that public expenditure as a proportion of GDP has reached

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the limits of acceptability, implying that the welfare state has developed to full maturity and, rather than future expansion, social democrats need to concentrate upon the prudent and efficient management of the welfare state (Mishra, 1990: 1006–1008, 1999: 54). The Swedish LO blue-collar trade union movement had accepted this as far back as their 1986 Congress Report ‘Fackföreningsrörelsen och Välfärdsstaten’ [the trade union movement and the welfare state], which suggested that the welfare state was now fully developed in terms of its overall share of national resources, and therefore additional benefits must accrue from initiatives to improve its efficiency of operations and service delivery (Whyman, 2003: 92). The Third Way challenges the existing efficiency of the welfare state in achieving its objectives, particularly in terms of the assumption that increase in social expenditure will automatically lead to a reduction in socio-economic inequality (Merkel, 2001: 52–57). Evidence produced by Le Grand (1982) has suggested that the welfare state has had the greatest benefit for the middle classes, rather than as a primary means of redistributing wealth to the poorer sections of the community. Moreover, the passive nature of welfare entitlements in the welfare state concerns Third Way theorists. It has been suggested that this prevents the establishment of a socially oriented and individually responsible citizenship, and rather promotes dependency, a loss of discipline and a lack of motivation to adapt oneself to the new educational challenges of the changing labour market (Merkel, 2001: 52–57; Giddens, 2002: 198). One consequence of the claimed ‘crisis of the welfare state’ is that it has provoked arguments for the retrenchment of the type of ‘strong state’ activity, that formerly characterised traditional social democracy, and some sort of ‘rolling back’ of the state. This viewpoint is particularly prevalent amongst neo-liberals and the Republican Party in the US, but it is a viewpoint also held by influential Third Way theorists (Stiglitz, 2003: 171). For example, Giddens (2002: 191) identifies what he perceives as an ‘overload of modern government’ which ‘is strangling the legitimacy of the welfare state’ due to the undue grafting of additional responsibilities and objectives onto the original post-war welfare state model. Thus, Minford (1999) is able to suggest that one feature that defines the Third Way is ‘government doing what it does best and leaving the rest to the private sector’ (Minford, 1999). This alleged overload of government is exacerbated by the fact that the structure of the welfare state has proved too inflexible in responding to changing times (Merkel, 2001: 52–57). The provision of standardised,

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mass services, created according to essentially Fordist principles, has found difficulty adapting to changing social conditions, accompanied by a shift in demand and needs (Giddens, 2002: 199). Changing work organisation, working-life balance, demographic changes, transformations in family structures and the changing role of women have all altered welfare requirements (Favretto, 2003: 147). Thus, Giddens (2002: 335) argues that ‘without the dismantling of old forms of welfare and their replacement with the tools of social capability, there can be no renewal of the social democratic project’. A second consequence arising from the criticism of the welfare state relates to the claim that it gives rise to ‘Eurosclerosis’, which essentially refers to the tendency for rising public expenditure upon welfare programmes to depress economic performance. The theoretical foundations of this argument rest upon neo-classical foundations, suggesting that the public sector has growth too large, and is draining the vitality out of the economy. Variants of this approach focus upon the ‘crowding out’ hypothesis, whereby public sector investment competes with more productive private sector investment opportunities for a relatively fixed level of savings, and in the process causes interest rates to rise in an attempt to ration excess demand, and thereby depresses the growth rate. The actual cost of the welfare programmes is leading to high levels of taxation having to be levied to pay for the schemes and that this, in turn, reduces incentives for economic actors and encourages ‘welfare dependency’ (Purdy, 2000: 182). Thus, raising corporate taxes may reduce investment and employment, whilst higher labour taxation may reduce work incentives. Similarly, increased savings taxation may reduce the amount of risk capital available to finance productive investment, whilst enlarged consumer taxes may increase inflation. Furthermore, failure to meet all of the costs of public expenditure through taxation must either be funded through printing money, which is considered inflationary, and/or borrowing, which is likely to increase interest rates, thereby reducing the incentive to invest and thereby impact negatively upon capital growth, productivity and economic growth rates. Dréze and Malinvaud (1994: 95) suggest that the objective should be to ‘make the welfare state leaner and more efficient’. In terms of the evidence presented to support this argument, Feldstein (1974: 922) claimed that the US social security system reduced private savings rates, thereby reducing the stock of capital and the level of national income.1 Therefore, reform of unemployment benefits ‘could substantially lower the permanent rate of unemployment’ (Feldstein, 1976: 956).

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Weede (1986: 506) likewise found that ‘social security transfers reduce growth rates rather strongly’. Persson and Tabellini (1994) found that social security transfers were negatively associated with average growth rates. Moreover, to the degree that welfare states truly decommodify workers, this weakens the discipline of the market, creating passive welfare clients who choose not to work, or at least weakening the incentives (positive and negative) employed to increase labour productivity and thereby growth potential. Furthermore, Layard et al. (1991) found that benefit duration and replacement rates were both positively associated with higher unemployment rates. Although other studies such as OECD (1991: 177) found no such statistical linkage. Sweden has often been used as the test case for the Eurosclerosis hypothesis as it has the highest share of its GDP accounted for by public sector transfers and expenditure. This is a fact that is portrayed as both a measure of economic failure, but also a cause of slow growth rates (Agell, 1996; Dowrick, 1996; Henrekson, 1996). In Sweden, a bourgeois government-established commission identified problems with the Swedish welfare state as causing a crisis with the ‘Swedish Model’. In particular, the commission identified an institutional framework which constituted ‘an obstacle to economic efficiency and economic growth’ due to over-concentration upon the provision of ‘income safety’ and distribution issues, rather than facilitating flexibility and economic incentives (Lindbeck et al., 1994: 17). Accordingly, the welfare state has been presented as over-burdening the economy and the case presented for the reform of benefit transfer payments in order to re-emphasise incentives to save and work, together with a general reduction in generosity and scope of the welfare state programmes to reduce the fiscal burden upon the state. Thus, the conclusions produced by this neo-liberal analysis are clear. Sweden’s public sector required reducing in size, its welfare system required reform to reduce dependency, and taxation levels reduced to provide greater incentives to work, save and invest. The Eurosclerosis argument is not without its critics, however, who point out that simple associations of statistical data can be misleading, particularly since the ranking of countries depends largely upon the time period from when the data is selected. Moreover, public expenditure has demonstrable beneficial effects upon economic growth. This is particularly noticeable with human capital and physical infrastructure investment. However, it also includes welfare expenditure due to its role as an automatic stabiliser, thereby preventing the economy from suffering a higher degree of capacity reduction than would otherwise occur during a recession (Korpi, 1985, 1996; Barr, 1992). There is, moreover,

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some evidence that an economy’s increasing insertion into world trade and capital flows is linked to greater, not less, welfare spending (Garrett and Mitchell, 1995). Thus, a number of studies found a positive relationship between social security transfer payments and economic growth rates (Korpi, 1985; McCallum and Blais, 1987; Castles and Dowrick, 1990). Endogenous growth theory finds a positive relationship between many aspects of public sector expenditure and economic growth rates (Atkinson, 1999). Barr (1992: 742) argued that ‘the welfare state has an efficiency function which is largely separate from its redistributive aims’. Likewise, Abramovitz (1981: 2–3) stated that: The enlargement of the government’s economic role, including its support of income minima, health care, social insurance, and other elements of the welfare state, was . . . not just a question of compassionate regard . . . It was, and is, – up to a point – a part of the productivity growth process itself. Schmähl (1995: 27) suggested that certain welfare programmes probably contributed to economic efficiency whereas others may detract from it, and therefore the task was to maximise the benefits accruing to the former and minimise those from the latter without necessarily having to eliminate areas of provision. Barro (1990), likewise, hypothesised a ‘hump shaped’ relationship between public goods financed through taxation and economic growth rates, signifying that, beyond an optimal level, the positive association becomes negative, as the Euroslerosis theorists predict. The absolute cost impact of demographic change is significant, but affordable (Callaghan, 2000: 122). The OECD (1988) calculated that the additional pension costs necessitated by an ageing population could be funded through relatively modest growth rates ranging between 0.5 and 1.2 per cent of GDP, depending upon the nation concerned. Furthermore, certain nations, including Germany and Sweden, have responded to demographic change by raising the retirement age and introduced additional measures to raise the proportion of economically active individuals of working age, primarily through the promotion of female employment, in order to maintain a healthy ratio of taxpayers to recipients of welfare schemes (Esping-Andersen, 1996a: 7). The New Labour government in Britain is currently debating the adoption of many of these solutions, particularly relating to public sector employees.

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Commodification of social policy Partly due to the fiscal crisis of the welfare state and the debate over benefit entitlement, incentives and ‘Eurosclerosis’, and partly resulting from its ideological departure from traditional social democracy, Third Way social policy has a distinctly work-orientated status. Rather than the welfare state existing to decommodify individuals and protect them from the consequences of market allocation, the Third Way version of the welfare state is to provide citizens with the assets they require to compete effectively within the global marketplace. In other words, employment-centred social policy commodifies individuals and promotes employment as the best means of avoiding poverty, providing individuals with self-esteem and providing a decent standard of living (Giddens, 1998a: 103; Smith, 2004: 222–223). It results from Third Way administrations seeking to ‘rebuild the welfare state around work’, such that ‘it is the Governments responsibility to promote work opportunities’ and ‘the responsibility of those who can take them up to do so’ (HMSO, 1998: 23, 31). The re-conception of the welfare state as an element of economic policy, contributing towards full employment, the promotion of productivity and economic growth, is indicated in the first budget speech made by the then newly elected British Chancellor of the Exchequer, Brown, where he stated that ‘childcare is now an integral part of economic development’ (Ainley, 1999: 94). Likewise, for Blair, the way to provide social protection today is not more and more regulation or high business costs and taxes; it is through making our workforce highly adaptable, more employable and better skilled; through encouraging the development of technology; promoting small businesses; and making our welfare systems help people off benefit and into work, with specific measures to combat exclusion. We need a new social model for a new European reality . . . a vision that lets us adapt the European social model to the new realities of global commerce’. (cited in Vaughan-Whitehead, 2003: 516) In Britain, this approach resulted in the ‘welfare-to-work’ programme, which sought to utilise tax incentives and minimum wage legislation to increase the surplus of wage labour over benefit entitlement (i.e. to make work pay), to improve employability through training and job search initiatives, and increasing the success rate in getting the unemployed off benefits and into work (Oppenheim, 1998; Blair and Schröder, 1999: 33; Gamble and Kelly, 2001: 176). The specified aim was to ‘build

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security through employability’ by helping individuals to develop and adapt their skills in accordance with the changing requirements of the labour market (DfEE, 1997; Finn, 2000: 384). In Portugal, socialist administrations pursued similar policies by utilising social security exemptions and state aid to hiring firms and business start-ups in 1995 (Costo-lobo and Magalhaes, 2003). In the US, the New Democrats promoted the conditionality of welfare, flexibly labour markets and ‘workfare’ (Corera, 1998, 1999; Driver and Martell, 1998; Marquand, 1998; Philpot, 1999; Walker, 1999; Deacon, 2000; Powell, 2000). Clinton memorably asserted that ‘the best anti-poverty program is still a job’ ( Jaenicke, 2000: 41). Moreover, one of the key slogans used by the Dutch social democrats is ‘work, work and work again’ (Favretto, 2003: 152). Furthermore, in Sweden, the welfare state has focused upon encouraging employment participation for the past half century. Indeed, the ‘trampoline not safety net’ metaphor was borrowed from the Swedish Model (Driver and Martell, 1998: 107; Hombach, 2000: 40). Distribution and endowment egalitarianism One area where Third Way social policy differs markedly from traditional social democratic performance relates to the fact that it ‘lacks an explicit conception of distributive fairness’ (Vandenbroucke, 1996: 63). Unlike social democracy, it is claimed that the Third Way is not egalitarian – that is, a belief that life’s outcomes should be made more equal (Driver and Martell, 1998: 30; Clift, 2001a: 61). Partly, this results from a firm belief that redistribution, based primarily upon progressive fiscal policy, will no longer be tolerated by electorates and is inconsistent with the realities of a globalised world (Hombach, 2000: xxxiii; Wood, 2001: 49). Certainly, the word ‘redistribution’ rarely appears in Third Way documentation because of its implications for tax policy (Gamble and Kelly, 2001: 182).2 In its stead, Third Way theorists emphasise the importance of ‘fairness’, reducing poverty, especially for the deserving poor (i.e. children, ‘hard working families’, etc.) and eliminating social exclusion (Driver and Martell, 1998: 30; Giddens, 1998a: 2000; Levitas, 1998). This stance undoubtedly retains a commitment to social justice that distinguishes the Third Way from a crude imitation of neo-liberalism, but it is one based upon the establishment of minimum standards and equality of opportunity rather than on redistribution and equality of outcome (Le Grand, 1998: 27; Buckler and Dolowitz, 1999: 189). However, considerations of equality, a critique of capitalism and the redistribution of power and economic resources for working people and their families

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have been replaced by the facilitation of individual opportunity (Driver and Martell, 1998: 160). The Third Way largely accepts social inequality as a ‘legitimate and functional stratification pattern in highly developed market economies under the conditions of globalised economic transactions’ (Merkel, 2001: 50). Indeed, ‘fairness’ can be presented as supporting the creation of incentives through reducing taxation for work and savings to reflect hard work, and not simply equality issues. Whilst Third Way social policy no longer seeks to redistribute primarily through fiscal policy, it does seek to equalise life chances to a certain degree through initiatives designed to change the initial distribution of assets and productive endowments: wealth, skills and jobs (Rogers and Streeck, 1994; Commission on Social Justice, 1994; Freeman and Rogers, 1997). This concentrates on primary rather than secondary redistribution, or asset based as opposed to fiscal egalitarianism, and seeks to tackle the root causes of poverty and inequality rather than merely compensating people for their poverty (Powell, 2000). Social justice is presented as a broadening and equalising distribution of individual ‘life chances’. This approach has been termed ‘endowment egalitarianism’ (Driver and Martell, 2003: 160). Measures to reduce individual inequality of opportunity involve investment in the stock of education and skills, together with creating an environment capable of facilitating the optimal utilisation of these endowments. These include initiatives such as the promotion of lifelong learning, welfare to work and reform of the tax and benefits system are intended to promote personal autonomy and choice, giving individuals the confidence and capability to manage their own lives (Esping-Andersen, 1994). Thus, the commitment to education and training is seen as a manifestation of economic egalitarianism, which also boosts productivity and economic growth (Clift, 2004: 37). The creation of a ‘learning society’, marked by lifelong learning and the attempt to systematically increase the skills and knowledge of all citizens, has the potential to enhance national economic competitiveness through facilitating the exploitation of technological innovation and thereby creating competitive advantage in dynamic global markets (Reich, 1997; Ainley, 1999: 94; Midgley, 2001: 161). Endogenous growth theory ends the ‘cleavage between economic and social policies’ (Reich, 1983). It also provides ‘new’ social democrats with a viable programme for economic ‘survival in the age of globally-mobile capital funds and technologies’ (Stedward, 2000: 171). White and Giaimo (2001: 216) argue that this is a form of ‘Left Thatcherism’, whereby government provides citizens with similar ‘initial

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endowments of marketable assets and then let the free market rip’ (White and Giaimo, 2001: 216). The Borrie report on Social Justice, on the other hand, contrasts what it terms the pessimist ‘levellers’, who concentrate upon distribution to the neglect of production, whilst ‘investors’ extend economic opportunity and thereby provide ‘the basis for prosperity as well as social justice’ (RJC, 1994: 79,104). According to Blair and Schröder (1999: 35), the state must play an active role in facilitating broad participation in economic development rather than being the passive recipient of the casualties of economic failure. Referring to the ‘enabling state’, Gordon Brown suggests that what is important is not ‘what the state can do for you but what the state can enable you to do for yourself’ (Favretto, 2003: 150). Critique There are a number of criticisms levelled at the Third Way work-centred approach to social policy. First, it remains silent upon how its measures can assist some of the most disadvantaged members of society, namely those not in work, including retired pensioners having to rely upon state pensions, single parents, severely disabled individuals and so forth (Myles and Quadagno, 2000: 166; Schmidtke, 2002: 16). Secondly, it is argued that the evidence portrays a disjointed ‘welfareto-work’ strategy, because there are only a limited number of jobs that actually depend upon high levels of education and training, and that most of the jobs created through deregulation and a flexible labour market are low paid, service sector jobs with low skill requirements (Barnett and Cavanagh, 1994: 292–293; Rifkin, 1995: 165–168; Hay and Watson, 1999b: 176; Mishra, 1999: 22). Thirdly, it is suggested that the development of a high skill labour force requires considerably greater institutional co-ordination, particularly with and between businesses, than typically occurs in the Anglo-Saxon economies. Therefore, it is only organised economies, such as in the more corporatist Scandinavian and Germanic nations that these policies will work optimally. According to this argument, the key organizational requirement for a flourishing vocational training system is that business is collectively organised, because this will encourage employers to invest in the skills of their workers, whilst coordination between employers helps to prevent ‘free riding’ upon the investment of others through the poaching of skilled workers (Wood, 2001: 56). Moreover, labour market regulation reinforces employer commitment towards their workforce’s human capital by making downsizing difficult and costly and thereby encouraging employees to be

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treated as fixed assets (Streeck, 1992a). In the absence of coordination between employers, managers dependent upon short-term capital face short-term planning horizons that militate against investment in human capital (Wood, 1999, 2001). This area of Third Way strategy is also one of the most variable in terms of the commitment of individual social democratic parties. Merkel (2001: 52–57) argues that the market-oriented approach of the US New Democrats and British New Labour parties can be contrasted with a consensus-oriented Dutch polder model, the reformed-welfare state approach of the Swedish and Danish social democrats, and finally the statist programme pursued by the French socialists. Sassoon (1996: 741–742) by contrast, distinguishes between the British New Labour, US New Democrats, Dutch PvdA and Finnish social democrats broadly adopt this approach, whilst social democrats in Germany, Sweden and France hold more ‘traditional’ viewpoints. Nevertheless, this point cannot be stretched too far. The German social democratic administration has been struggling for a number of years to secure reforms to the welfare state, each of which would shift the German model slightly towards the Third Way consensus. Similarly, although the Sweden welfare state remains at one end of an internationally comparable spectrum, social democratic administrations have introduced limited privatisation, contracting out of services and introduced a number of employment-orientated reforms in the last decade.

Conclusion The Third Way response to its rejection of active Keynesian macroeconomic demand management has been to intensify its efforts to secure supply-side reforms intended to promote employment, increased productivity through human capital investment, and reducing disincentives through judicious shifting of emphasis from passive fiscal welfare transfers to endowment-orientated ‘welfare-to-work’ initiatives. Simultaneously, the adoption of New Public Management reforms has sought to increase the efficiency of public expenditure financing public service provision, whether in the fields of welfare, education, housing, health or local government. The endogenous growth model predicts that this reorientation of public expenditure should raise the economy’s long-term growth potential and promote rising employment without the need for (self-defeating) Keynesian intervention. Yet, it is interesting to note that many of these initiatives could compliment a Keynesian supply-side reform programme equally as a New Keynesian neo-liberal

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Third Way synthesis. The exceptions would be that a post-Keynesian approach would take greater account of the institutional framework within which policy was intended to operate, and it would take greater account of welfare transfers as a source of aggregate demand in addition to representing a drain upon the national budget. This may, arguably, produce a more balanced approach to welfare reform than the Third Way has produced, but this remains an untested hypothesis.

Notes 1. It is important to note that the link between a decline in the personal savings rate and capital stock depends upon the neo-classical assumption that it is the level of savings in the economy that provides the pool of money from which productive investment can be made, and hence the level of savings determines the level of investment, capital stock and growth rates. PostKeynesians do not, however, accept this analysis, arguing instead that it is the level of investment, prompted by expectations about the potential future level of profits and funded primarily through current retained profits, that generates additional income, some of which is saved. Therefore, according to post-Keynesians, investment stimulates savings, although there is no presumption, unlike for neo-classical economists, that the two values will be in equilibrium at a full employment level of production. Keynesians accept the likelihood that savings will not equate to investment at the full employment position for the economy, and therefore government action must be used to stimulate private investment, increase public sector investment or utilise redistributive taxation to reduce private savings in order to eliminate the gap. 2. The exception might focus upon Brown’s policy of ‘redistribution by stealth’ in the UK, where successive budgets did appear to introduce a modest form of redistribution across social groups, although this has been insufficient to reverse the trend towards social inequality due to widening differentials in pre-tax incomes (Keegan, 2003: 258).

7 Regional Economic Integration

Introduction The increasing internationalisation of economic activity has, as demonstrated in Chapter 2, occupied a central role in the development of a distinctive Third Way economics. The adoption of the hyper-globalist position, namely that globalisation is a real phenomenon and one which effectively undermines traditional forms of social democratic programme, leads Third Way supporters to accept such changes in the external economic environment rather than oppose them. Indeed, Third Way policy tends to promote internationalisation through privatisation and liberalisation of regulatory controls over trade and capital movements, and thereby contribute towards the further acceleration of globalisation. One facet of this approach concerns the encouragement of what Vandenbroucke (1996: 12, 57) calls ‘regional globalisation’, namely the facilitation of regional economic integration. Here, Clinton steered the NAFTA through Congress, despite opposition from trade unions, a number of prominent (pro-protectionist) Republicans and significant elements within the Democratic Party. However, the clearest example of Third Way promotion of regional economic integration concerns social democratic support for the intensification of economic and political integration within the EU. Consequently, it is upon this phenomenon that this chapter will focus.

The European ‘project’ The EU is a fascinating organisation. Originally established to facilitate co-operation between a small core of European countries upon such sensitive issues as nuclear power, coal, iron and steel, it has greatly 146

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expanded and evolved through stages as a customs union, free trade area and common market, before moving beyond its trade-orientated focus towards the promotion of full economic and political integration between member states. The most explicit example of the realisation of this agenda concerns the establishment of EMU between twelve member states during the latter years of the twentieth century. Political integration has resulted in closer co-operation in foreign and defence policy, policing, border controls and immigration issues. The EU has drawn up its own constitution (yet to be formally ratified by all member states), adopted a flag, passport and national anthem. Indeed, all citizens of EU member states are automatically EU citizens as well. Thus, the EU has many of the trappings of a nation state, and is committed to pursuing others. Tensions remain within the organisation for a number of reasons. One relates to the fact that EU institutions and practices have long been criticised for a lack of transparency and democratic accountability. Part of the problem arises from the continual evolution of the objectives of the organisation, whilst corresponding institutional reform suffers from a significant time lag. A more significant concern, however, relates to the future direction of the EU, and in particular whether this involves intensification of integrationist momentum towards a fledgling federal super-state or the reversal of direction and movement towards a looser form of organisation co-ordinating delegated competences from otherwise sovereign nation states. Blair and Chirac have expressed a clear preference for a model of the new Europe that combines supranationalism with inter-governmentalism, rather than the federalist vision of accelerated integration. Thus, as Stephens (2003: 254) explains, the preference is for a ‘united Europe of states rather than a United States of Europe’. Despite its shortcomings, the EU remains a pioneering form of transnational governance, whereby member states have agreed to pool sovereignty on an increasing number of issues, with the intention that this will deliver additionality to both member nations and the organisation itself. In trade policy, the introduction of the single internal market (SIM) is intended to promote industrial restructuring and thereby enhancing economies of scale, stimulating internal competitive pressures and reducing prices for consumers. In the area of EMU, it is intended that this will secure financial market integration, promote investment and reduce interest rates within the Euro-zone, whilst creating the infrastructure capable of promoting non-inflationary growth.

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Europeanisation is the only way? The European Left is increasingly identified with the ‘European project’. Young (1998: 515) claims that European integration represents ‘the given reality’, whilst Favretto (2003: 136) states that New Labour views closer European integration as ‘the only framework within which the European Left can have a future’. Accordingly, the potential failure of the European integration project would gravely undermine a sizeable proportion of contemporary social democratic strategy. Using rather apocalyptic language, Sassoon (1999: 35–36) claims that ‘the stakes are considerable’, and that the demise of European regional integration would foreshadow the dissolution of the European Left in any recognisable shape. It is unlikely, after all, that the Left could reconstruct itself in any viable form out of the inevitable economic and political dislocation which would occur. With Europe sinking, once again, in regional rivalries, squabbling nationalisms, and narrow politicking, there would be no serious obstacle left to the world-wide hegemony of unfettered market forces. This enthusiasm for closer European integration is in sharp contrast to previous policy positions held by the British and Scandinavian labour movements in earlier decades. For the Swedes, EU membership was opposed for decades on the grounds of its incompatibility with its neutrality policy, in addition to perceived threats to the ‘Swedish Model’ characterised by full employment and a generous welfare state. Furthermore, Swedish social democrats distrusted EU institutions due to a perceived bias in favour of ‘big business’ and against the interests of workers and the wider citizenry. For the British Labour Party and TUC, opposition in the early 1980s was primarily because the obligations of EU membership were considered to be incompatible with the AES. This sought to extend national control over economic forces and secure a sustainable reflation strategy through a combination of protectionism, active industrial policy and expansionary Keynesian demand management (Hill, 2001: 167; Daniels, 2003: 227). The New Labour leadership, by contrast, have consistently claimed that Britain will play a leading role in establishing a ‘people’s Europe’.1 Daniels (2003: 226–227) and Whyman (2003: 126–142) explain the shift in policy within both labour movements partly as a result of a perception throughout the party that globalisation has significantly constrained national economic policy. For the leadership, it represented

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part of an electoral strategy, which sought to create an image for the party of a ‘credible’, responsible government-in-waiting. Thus, the majority view in the British Labour Party has shifted towards a regionalist perspective, although intergovernmentalist arguments retain significant support on both wings of the parliamentary party (Baker et al., 1999, 2002: 421).

Euro-Keynesianism vs market-adaptation The EU represents both a response towards, and expression of, globalisation (Giddens, 2002: 70). The establishment of the SIM, reinforced by the facilitation of a single European financial market through the creation of a single currency, has promoted regional (if not always international) globalisation. However, the scale of the organisation does provide the opportunity for member states to avoid full-scale acceptance of the hyper-globalist viewpoint relating to the dictates of the global marketplace, and instead create an alternative model of capitalism within regional boundaries. Though not necessarily the ‘Fortress Europe’ approach of earlier years, the EU does potentially provide sufficient economic space in which to sustain (or create) a different type of market economy than that championed by neo-liberals, and characterised most explicitly by the deregulated and flexible product and labour markets of the US. It is on this basis that Marquand (1999: 15) argues that membership of an increasingly integrated Europe provides ‘the only force capable of countervailing the sovereignty of the global market-place’. Until the 1980s, social democracy was considered predominantly in national terms (Favretto, 2003: 136). However, the open regionalist perspective claimed that the objectives of national economic management could be better achieved at super-national level (Baker et al., 2002: 414). A principal catalyst for this approach concerned the failure of the French 1981–83 Mitterrand administration to maintain a strong form of ‘Keynesianism in one country’, even when facilitated by a significant increase in state ownership in the financial sector, against the combined pressures of internal political opposition and a currency crisis provoked by international financial markets (Hall, 1986, 1987; Ross et al., 1987; Sassoon, 1996: 548–561; Callaghan, 2000: 108). The termination of this ‘experiment’ subsequently came to be viewed as a pivotal episode in international political economy, whereby national Keynesianism was increasingly viewed as obsolete as its instruments had lost their power due to the opening-up of national economies, leading to leakages from reflation strategies confined to national boundaries. However,

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the open regionalist perspective offers social democrats the potential of re-creating the tools to achieve traditional social democratic goals at super-national level. According to this perspective, European integration could provide the means to reinvigorate Keynesianism and thereby facilitate the continued pursuit of full employment, development of European welfare states, the creation of an advanced common system of social protection and an inclusive form of industrial relations. The internal European market would largely insulate Euro-Keynesianism from the destabilising actions of international financial markets, whilst import penetration of the common market was a far smaller percentage than for each individual member state, thereby facilitating a more effective used of aggregate demand management. Moreover, pressures upon national social policy and industrial relations systems may additionally be resolved at European level due to the lower level of international penetration, whilst common levels of social support prevent strategies of social deconstruction to secure competitive advantage. The potential advantages inherent within the creation of a supranational Euro-Keynesianism led to considerable support for this approach in the early 1980s, as the ‘monetarist’ recession led to the return of mass unemployment across almost all industrialised economies for the first time since the 1930s depression. However, despite leading members of the European group of socialist parties supporting proposals for a Euro-reflation strategy, the political conditions were insufficient for this approach to be implemented at European level (Callaghan, 2000: 150). The balance of power across the major European economies favoured the political Right at this time, and it proved difficult to reach a consensus amongst those nations that favoured reflation, relating to whether this would be better achieved on a national (i.e. Britain’s AES), European (France, Italy) or at G-7 level (Britain, Scandinavia). Although advocacy of Euro-Keynesianism peaked in the mid-1980s, the essence of the strategy, namely a regionally coordinated reflation strategy, has resurfaced on a number of occasions in more recent years. For example, the EU Commission in 1991, under the leadership of Delors, proposed a ‘Keynes-Plus’ European recovery programme, designed to create 15 million new jobs through a combination of aggregate demand reflation, industrial policy to promote the restructuring of European industry, regional and social policy (Coates, 1998; Callaghan, 2000: 149). French socialists and Swedish social democrats have maintained their interest in the benefits of coordinated macroeconomic policy, and their efforts have led to the adoption of a European Employment Strategy,

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involving each member state having to develop national action plans concerned with reducing unemployment (Clift, 2004: 42). This has partly re-balanced the EU’s economic framework, which has of late been more concerned with financial rather than real economic objectives. Nevertheless, aspirations to establish binding commitments upon the EU Commission to create jobs through reflationary measures have remained unfulfilled (Clift, 2004: 47). In a similar vein, Jospin proposed a measure of tax harmonisation across the EU member states as a means of protecting the tax revenues necessary to sustain fiscal activism and a distinctive form of European social model from pressures for tax competition as a means of attracting FDI. However, this was opposed by a number of nations, including New Labour, on the basis that it might threaten competitiveness (Aust, 2003). Third Way economics provides an alternative approach towards regionalism, in that it does not seek to utilise it as a form of ‘Fortress Europe’, intended to protect a distinctive form of European capitalism from the full impact of market forces, but rather prefers to utilise the power of the state to adapt institutions and individual behaviour in ways that maximise their strength within the market. Certain adherents, like Giddens (2001: 14) argue that this shift in policy has occurred because the Euro-Keynesian-corporatist model of ‘old-style social democracy’ was ‘doomed to failure’, either due to an absence of the political resources necessary to implement the strategy, or because the entire approach was inherently incapable of delivering traditional progressive goals amidst new external circumstances. Thus, Third Way economists remain committed to the principle of full employment, but differ markedly over the means necessary to achieve this target (Brown, 1999). Instead of state regulation, corporatist industrial relations and aggregate demand management, Third Way theorists prefer the promotion of private enterprise and competitive market pressures, the creation of a stable, low inflation macroeconomic framework within supply-side interventions are utilised to adapt society to the dictates of free markets.

Reform of European social model (ESM) A second distinctive feature arising from Third Way economics relates towards its reaction towards the development of what is often described as the European Social Model (ESM). In ideal form, references towards an ESM typically relate towards a variant of the post-war German social market, which combined a successful, competitive market economy

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with generous welfare provision and labour protection. The central tenant of their approach was to encourage social institutions to mediate between state and market to safeguard the decommodification of labour. This required a comprehensive social framework providing protection to workers and citizens, an industrial relations system based upon social partnership, together with a macroeconomic strategy that accommodated and reinforced each of these elements (Glasman, 1997: 136). The inclusion of workers and their unions in the working of the economy facilitates an expression of ‘voice’ rather than ‘exit’ and this, in turn, encourages co-operation in adapting to change, superior morale resulting in enhanced productivity and lower employee turnover, and finally the prevention of low-skill, low investment competitive alternatives stimulates productive investment and innovation (Streeck, 1992a: 5; Hutton, 1994; Coates, 1999: 654–655). De-commodified workers are more likely to be encouraged by their employers to engage in investment in their own human capital because of the rewards both parties will share due to increased productivity (Teague, 1997). The growth of the knowledge economy would tend to hint at the superiority of this approach. Euro-bargaining may additionally provide one solution to the tensions created amongst national labour markets due to TNCs pursuing internally consistent labour strategies. Whilst national competitiveness may depend upon real wage moderation best secured through co-ordinated bargaining. The multiplicity of demands made upon labour market actors might be better resolved through their active participation in ‘social partnership’. An ESM would further provide a comprehensive system of welfare provision, combining quality public services with social transfers providing a high replacement ratio, to enable all citizens to participate fully within society. The socialisation of risk through the collective provision of social insurance frees employees to undertake greater risks if this increases efficiency and hence standards of living. Income redistribution narrows social and economic advantage based upon inheritance rather than merit. Decommodification empowers employees and enables the development of work relationships based upon trust and loyalty, rather than the market nexus – a difference increasingly important in the dynamic knowledge-based sectors of the economy. Moreover, social citizenship and stable labour markets provide excellent foundations for Keynesian macroeconomic strategy. The ESM has been advocated as an alternative model to neoliberalism by the President of the EU Commission, Jacques Delors, when outlining his vision of a ‘social Europe’ to the 1988 British TUC Congress

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(Strange, 1997). However, despite its obvious attractiveness for social democrats, and particularly for trade unionists, in placing labour rights and decommodification issues at the centre of both economic and social policy, the ESM remains largely a vision of what is possible rather than a practical proposition, with little consideration of its plausibility and internal coherence. Particular reference here has to be made to the diverse group of EU member states, particularly after the ten-nation enlargement round, in 2004, and their individual preference relating to social welfare provision, labour market regulation and its impact upon international competitiveness. Thus, whilst German workers might fear internationalisation acting as a ‘race to the bottom’ in pressuring companies to reduce relative wages and favourable working conditions, and thereby might support efforts to maintain a high quality ESM. Other, less productive nations, may prefer to maintain lower wages and inferior social conditions as a means of competing with more productive German industry, and thereby protecting their employment and productive base. One person’s ‘social dumping’ is thus another’s international competitive strategy, and without a compensatory rise in productivity, any increase in unit costs would have a devastating impact upon the less productive economy, as occurred in East Germany after reunification at an unrealistic parity currency exchange rate (Porstman, 1990; Buechtemann and Schupp, 1992: 95–97, 102–104; Lumley, 1996: 26). It is the relative (or unit) cost of labour that matters more than absolute cost levels since low wage economies tend to be low productivity economies. This explains why three-quarters of the FDI flows that have taken place over the past two decades have been concentrated amongst industrialised economies rather than moving from high-wage industrialised nations to low-wage developing nations (Dicken, 1992: 54; Hirst and Thompson, 1996a: 67–68; Mishra, 1999: 22). Thus, whilst some evidence exists to indicate that social dumping is a real and potentially threatening phenomenon, it is thus far rather exaggerated (Leibfried and Pierson, 1994; Adnett, 1995). One problem with social democratic support for continued European integration resting upon the successful introduction of a ESM arises because of the determination displayed by a coalition of Third Way and conservative forces amongst EU member states to reform or ‘modernise’ this aspect of economic and social policy (Bulmer, 2000: 250; Vaughan-Whitehead, 2003: 516). Blair has indicated a desire to ‘create a Europe in his own image’, with the Third Way informing ‘the foundation of a reformed European social model of which Britain can not only be part,

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but take a lead in helping to create’, based upon the promotion of an enterprise agenda and improving competitiveness through increased flexibility and employability in labour markets, alongside a renewed commitment to equality of opportunity (Blair, 1998a; Clift, 2001a: 61). He further argued that ‘we need to curb the European social model, not play around with it’ (Blair, 1998b). Britain’s flexible labour markets and ‘new deal’ labour market policies were presented as an alternative to ‘Euro-sclerosis’ (Favretto, 2003: 136). Moreover, Brown advocated the introduction of elements of the ‘entrepreneurial and flexible’ US labour market, and in the process rejecting the ‘old European model, which stifled job creation with over-regulation and inflexibility’ (cited in Callaghan, 2000: xi). This argument has been more or less accepted by the EU Commission, as social policy is increasingly viewed as a means of promoting adaptability and flexibility across the European economy (Vaughan-Whitehead, 2003: 516–517). One interesting comparison can be made between the drift of European policy, from a traditional form of social democracy towards acceptance of the Third Way, and the continued emphasis in the US upon the significance of aggregate demand policy and the reaffirmation of a commitment to the pursuit of full employment through the dual mandate given to the Federal Reserve. Whilst European macroeconomic policy has become increasingly deflationary, with the introduction of a single currency accompanied by tight fiscal rules and the transfer of monetary policy to the ECB with its sole objective to pursue price stability irrespective of the impact of its actions upon the wider real economy, the US, by contrast, has resisted similar proposals (Clift, 2004: 40). Thus, whilst Clinton successfully pushed back the Republican attempt to add a balanced-budget amendment to the Constitution, which would have effectively terminated policy initiatives based upon Keynesian economics, the Europeans ‘almost enthusiastically agreed to have their hands tied’ through the rules governing EMU, with depressingly predictable results (Stiglitz, 2003: 298).

Economic and monetary union (EMU) Economic and Monetary Union represents the latest and most significant economic initiative undertaken by EU member states. Initially, this involved twelve member states replacing their individual currencies by a single currency, the Euro, although three further nations (i.e. Denmark, Sweden and the UK) maintained opt-outs from the process. EMU is

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perceived as a central element in the continuation of momentum towards closer European economic integration in the early years of the twenty-first century. In terms of its impact upon economic management, EMU necessitates a significant transfer of national sovereignty towards an ECB that will undertake Euro-zone exchange rate and monetary policy. EMU rules require that fiscal policy becomes subject to tight rules dictating constraints upon budget deficits and government borrowing. Therefore, discretionary national macroeconomic management will be largely superseded by rule-based economic co-ordination, which is intended to sustain monetary union whilst creating ever closer economic union between participating member states. It will fundamentally alter the present methods of economic management and democratic accountability. Thus, Verdun (2000: 1) suggests that this is ‘one of the most-far-reaching transfers of sovereignty to European level’ that EU member states have thus far experienced. In its present form, the proposed EMU is without precedent in the history of the civilised world. There has never been an EMU between a group of countries without a simultaneous movement towards political union, although a number of attempts have been undertaken to secure the greater predictability that a fixed exchange rate regime can provide, the aim being to reduce exchange rate risk and hence promote trade, investment and ultimately economic growth. The most successful fixed rate regimes, the Classical Gold Standard and Bretton Woods, each helped to establish an international economic environment which facilitated decades of economic expansion, before a combination of political and economic factors forced their ultimate termination. Badly constructed fixed exchange rate systems, on the other hand, such as the 1920s return to the Gold Standard on pre-First World War parities, or the ERM crisis of 1992 when shifts in economic fundamentals combined with economic policies harmful for some member states, were associated with economic recession, bankruptcies, house price collapses and mass unemployment. Consequently, whilst a properly constructed system can be a benefit to participating countries, a badly designed regime can cause untold damage to its members. The importance of this point is reinforced by the fact that EMU membership is intended to be an irrevocable act, with the Maastricht Treaty deliberately failing to specify a means by which a member state might exit the arrangement in the future. It is intended to be a one-way shift towards further economic integration. Consequently, even greater emphasis is placed upon the estimated balance of costs and benefits by which a country decides whether or not to participate in this unique currency arrangement.

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The implications that membership would exert upon national economies signifies that social democratic reaction to the single currency is likely to be the most important and far-reaching economic and political decision of the present generation. If the advocates of membership are correct, joining the single currency could unleash economic potential which would increase economic growth and investment throughout the EMU zone, achieve low and stable inflation, and build a strong European economy to the envy of the rest of the world. Some of the main economic and political benefits claimed for EMU entry are (Baimbridge et al., 2000) as follows. • Greater nominal exchange rate stability will occur, which reduces the risk associated with fluctuating exchange rates and is therefore assumed to encourage greater trade and investment, which, in turn, should result in higher growth and employment in the longer run. • A reduction in transaction costs should occur since firms exporting or importing goods and services to another participating country will no longer have to exchange currency to complete the sale, thereby saving upon commission charges. Whilst less onerous for large companies than tourists changing small amounts of foreign currency, the removal of this small but significant charge upon international trade should encourage exports and thereby stimulate economic growth. Even a small annual boost to economic activity may become significant if its effects are cumulative over time. • Price transparency should increase, because goods, services and labour are priced in the same currency, facilitating traders to make cheaper purchases and increase competition across the Euro-zone, thereby exerting a downward pressure upon prices to the benefit of European consumers. It is further argued that this price transparency is a precondition to the final completion of the single market. • The ECB is charged with ensuring price stability above all alternative economic goals and therefore many proponents of EMU entry argue that inflation is likely to be lower for those countries with the single currency, particularly in the longer run. Accordingly, interest rates might be lower, thereby boosting investment and economic growth. • Creation of the Euro would establish a major world currency capable of rivalling the US dollar and Japanese yen, which could confer certain economic advantages in addition to providing political prestige based upon the EU’s combined economic strength and greater world political influence. This might, or might not, involve

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closer political integration between EU member states, which would rival the US in terms of population and wealth. Advocates of EMU participation argue that failure to join will leave nation states vulnerable and incapable of influencing the monetary policy of the EMU-zone from the outside. Potential threats are suggested to include the risk of losing markets due to some sort of ‘unofficial’ protectionism preventing the free passage of domestically produced goods and services across the rest of the EU and the risk of losing political influence within the EU. Arguments that membership of EMU reduces national sovereignty are rejected on the grounds that sovereignty is not absolute any more, due to the globalisation of financial markets and voluntary limitations imposed by international treaties such as membership of NATO, the Geneva Convention, the United Nations and the WTO. Sovereignty is not given away because nations are still able to influence decision-making through the European Council, but as one voice amongst fifteen. Thus, sovereignty is shared, or pooled, within the EU, with decision-making subject to the collective viewpoint of participating member states. Advocates of further European integration often point out that many critics of the single currency are content in supporting continued EU membership and the SIM, despite the fact that both reduced national independence to a greater degree than EMU may require. The Treaty of Rome required the freedom of movement of labour and capital, thereby undermining the potential for isolating individual economies from international financial markets. This is a move exacerbated by the Single European Act (SEA) which required the abolition of exchange controls and gave the European Court of Justice jurisdiction over domestic law where a contradiction occurs. The apparent inconsistency amongst many single currency critics may undermine their arguments or require them to reassess continued EU membership, a policy which appears to be less popular than opposition to EMU. Finally, the argument which caused the majority of national trade unions to accept EMU entry is based upon their desire to achieve the European ‘social model’. The example of recent Conservative government in the UK convinced many trade union leaders that locking the economy into a European model, which embraces a social dimension, is an improvement upon the laissez-faire alternative variously supported by Labour and Conservative leaderships. The conditionality of this support distinguishes trade unionists from

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other advocates of EMU, because of their concern that the social dimension may be abandoned in favour of fiscal rectitude. However, many critics of the single currency argue that the costs of entry are in fact potentially far larger, so that it may be in the various national interests to remain outside the currency union. The principal arguments advanced by those critical towards EMU, include: • The loss of control over monetary policy and of influence over the exchange rate weakens national economic management, which is further constrained by the restraints upon fiscal policy resulting from the MCC and Stability Pact rules on government borrowing. This combination reduces the potential capacity of a country to respond to internal or external shocks, exacerbating the danger of national destabilisation. • The lack of prior cyclical and structural convergence amongst all participating member states will create strains within EMU. Consequently, unsynchronised business cycles and/or structural differences magnify the effects of asymmetric external shocks (i.e. oil price rises), whilst a unified monetary policy will be unable to meet satisfactorily the needs of all economies, concentrating upon the ‘average’ member state as it is likely to do. Thus, incorrectly set interest rates may damage individual economies, increasing their initial misfortunes rather than moderating them. • The ‘generous’ interpretation of the MCC in order to ensure as many countries as possible participated in EMU implies that the majority of participants must continue to deflate their economies by raising taxes or cutting government spending in order to meet the rigid financial criteria established by the MCC and Stability Pact. The combination of these measures will result in higher unemployment and slower growth within the single currency zone. • The absence of any substantial fiscal redistribution mechanism, which could stabilise EMU by transferring resources from favoured to weaker regions, means that less competitive areas may suffer declining incomes and persistent mass unemployment, thereby increasing inequality and social tension across the single currency area. • Many of the economic objectives claimed by single currency advocates could be achieved through effective national economic management, such as price stability, high economic growth and full employment. Moreover, since the ECB will include Mediterranean

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countries as well as Germany, it is unlikely that it will initially possess the anti-inflation credibility that the Bundesbank enjoyed, meaning that the Euro might be a weak currency. The costs of transition to the new currency may be in the region of £18.5 billion, thereby cautioning against participation unless the benefits can be demonstrated to be substantially higher over time. The private financial sectors in certain countries (i.e. UK) are more sensitive to changes in interest rates since a higher proportion of mortgage debt is denominated in flexible rather than fixed interest rate stock. Consequently, were the ECB to vary interest rates in order to stimulate or restrain average EMU economic activity, nations including the UK would bear a disproportionate brunt of the corrective measures, causing the economy to diverge further from the EMU average. Thus, a uniform monetary policy would be likely to create fluctuating boom–bust cycles in the UK economy rather than a smooth and sustainable rate of economic development. Individual nation states have competitive advantage in different sectors of production – that is Germany has an advantage in medium-level technological metalworking, whilst Britain has an advantage in high technology, aeronautical, pharmaceutical and energy sectors. The latter grouping, however, are typically priced in US dollars and compete principally with US and Japanese companies even when exporting to other EU member states. Thus, the sterling– dollar exchange rate will remain far more important to this key element of British manufacturing than sterling–Euro, and hence participation in the Euro might increase exchange rate volatility for a crucial sector of the UK economy. This is not the case for DM–Euro. Opponents of EMU dismiss the threat of loss of markets through protectionist measures enacted by single currency members against nonparticipants in the project since these would flout the Treaty of Rome, the SEA, the ‘Maastricht’ Treaty on EU and the rules of the WTO. Critics of European integration generally reject the view that sovereignty can be pooled, suggesting that it refers to a national authority using every means at its disposal to achieve its objectives, within the constraints imposed by international markets and treaty obligations. Thus, sovereignty can be exercised either by national government or by the EU, but not by both. EMU would result in the loss of economic sovereignty to the ECB, with national authorities losing autonomy. The ECB is undemocratic because it is deliberately insulated from all political influence; the authors of the Maastricht Treaty believed that

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such insulation would enhance its ability to secure price stability. Thus, electors would no longer be able to influence monetary and exchange rate policies, whilst fiscal policy is also tightly constrained through the Growth and Stability Pact. These policies deeply affect individual citizens’ lives, from setting the cost of their mortgage to the possibility of losing their job. • One final criticism is that, rather than EMU creating a European super-state, it is in fact designed to ‘rollback’ the state and reduce its ability to regulate the actions of the owners of private capital and the international financial markets in the interests of their citizens. Increased constraints placed upon government economic autonomy reduce the choices available through the democratic process, whilst limiting the ability of one country to pursue a significantly unorthodox economic strategy intended to meet nation-specific goals. Critics of EMU claim that fundamental structural differences between individual European economies preclude an easy ‘marriage’. This has heightened the problem that federal economic policies would have to manage the entire EMU-zone, because it is likely that common monetary policies would prove unsuitable to the circumstances of outlying economies, potentially resulting in the reinforcement of both inflationary and depressed zones on the margin of the EMU economy. On the most optimistic scenario, EMU could re-create a golden era similar to the original Gold Standard of the nineteenth century or post-war Bretton Woods, when members shared decades of economic growth and relative price stability. However, at worst, it would generate the conditions pertaining in the 1930s depression, as adherence to a fixed exchange rate unsuitable to the economic realities of individual countries compounds the misery of mass unemployment. As part of the European ‘project’, European social democrats are closely associated with the introduction of EMU. Notermans (2000: 243) notes that a significant proportion of these view EMU as ‘the only possible road to recovering at least some of the national policy autonomy’ that they believe was lost as a result of increasing economic internationalisation. Thus, Hombach (2000: 12) claims that EMU provides ‘the last chance for the Old World to assert itself’ as a global economic force. Other motives include the desire to secure an ‘achievement of historical substance’, or, the New Labour leadership’s desire to ‘end the ambiguity’ relating to Britain’s relationship with the EU (Carter, 2003: 5). It is interesting to note that, although support for the European ‘project’ has remained a fundamental New Labour constant,

Regional Economic Integration 161

nevertheless where this appears to conflict with the maintenance of successful macroeconomic management of the national economy, participation in the Euro has shifted to a secondary, not primary, target for government (Carter, 2003: 5–6). Despite majority support for EMU amongst social democrats, this is not to say that a consensus exists relating to issues concerning the type and number of powers that would be exercised at federal rather than national level, together with the desirability of the creation of a supportive tier of macroeconomic management to sustain economic union; for example, fiscal federalism, tax harmonisation and/or the creation of a federal ‘economic government’ to manage the economy of the EU (Baker et al., 2002: 414; Jospin, 2002: 17). The failure of French and German governments to keep to the conditions imposed by the SGP has led to a number of attempts to reform this ‘over-narrow and mechanistic’ element of the EMU framework, with interest expressed in the monetary policy strategy utilised by New Labour (Clift, 2004: 41). However, thus far at least, fierce opposition from a combination of smaller EMU participating states, together with monetarist-orientated central bankers associated with the ECB, has prevented successful reform of the EMU rules and institutions. Notermans (2000: 243) argues that there are no factors inherent within EMU that ‘intrinsically discriminate’ against social democratic objectives. Instead, he identifies the policy orientation of the ECB, together with the economic policy pursued by national governments, as key to determining the success (or otherwise) or EMU. Here, Notermans points to the support given by Southern European social democrats towards monetary union placing constraints upon domestic policy, through the MCC and SGP. This indicates that many of the restrictions that EMU imposes upon national governments are in fact welcomed by those same governments, perhaps as one means of providing freedom from the lobbying of special interest groups, or through the establishment of a scapegoat upon which to blame all future public spending reductions and economic setbacks. Of all progressive organisations, one might anticipate that trade unions would be most sceptical about EMU due to the potentially damaging impact upon employment and social spending (Whyman, 2001). Verdun (2000: 143–146, 170–171) suggests three reasons why European trade unions generally supported EMU despite severe doubts over the claimed benefits of the process. First, because of their believe that the process was inevitable. Secondly, that their support in legitimising the project might produce the benefit of enhanced influence at the

162 Third Way Economics

European supranational level. And, thirdly, that EMU was an acceptable price to be paid if it produced a European Social Model (ESM) distinct from the market-dominated, neo-liberalism associated with the US. However, as already noted in this chapter, this tends to conflict with the reforming intentions, particularly associated with advocates of Third Way economics. Consequently, there remains considerable disquiet regarding whether social democratic support for EMU, on the basis that the European ‘project’ will safeguard a distinctive form of ESM, is either practical politics or based upon a fundamental misunderstanding of the compatibility of the two objectives. The problem for social democrats relates to their determination to support EMU on the basis that it forms part of a package that includes the development of a distinctive ESM, that will protect citizens from the worst excesses of rampant market forces, and/or it might provide the basis for an expansion in super-national regional economic governance that will prove more effective in regulating international capital flows and therefore provide greater ‘room’ for policy autonomy for EU member states – either individually or, more probably, collectively. However, the subtlety of the distinction between wholesale and conditional support for the venture is lost upon many natural supporters. Thus, if EMU founders because of its inherent deflationary bias, entrenched because of the neo-liberal foundations upon which it has been established in its present form, or because it proves to be incompatible with the satisfactory development of a new society based upon a ESM, then the social democratic project will itself lose credibility. Two options remain. Reform the institutional superstructure underpinning EMU, to ensure its compatibility with progressive objectives, or shift policy to openly oppose those elements of the process with which social democrats have little natural sympathy (Whyman, 2002).

Conclusion Regional economic integration has formed a central element in the Third Way approach. This encompasses both Clinton’s support for NAFTA and, more significantly, the close association between most European social democratic parties and trade unions and the European ‘project’. This regionalism can be considered to be both an expression of, and response towards, globalisation. However, the potential inherent within regionalisation is hindered by the lack of a consensus amongst new social democrats relating to the balance between these two elements, namely whether to champion deregulation in order to

Regional Economic Integration 163

accommodate and stimulate further internationalisation, or to utilise regional economic power to seek to re-impose a degree of regulation and control over global forces. Third Way advocates, due to their greater predisposition towards neo-liberal economics, tend to emphasise the benefits of globalisation and the need for governments to accommodate and support these changes. More traditionalist social democratic opinion would prefer to re-create a greater degree of regional (or national) economic autonomy, if not residual support for the type of Euro-Keynesianism that had been articulated (but never implemented) a decade or more previously.

Note 1. Examples include the speech given by the Prime Minister, the Rt. Hon. Tony Blair MP, to the Party of European Socialists Congress, Malmö on 6 June 1997; a speech given by the Rt. Hon. Gordon Brown, MP, Chancellor of the Exchequer, to the Royal Institute of International Affairs, ‘Britain leading in Europe’, on 17 July 1997; and a speech given by the Prime Minister, The Rt Hon. Tony Blair, MP at the Lord Mayor’s Banquet London, Guildhall, ‘The principles of a modern British foreign policy’, on 1 November 1997.

8 Evaluation of Third Way Economics in Practice

Introduction Interest in Third Way economics has stemmed, at least in part, from its apparently successful record, both in terms of electoral success and economic performance (Latham, 1998; Harcourt, 2001; Pierson, 2002: 180). This chapter provides a brief evaluation of the economic record generated by the adoption of elements of Third Way economics. Clearly, a comprehensive analysis is worthy of a book in its own right. Moreover, space limits the degree of detail that can be achieved in relation to each initiative pursued by every nation professing a degree of influence from Third Way thinking during the past two decades. Nevertheless, this book would be incomplete in the absence of an attempt being made to determine how effectively Third Way economics has worked in practice.

Macroeconomic policy Macroeconomic policy was conducted on largely non-Keynesian lines by most of the nations included in this study, with the prioritisation of price stability over full employment and economic growth (Neville, 2000: 155; Clift, 2001b; Driver and Martell, 2002: 92). Fiscal policy was largely orthodox in nature, with the object of reducing budget deficits in order to appease financial markets given greater priority than deficit financed counter-cyclical policy to maintain full employment. Monetary policy dominated the overall macroeconomic framework, and sought to enhance the credibility of monetary authorities by pursuing inflation targets, awarding central banks with differing degrees of policy autonomy and/or pursuing long-term, transparent monetary goals. 164

Evaluation of Third Way Economics in Practice 165

A large number of European nations went one stage further and became active participants within the EMU established within EU member states. This imposed additional constraints upon the autonomous macroeconomic policy design, through the operation of a permanently fixed exchange rate, common monetary policy implemented by the ECB and budget deficit limits imposed upon national fiscal policy. Denmark, Sweden and the UK were more reluctant to place these limitations upon economic policy, at least in the early years of the EMU project. Therefore, half of the Third Way economies discussed in this chapter maintained floating exchange rates and half preferred fixed arrangements (Hemerijck and Visser, 2001: 192). There were, of course, differences between the approaches adopted by different social democratic parties, and moreover within individual parties but during a different time period. Thus, whilst the Spanish socialist government was elected on a traditional social democratic-Keynesian platform in 1982, it almost immediately abandoned counter-cyclical demand management in favour of the promotion of industrial adjustment through deregulation and privatisation, the attraction of FDI and tight control of wages to facilitate productive investment (Paramio, 1992: 530–533; Pérez, 1997). The Australian Labor Party had similarly shifted away from the fiscal Keynesian–corporatist approach that characterised its first two years in office, 1983–84 (Scott, 2000: 218–219; Pierson, 2002: 183). The consequent ‘rationalist’ economic policy programme prioritised deregulation and appeasement of the international financial markets, and hence bore a striking relationship with the Third Way, developed some years later. Indeed, the similarity enabled Finance Minister and latterly Prime Minister, Keating, to claim that Australia was ‘in the vanguard of social and democratic progress’ (Emy and Hughes, 1988: 81; Pusey, 1991; Archer, 1992: 394; Battin, 1993: 235; Keating, 1993: 2; Mitchell, 1998: 5, 11–12; Neville, 2000: 156; Phillimore, 2000: 565). In contrast, the Swedish SAP and German SPD retained an appreciation for the role of macroeconomic policy as a necessary corollary of supply-side policies in promoting economic growth and securing full employment (Clift, 2004: 43–44). For the Swedish SAP, which had traditionally been amongst the most committed to a rather sophisticated form of Keynesian policies, its prioritisation of price stability above full employment, and the requirement to reduce burgeoning budget deficits inherited from the previous bourgeois government, effectively constrained the use of even the coarse tuning of aggregate demand (Finansdepartmentet, 1991: 9). However, the SAP remained committed

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to the use of active labour market policies and took advantage of a competitive exchange rate to pursue export-led growth. In Germany, the SPD leadership may have ‘long since turned away from the idea of Keynesian panaceas that will work overnight’ and pursued a ‘supply-side economics of the left’ (Hombach, 2000: 104–121). However, a sizeable proportion of rank-and-file SPD members, many associated with the former leader Oscar Lafontaine, advocate Keynesian demand-side macroeconomic activism at both national and supranational (EU) level (Lafontaine, 1998: 79). This struggle for the heart of the party’s macroeconomic policy may explain why the 2002 SPD manifesto emphasised the importance of ‘a prudent combination of supply and demand policy, which will put more money into workers’ pockets’, to ‘consolidate Germany’s economic strength with public investment in infrastructure’, although this did not represent the central focus of Schröder’s actual policy programme. However, German membership of EMU meant that it had relinquished control over its exchange rate and monetary policy to the ECB, whilst fiscal policy was constrained by the rules governing the SGP. This left few economic policy tools available for the Schröder administration to use even if it decided to pursue a counter-cyclical macro-stance. Another example of residual Keynesian support within European social democracy involved the establishment of a European Employment Pact, intended to commit European member states towards co-ordinated macroeconomic policy measures designed to reduce unemployment (PES, 1999). This measure was promoted most explicitly by Jospin in France, Schröder in Germany, and Persson in Sweden (Dyson, 1999: 203–204). However, largely due to Blair joining with bourgeois governments in Italy and Spain during intergovernmental negotiations, this initiative became limited to microeconomic reforms with an emphasis upon flexibility, liberalisation and ‘modernisation’ of the welfare systems, with the macroeconomic dimensions failing to even be discussed (Aust, 2003). Economic growth Turning from the overall macroeconomic stance to the major performance indicators, Pollin (2001: 60, 2003: ix) notes that it is the economic growth record of the US economy that is often used to provide evidence to justify the superiority of the Third Way. Indeed, at first glance, the performance of the US economy does appear impressive, with an average 3.7 per cent growth rate, productivity of 1.9 per cent, inflation of 2.6 per cent and unemployment averaging 5.2 per cent over the

Evaluation of Third Way Economics in Practice 167 Table 8.1 Macroeconomic performance indicators by presidential administration, 1961–2000 1961–68

1969–76

Kennedy/ Nixon/ Johnson Ford Per cent real growth (GDP) Per cent productivity growth Per cent unemployment Per cent inflation

1977–80

1981–92

1993–2000

Carter

Reagan/ Bush

Clinton

4.8

2.7

3.4

2.9

3.7

3.4

2.1

0.5

1.7

1.9

4.8

5.8

6.5

7.1

5.2

2.0

6.4

9.7

4.6

2.6

Source: Pollin, 2003: 35.

eight-year Clinton administration (Table 8.1). This represents the longest unbroken period of economic expansion ever achieved in the US (Frankel and Orszag, 2002: 1). Moreover, it represents an improvement over the Nixon/Ford, Carter and Reagan/Bush (Pollin, 2000: 300). However, the Clinton record is notably weaker than that achieved during the Kennedy–Johnson ‘Keynesian’ period (Pollin, 2001: 65). Furthermore, when comparing the performance of the economy in the full business cycle of 1991–98 as against earlier business cycles, the achievements of the Clinton period are more modest and relatively indistinguishable from the 1970s (Pollin, 2000: 30). Thus, whilst the Clinton administration recorded superior figures to the immediate neo-liberal predecessor, Reagan-Bush regimes, it failed to match the record associated with undiluted Keynesian policies. Examination of Figure 8.1 illustrates that the Clinton period in the US, New Labour in the UK and Persson governments in Sweden appeared to sustain healthy rates of economic growth, whilst the continental European economies featured performed more moderately. However, when deconstructing the factors lying behind these examples of favourable macroeconomic performance, whereas the US and UK depended largely upon consumer expenditure as the motor for the economy, and this in turn depended upon wealth effects arising from financial asset bubbles, Sweden’s performance is more sustainable since it is based upon export-led growth. Furthermore, Figure 8.2 indicates that marked business cycle associated with gross fixed capital formation, a key determinant of productivity growth, rather than

168

6 5 4

% growth

3 2 1 0 1980–90 1991 av

1992

1993

1994

1995

1996

1997

1998

–1

2000

2001 Australia Italy Spain UK Euro-area

–2 –3 Figure 8.1

1999

Real GDP growth rates (percentage), selcted nations, 1990–2004

Source: OECD Economic Outlook, selected years.

2002

2003

2004

Germany Netherlands Sweden USA OECD

25 20 15

% change

10 5 0 1979– 89 1990 av

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

–5 –10 –15

Australia Germany Italy Netherlands Portugal

–20

Spain Sweden UK USA EU Euro-area

Figure 8.2 Real total gross fixed capital formation (per cent change), selected nations, 1979–2004 Source: OECD Economic Outlook, selected years.

169

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depicting a noticeable upward shift in productive investment that would have been anticipated to provide a sustainable upward shift in economic growth trend. Unemployment The second area where Third Way economics appeared to demonstrate an extraordinary degree of success, at least in terms of the record during recent decades, relates to its ability to deliver simultaneously low rates of unemployment and inflation (Pollin, 2000: 37) (see Figures 8.3 and 8.4). The Clinton administration, for example, managed to reduce unemployment from 7.5 per cent to 4 per cent between 1993 and 2000, whilst inflation declined to a 1.6 per cent low point in 1998, before rising to 3.4 per cent in 2000, thereby confounding the predictions of higher NAIRU limits (Gordon, 1997, 1998; Baker, 2000: 223–236; Pollin, 2003: 50–51). The Netherlands was a second admirable performer in this regard, having reduced unemployment from approaching double figures in 1989 to 3 per cent by 2002, and in the process achieving rates of employment growth of 1.5 per cent over more than a decade, a rate exceeding the EU average (Visser and Hemerijck, 1997; Hirst, 1999: 92). Indeed, between 1984 and 2001, the number of employed workers rose by 50 per cent; a rate forty times greater than during the previous fourteen years (Spithoven, 2002: 342). Figure 8.3, furthermore, indicates that all but two Third Way economies produced superior unemployment performance than the EU and Euro-zone average, whilst Sweden and the UK additionally secured a marked drop in unemployment rates during the terms of office of the ‘new’ social democratic administrations. Headline figures are not conclusive evidence of the superiority of any particular economic strategy, in particular because the US and Netherlands secured similar degrees of employment growth but in dramatically different fashion. First, whereas the US economy relied upon high rates of economic growth and the dynamism arising from flexible labour markets, the Netherlands preferred corporatist negotiation over wages and employment conditions, thus producing wage moderation, together with vigorous government action to promote part-time working (Vandenbroucke, 1996: 30). Secondly, this favourable inflation–unemployment trade-off was influenced by a range of transitory factors. These included a fall in the prices of medical and computer equipment, the stagnation of oil and raw material prices during the period in question, the appreciation of the dollar during the second-term administration and the deflation suffered by many East

25

Australia Germany Italy Netherlands Portugal Spain Sweden UK USA EU Euro-zone

20

% standardised unempt

15

10

5

0 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 Figure 8.3 Standardised unemployment rates (per cent of civilian labour force), selected nations, 1984–2002 171

Source: OECD quarterly labour force statistics, various years.

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Asian economies resulting from the financial crisis suffered by their region around 1997 (Frankel and Orszag, 2002: 8). Moreover, changes in measurement of inflation statistics may have dampened headline figures by up to 0.3 percentage points (Baker, 2000: 226). Nevertheless, the inflation–unemployment trade-off still represents a remarkable achievement, although scepticism remains concerning whether this improvement in economic performance is sustainable in the medium to long term. Finally, whereas certain economies that were associated with Third Way economics had a successful record in relation to reducing unemployment, others did not. In Germany, for example, unemployment rose from 4.6 million in March 1998, representing 11.3 per cent of the total labour force, to exceeding five million people openly unemployed, in 2005, with a further two million individuals in training and government work programmes (Hombach, 2000: 122). One-third of all German unemployed workers have been without a job for more than one year and unemployment rates in former East Germany are closer to 20 per cent, thereby raising concerns over the long-term sustainability of Modell Deutschland (Harding, 1999: 70; Hombach, 2000: 122).

Fiscal policy Fiscal policy played little active role in the Clinton period, despite Clinton’s initial programme envisioning the use of a (marginal) ‘stimulus package’ to accelerate a disappointingly sluggish economic recovery (Meerpol, 1998: 227–279). For the remainder of the Clinton administration, fiscal policy was used to pursue the primary macroeconomic goal of reducing the budget deficit (Baker, 2000: 230). Woodward (1994) claims that this fiscal orthodoxy stemmed from a meeting between President-elect Clinton and the chairman of the Federal Reserve Board, Alan Greenspan, in December 1992, where Greenspan convinced Clinton that reducing the long-term interest rate was the best method of increasing economic growth and this, in turn, required convincing the financial markets of the administrations resolve to reduce the federal budget deficit. Because long-term interest rates reflected the financial market’s expectations of future investment risk, either due to inflation, exchange rate devaluation and/or political instability, Greenspan argued that financial markets would assume that rising US deficits would eventually result in inflation and would therefore raise the risk premium on US long-term interest rates.

Evaluation of Third Way Economics in Practice 173

The reduction of the federal budget deficit proved to be one of Clinton’s economic successes. However, it is instructive that he utilised public sector cuts to secure 54 per cent of total budget strengthening, whilst additional tax revenues contributed 29 per cent of deficit reduction, additional capital gains revenues (as a result of the booming stock market), 10 per cent, and faster economic growth a mere 7 per cent of the total (Pollin, 2003: 73). In the process, public expenditure as a share of national income was reduced from 21.9 per cent in 1992 to 18.1 per cent of GDP in 2000, representing a decline of 17.1 per cent over this period (Pollin, 2003: 28). The largest areas of public spending cuts were defence and, perhaps surprisingly, the education and science budgets (Pollin, 2003: 29). Indeed, Clinton’s 1996 State of the Union address boasted that ‘the era of big government is over’ (Baer, 2000: 1; Klein, 2002: 157). Neo-liberal economics would predict that down-sizing government expenditure should result in increased private investment that was formerly crowded-out, alongside reductions in interest rates. However, although investment rose as a proportion of GDP by 1.5 per cent as the economy expanded, this was largely offset by an increase in the trade deficit, as the negative balance on net exports rose by 1.2 percentage points, whilst private consumption rose as a proportion of GDP by 2.1 per cent between 1989 and 1999 (Baker, 2000: 221). Thus, the favourable growth rates achieved during the Clinton years were secured by growth in consumption expenditure and not productive investment. Furthermore, with household savings declining from 7.5 per cent in 1989 to 2.1 per cent at the end of 1999, and the ratio of non-mortgage consumer debt to disposable income rising to the record level of 24.2 per cent at the end of 1998, Third Way growth figures were overwhelmingly the result of a short-term consumer boom, fuelled by personal borrowing (Baker, 2000: 222). This was hardly the basis for a sustainable, long-term economic strategy. Most other Third Way administrations followed a similar strategy to that adopted by Clinton. For example, in Italy, successive centre-left administrations pursued fiscal austerity, with the end result that the nation passed the convergence criteria relating to budget deficits (if not national debt) and therefore could participate in EMU (Favretto, 2003: 137). Post-1984 Australia likewise pursued an orthodox fiscal policy, intended to produce successive budget surpluses and reduce public spending as a proportion of national income to levels equivalent with that last seen in the 1950s (Scott, 2000: 224; Johnson and Tonkiss, 2002: 8). The result was a fall in the contribution of taxation to the Federal budget that had fallen from 27.8 per cent of GDP in 1986/87

174 Third Way Economics

to 23.5 per cent in 1993/94 (Mitchell, 1998: 23). Likewise, the Netherlands PvdA pursued a restrictive budgetary policy during its participation in various government coalitions, although it prioritised expenditure on training, public sector capital investment and employment policy (Merkel, 2001: 62). As a result, from 1994 to 1998, public expenditure declined by more than 5 per cent to 42.6 per cent of GDP. Income tax reductions saw the top rate being reduced from 70 per cent to 60 per cent, whilst the introductory rate from 14 per cent to 6.35 per cent (Merkel, 2001: 63). During New Labour’s first term, fiscal policy pursued ‘stability through constrained discretion’, seeking to establish policy transparency through fiscal rules and low inflation credibility in the manner that Greenspan suggested (Clift, 2001a: 63; Gamble and Kelly, 2001: 173–174). Balls (1998: 122) claimed that ‘the rapid globalization of the world economy has made achieving credibility more rather than less important, particularly for an incoming left-of-centre government’. Likewise, Brown argued that ‘you cannot build the new Jerusalem on a mountain of debt’ (cited in Routledge, 1998: 315). Credibility was enhanced via an atypically slow rate of growth in public spending which, at 1.7 per cent per annum, implied a 1 per cent average annual real reduction. This facilitated the repayment of a sizeable chunk of national debt, whilst reducing public spending from 43.7 per cent of GDP in 1996 to 31.3 per cent in 2001 (Dilnot and Emmerson, 1998; IFS, 2001: 11; Keegan, 2003: 250, 281). The degree of fiscal austerity was relaxed during the second New Labour administration, as a combination of indirect tax increases and fiscal drag facilitated rising spending (Keegan, 2003: 281; Annesley and Gamble, 2004: 148). The timing of this fiscal stimulus to the economy was fortuitous, due to its occurrence simultaneously to a world economic slowdown during 2002–2003. Indeed, Keegan (2003: 332) identifies that ‘unintended Keynesianism’ as one of the main reasons why the UK managed to avoid recession and maintained high rates of employment despite the decline in world demand. Nevertheless, the New Labour approach explicitly rejected reliance upon the very type of domestic demand expansion to secure and sustain full employment that they had themselves engineered and derived electoral benefit. Other social democratic parties associated with the Third Way have not consistently pursued budget restraint. For example, the early Spanish socialist governments combined an expansive fiscal policy, aimed at stimulating economic growth rates, with a restrictive monetary policy intended to restrain inflation (Royo, 2000: 187, 217). Fiscal policy did

Evaluation of Third Way Economics in Practice 175

ultimately become more orthodox in nature during the later years of the various Socialist administrations, yet budget deficits tended to persist for most years in office. The Australian Labor Party followed a similar policy path, initially relying upon active fiscal policy to stimulate the economy during the 1982–83 international recession, and doing so with rather favourable results, before adopting a more fiscal orthodox approach the longer in government. The German SPD sought to pursue fiscal responsibility, as required by the SGP of the European EMU, by ensuring that budget deficits did not exceed 3 per cent of GDP in all but the most exceptional circumstances. However, this has proven extraordinarily difficult in practice for the Schröder administrations, and indeed Germany has repeatedly breached the SGP budget deficit rules. One reason for such problems would appear to stem from Germany’s very large level of unemployment, standing at a little over five million for the first time since the 1930s and the Nazi period. The neo-liberal-Third Way consensus is that this level of unemployment is due to primarily structural reasons and is not demand constrained. Therefore, the measures taken to try and reduce unemployment have focused upon supply-side reforms. These have comprised talks with social partners aimed at establishing a social pact which would moderate pay on the condition that the additional profit would be used to invest in new jobs (unsuccessful), together with a series of welfare and labour market reforms, entitled ‘Agenda 2020’ (or the Hartz reforms), where work incentives have been enhanced through time-limited benefit restrictions and reductions made in replacement ratios. Unfortunately for the SPD, membership of EMU effectively prohibits experimentation with an alternative strategy, based around the achievement of a more competitive currency (through devaluation), operating a loose monetary policy and utilising fiscal policy to stimulate the domestic economy. Moreover, many of the fiscal problems being faced by the Schröder government relate to the costly mistakes made by the previous Kohl (bourgeois) administration, whose determination to complete reunification at a one-to-one exchange rate effectively bankrupted most of the East German industries. Transfers from west to east Germany have, therefore, continued at a rate of approximately 5 per cent of GDP for a decadeand-a-half, with the total bill fast approaching £900 billion since 1990. Indeed, the EU Commission has estimated that the fiscal drain and resultant tax rises necessitated by reunification has caused one-third of German under-performance compared with other European nations during the 1990s.1

176

80

70

Govt Express % GDP

60

50

40

Australia Germany Italy Netherlands Portugal Spain Sweden UK USA EU Euro-zone

30

20

10

0 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004

Figure 8.4

General government outlays as percentage of nominal GDP, selected countries, 1986–2004

Source: OECD Economic Outlook, selected years.

Evaluation of Third Way Economics in Practice 177

The Swedish social democrats’ attitude to budgetary orthodoxy has been equally ‘hesitant and uneasy’ (Vartiainen, 1998: 37; Clift, 2001a: 65). Although initial fiscal austerity was justified on the basis that the budget deficit was in danger of spinning out of control, and this would undermine the long-term sustainability of the prized welfare state, two-thirds of this gap was filled by tax rises and not expenditure reductions (Clift, 2001a: 65; Lindblom, 2001: 171). Moreover, the fact that the government accepts the proposition that welfare expansion has more or less finished, this does not imply support for a downsizing of public expenditure. Indeed, the high proportions of welfare expenditure and taxation as proportions of Swedish national income are widely supported by the majority of the population, and have not been significantly affected by requirements for fiscal consolation. Once budget surpluses were restored, the Swedish government reverted partially to type, so that temporary welfare cuts were restored and a degree of fiscal activism returned to macroeconomic policy (EU Commission, 2005: 238). One remarkable feature, indicated by Figure 8.4, is, with the main exception of Sweden during the bourgeois years, the degree of relative consistency in terms of public expenditure as a proportion of GDP. Nevertheless, Nevile (1995: 117) notes that, of the countries that persisted with a constrained, orthodox fiscal policy, international recessions caused growth to fall and unemployment rise more dramatically than nations which responded to a decline in world demand by expansionary fiscal policy. Moreover, those nations hardest hit, perhaps due to the effects of hysteresis, found it problematic to reduce unemployment once world demand had recovered. Therefore, Nevile’s conclusion is that expansionary fiscal policy remained effective in countering the impact of external shocks and in preventing stubbornly high levels of unemployment.

Monetary policy Monetary policy, for Third Way economics, superseded fiscal policy as the primary economic policy tool to achieve stabilisation of the national economy (Meerpol, 1998: 255; Mitchell, 1998: 5). Monetary policy was to secure low inflation and hence reduce long-term interest rates in order to facilitate economic growth. However, the proposition is based upon a number of questionable assumptions. First, it makes the assumption that the only factor restraining an immediate increase in productive investment is the interest rate. Yet, Keynes claimed that businesses invest on the basis of expected future profitability, and fund

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much of this through retained profits (Keynes, 1936: 135–141; Kalecki, 1971; Arestis, 1989: 614; Caporaso and Levine, 1992: 107). Leading on from this, the second assumption relates to the interest sensitivity of investment expenditure (Meerpol, 1998: 231). Empirical evidence indicates that interest rates are a weaker determinant of investment than other factors, including corporate profitability, cash flow and capacity utilisation (Fazzari et al., 1988; Hubbard et al., 1995; Hubbard, 1998; Baddeley, 2003). Thirdly, Greenspan’s argument appears to blame budget deficits for increases in inflation, and yet historically this is a weak claim to sustain, because the inflationary surges in the 1970s were more closely related to the inflationary consequences of the Vietnam war, oil and commodity price rises, together with currency fluctuations. Careful examination of US experience tends to cast doubt upon the closeness of the suggested relationship between fiscal constraint and low interest rates (see Figures 8.5 and 8.6). Indeed, the more accommodatory monetary policy that the US Federal Reserve was able to pursue after 1995 was, according to Greenspan (2003), based upon a perception of an ‘improving trend in structural productivity growth’ that allowed monetary policy to be more expansionary than previous experience would have held to be prudent. This was partly due to a belief in some quarters that the ‘new economy’, based around information technology, computers and development of the Internet-based commerce, had caused an upward shift in structural productivity, although later studies have cast doubt upon this phenomenon (Gordon, 1998). Perhaps, therefore, the more significant reason for low interest rates related to what became known as the ‘traumatised worker’ phenomenon, which Greenspan referred to in terms of the ‘heightened sense of job insecurity and, as a consequence, subdued wages’ (Greenspan cited in Pollin, 2001: 73, 76). Moreover, the depression of raw material prices, especially oil, reinforced this conclusion that cost-push inflationary pressures were unlikely to prove problematic during the Clinton period in office. Thus, the evidence suggests that the low interest rates secured by the Federal Reserve during the Clinton period were built upon a temporary restraint in oil and commodity prices, which has subsequently proven to be much more of a problem for the successor Bush administration, but also because the US labour market proved to be particularly harsh for many American workers – not typically a source of pride for a progressive political movement. A second element of Third Way monetary policy related to the tendency to move towards granting national central banks policy autonomy to

18 Australia Germany Italy Netherlands Portugal Spain Sweden UK USA Euro-area

16

Real short-term interest rates

14 12 10 8 6 4 2 0 1991

1992

1993

1994

–2

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

Years

–4 Figure 8.5

Real short-term interest rates, selected nations, 1989–2004

Source: OECD Economic Outlook, selected years.

179

180

12

Australia Germany Italy Netherlands Portugal Spain Sweden UK USA Euro-area

10

Inflation (%)

8

6

4

2

0

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

–2 Figure 8.6

Consumer price inflation (percentage change per annum), selected nations, 1990–2004

Source: OECD Economic Outlook, selected years.

2002

2003

2004

Evaluation of Third Way Economics in Practice 181

meet inflation targets established by government. It is perhaps not surprising that Italian Olive Tree (I’Ulivo) coalition governments adopted this particular approach due to the appointment of technocrats to act as figurehead to the left-coalition (Sala, 2002: 128). However, more surprising was the rapid, and unexpected decision by the 1997 New Labour government to immediately give the Bank of England operational independence (Gamble and Kelly, 2001: 174). The intention was to cause an independent central bank to balance low inflation with a high rate of employment and a reasonable rate of economic expansion. The MPC could operate considerable discretion to changeable economic circumstances according to their judgement concerning how to best meet the inflation target, and therefore avoid the overly prescriptive fixed policy rule advocated by Friedman et al. (Balls, 1998). Thus, the MPC, not the finance ministry, was effectively responsible in practice for short-term demand management (Keegan, 2003: 248). The performance of Third Way monetary policy has not, however, been as successful as advocates would have hoped. First, the success achieved in delivering low inflation and falling unemployment in the US indicates the preference for a ‘dual mandate’ for a monetary authority, whatever the institutional or structural relationship with government. The fact that the Federal Reserve demonstrated that monetary policy fine-tuning was both possible and successful demonstrates the potential for active government policy in this area (Blinder, 2002: 46). However, this potential would remain unrealised were a monetary authority to concentrate upon a sole objective, namely the achievement of low inflation, and thereby over-deflate the economy to realise their over-riding goal at the expense of the real economy. Secondly, real interest rates, whilst lowered relative to the monetarist years of the early 1980s, remained far too high in historical terms (see Figure 8.5), with the inevitable consequence that industrial production did not rise as quickly as it could have done (Arestis and Sawyer, 1998: 26). Indeed, in certain nations, such as the Australia and the UK, real interest rates were kept far higher than in US and EMU-Europe (Mitchell, 1998: 26). This was at least partly because fiscal policy was more stimulative in the UK than other nations, and as a result British manufacturing industry struggled to escape from recession and expanded output throughout the entire two periods of New Labour government. Furthermore, imbalances arose in the economy, between manufacturing and service industries on the one hand, and due to the stimulation of a consumer boom by rising stock exchange and house price asset ‘bubbles’. Indeed, UK industrial production fell by

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2.5 per cent between 1997 and 2002, compared to an 9.25 per cent increase in the EU, whilst between 1995 and 2002 imports rose by 66.2 per cent but exports by only 39.9 per cent leading to a worsening of the balance of payments and highlighting an underlying lack of international competitiveness that government would ultimately have to counter (Keegan, 2003: 332).

External balance: Exchange rates and balance of trade The management of exchange rates is not one of the core elements outlined in this book relating to Third Way economics, and for one good reason, namely that individual nations disagree profoundly upon the type of approach to pursue. Thus, the US, Australia, UK and Sweden have preferred to maintain a floating exchange rate, and thereby retaining the ability to target monetary policy upon the achievement of domestic goals (typically low inflation) rather than having to use interest rates to maintain fixed currency parities (Green and Wilson, 2000: 424). This flexible regime has prevented quite significant current account balance of payments deficits in the UK and USA to undermine national macroeconomic policies (Ludlam, 2001: 29). Moreover, if it had not been for the significant devaluation of the Krona following its ejection from the ERM in 1992, the ‘new’ SAP macroeconomic strategy would have found it far more difficult to register the growth rates, and with it the consolidation of public finances, that have been achieved. Indeed, New Labour has not experienced an exchange rate crisis – a historical circumstance almost unprecedented for a Labour administration (Callinicos, 2001: 27; Keegan, 2003: 17). Other Third Way economies have preferred to adopt a hard-currency regime in the attempt to deliver low rates of inflation and promote international trade through greater exchange rate certainty (Hemerijck and Visser, 2001: 192). These nations included Spain, the Netherlands and Germany. Moreover, each of these three nations participated in the first wave of entrants to the single European currency, the Euro, thereby necessitating the transfer of exchange rate and monetary policy to the federal ECB, for use in managing the Euro-zone economy (Royo, 2000: 220). The balance of trade is significant in the long run for all economies, because a persistent deficit implies the economy consuming more than it produces, and thereby incurring debt (or dwindling assets) to other nations, whereas a persistent surplus may be inflationary. The significance of the balance of trade in the short run depends upon

8 6 4

Current A/C as % GDP

2 0 –2 –4 –6 Australia Germany Italy Netherlands Portugal Spain Sweden

–8 –10

UK USA EU Euro-area

–12 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995

1996 1997 1998 1999 2000 2001 2002 2003 2004

Source: OECD.

183

Figure 8.7 Current account balances as a percentage of GDP, selected countries, 1986–2004

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the type of exchange rate arrangement the nation has committed to maintain and the strength of speculation in determining exchange values. In terms of the former, a fixed rate requires rapid action on behalf of the government to rectify large and persistent trade imbalances to prevent pressure on the exchange rate, whereas floating insulates government from the necessity of such immediate intervention. However, if speculation and short-term financial flows of capital account for the vast majority of the impact upon exchange rates, then the importance of trade balance inevitably lessens in the short term, irrespective of the form of exchange rate management system selected for the nation, but it nevertheless remains a significant issue in the long run. On this basis, Figure 8.7 indicates that the UK, US, Spain and Australia have a negative trade imbalance, whilst the Netherlands and Sweden maintain significant trade surpluses, and Germany has been in approximate balance over the period under investigation. This implies that, ultimately, the UK, US and Spain will have to increase net exports significantly and, unless this can be achieved through ensuring the income elasticity of exports, then the economies will be forced to slow their levels of private consumption and economic growth. Indeed, they may be constrained by a lack of competitiveness to grow at a slower rate than their major competitors (Thirwall, 1979, 1982). On the other hand, Sweden and the Netherlands have the potential to stimulate their economies without this leading to an immediate trade deficit, although this is presently unnecessary as both nations have relatively low levels of unemployment.

Financial deregulation The deregulation of the financial sector was a near universal element of Third Way economics as practiced by social democratic parties during the past two decades. This represented more than passive acceptance of a supposed new international reality, as globalisation integrated financial markets, but rather an active promotion of such developments (Mitchell, 1998: 12; Scott, 2000: 219). The Clinton administration pursued the continued deregulation of financial markets, and in the process encouraged an extraordinary 225 per cent expansion in stock market capitalisation between 1989 and 1998, adding in excess of US$8 trillion in financial wealth in the process (Pollin, 2000: 28). The stock market boom was encouraged by a marked redistribution national income from labour to capital, as

Evaluation of Third Way Economics in Practice 185

the profit share of national income rose 14.9 per cent in 1989 to 17.5 per cent in 1998, equating to its highest rate in the post-1945 period. However, far from equity prices reflecting the underlying performance in the real economy, the rise in stock prices during the Clinton period was 13.9 per cent per annum faster (Pollin, 2000: 32). The 17.6 per cent annual average growth of the Standard and Poor index of the stock prices of the top 500 companies in the economy during the Clinton period had no historical precedent, having formerly expanded by 6.2 per cent during the Kennedy/Johnson and Reagan/ Bush administrations, whilst the index declined during the Nixon/Ford and the Carter years (Pollin, 2000: 32). At the peak of the market in March 2000, the market capitalisation was US$17 trillion, or 1.7 times the value of US GDP (Stiglitz, 2003: 138). The stock market boom contributed towards budget deficit reduction, as revenues from capital gains taxation rose from US$126.7 to US$362 billion, between 1992 and 1997, thereby representing a rise in total tax receipts from 2.7 per cent to 5 per cent (Pollin, 2000: 24). Furthermore, the wealth effects arising from growing asset prices encouraged consumers to borrow against the growth in their financial assets (stocks, property). Indeed, it was largely this rise in deficitfinanced consumption that maintained a buoyant level of aggregate demand in the US economy, despite the fact that government expenditures have declined and the trade deficit has grown (Pollin, 2000: 40). Ratios of household debt to income have risen well above previous historic highs, as consumer borrowing rose from 77.8 per cent to 94.2 per cent of disposable income during the Clinton period (Pollin, 2000: 32–33; Pollin, 2001: 67; Papadimitriou et al., 2002; Godley, 2003). A Bank for International Settlements analysis showed that, of 15 per cent growth in real private consumption between 1996 and 2001, one-third was financed by higher disposable income, most of the remainder by higher property prices (‘equity withdrawal’), and the balance through the rise in equity prices (Godley and Izurieta, 2003a,b; Keegan, 2003: 233). A sizeable literature documenting the manner in which ‘speculative manias’ periodically occur in financial and/or property markets throughout recorded history (Kindleberger, 1978; Pollin, 2003: 60). Extrapolating from this experience, Pollin (2003: 60) argues that ‘in the absence of effective regulation, speculative excess will inevitably occur in financial markets’. Moreover, asset price inflation reached ‘unprecedented peaks’ during the Clinton era, caused by what Greenspan called ‘irrational exuberance’, because neither government nor Federal Reserve

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introduced effective controls to prevent its occurrence (Baker, 2000: 223; Galbraith, 2003: 20). The resultant stock market bubble and related debt-financed consumer expenditure combined to produce a high level of effective demand, and therefore the US economy performed comparatively well related to other national economies (Galbraith, 2003: 20). However, the underlying reality of ‘Clintonomics’ depended upon an unsustainable asset boom, deriving from the stock market, together with private consumption financed via increasing personal debt (Pollin, 2001: 61). Thus, ‘Clintonomics’ failed to develop into a viable economic model that could sustain economic expansion into the medium and long term. Instead, these excesses were instead edging the US economy into a ‘Minskian state of financial fragility’ (Papadimitriou et al., 2002: 8). There was a similar pattern observed in many Third Way economies. In Australia, Harcourt (1992) and Stretton (1987) have shown that the deregulation was not beneficial to the economy, introducing instability, penalising small consumers and has reduced the effectiveness of monetary policy. In the UK, where economic growth rates were stimulated at least in part through a debt-financed consumer boom, financed by a threefold increase in housing prices during the two New Labour administrations, the potential economic reverse that could follow a collapse in housing prices is the main shadow upon the record of relative success surrounding New Labour’s economic policy (Goodman and Oldfield, 2004: 28). One alternative to the predominant Third Way preference for financial sector deregulation has been discussed within the German SPD, namely to encourage super-national political organisations, such as the EU, to regulate capital and thereby prevent potential financial crises and the threat of social dumping undermining national standards in the fields of welfare and taxation (Callaghan, 2000: 166–167). The Swedish social democrats have shown similar equal interest in this type of initiative (Newman and de Zoysa, 2001: 42). However, this strategy fails to consider how a super-national regulation would co-exist with the neo-liberal foundations upon which the EU, and especially EMU, is built. Thus, the free movement of capital within the SIM empowers capital at the expense of nationally based governments and trade unions, whilst the operation of the European Monetary System (EMS) has depressed the European economy for a decade or more, resulting in a substantial demand-deficient output gap (Gordon, 1987; Solow, 1991). Moreover, the convergence criteria, forming the basis of EMU, frustrate counter-cyclical, Keynesian policy intervention in order to reduce mass

Evaluation of Third Way Economics in Practice 187

unemployment (Landau, 1995; Vanhoudt, 1999: 212–213). This criticism of the EU is rejected by Smith (1997), who argues that such blame is disingenuous because it deflects consideration that national governments often favour the policy change, and therefore use the EU as a scapegoat for measures they would have pursued in any case. Nevertheless, EU membership locks national governments into its quasineo-liberal policy framework, unless or until the social democratic forces within Europe can re-negotiate the international treaties that have established the institutional model for European integration.

Supply-side reform In terms of supply-side policies, most Third Way governments pursued ‘modernization’ through embracing economic liberalisation, flexible labour markets and ‘positive’ welfare (Sala, 2002: 122–124). Unemployment was considered to be primarily the consequence of structural problems in the labour markets of individual nations and not due to demand deficiency (Royo, 2000: 152). In Spain, for example, the level of wage bargaining and the power of ‘insiders’ in the bargaining process were highlighted as critical factors in this regard (Royo, 2000: 187–188). Similarly, the Dutch Partij van de Arbeid (PvdA) had implemented fiscal consolidation, wage moderation, deregulation, privatisation and internal markets in the public sector, flexibility and training initiatives in the labour market, and had reallocated resources from social security to the public investment in human capital (de Beus, 1999; Hemerijck and Visser, 2001: 190; Merkel, 2001: 62). Third Way economics emphasises the importance of supply-side initiatives in terms of shifting the supply-determined long run equilibrium unemployment rate to the left, thereby enabling the achievement of lower levels of unemployment consistent with a low level of inflation. Supply-side reforms can, additionally, remove the impediments to market forces, although whether this leads to improved allocation and distribution of resources depends upon whether it results in a degree of market failure. ‘Welfare to work’ programmes can be seen as contributing towards greater market allocation, together with reinforcing incentives to work, invest and save, and thereby to improve employability and encourage people into jobs (Oppenheim, 1998). Furthermore, the endogenous growth theory indicates that supply-side variables can influence the nation’s long-term growth rate (Moran and Alexander, 2000: 114; Gamble and Kelly, 2001: 176). Indeed, one criticism of Clinton’s administration claims that it was overly concerned with ‘nano-level’

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(i.e. small scale) policy reforms and accordingly neglected the larger strategy (Frankel and Orszag, 2002: 5). At the European federal level, the Lisbon strategy to increase EU competitiveness sought to do so via a set of measures that fit in well with the general thrust of Third Way economics, including the promotion of sounder public finances, more active labour market policies, more productive investment in the areas of human capital, competition policy, flexible labour markets and welfare reform (EU Commission, 2005). Traditional social democratic industrial policy, involving public ownership and economic democracy initiatives, intervention in the decision-making processes of companies, together with provision of credit to finance productive capital formation through public-owned investment funds and/or banks, has been superseded by a marketorientated programme. As a result, critics claim that Third Way industrial policy has a paucity of proposals aimed at rectifying weakness inherent in regional policy, stimulating productive investment and raising productivity rates. Yet, this remains an area of policy weakness for nations like the UK (Watson and Hay, 1998).

Industrial policy Third Way industrial policy focuses upon the promotion of market forces, through privatisation and the encouragement of competition within both private and public sectors. It rejects more interventionist approaches on the basis that market allocation of resources is superior to ‘political’ interference. It seeks to create optimum conditions for business operations, to promote domestic companies and attract FDI, and it favours private over public ownership, arguing that control of physical capital was less important in the information economy than investment made in human capital (Giddens, 1998a; Blair, 2000; Stedward, 2000). The Italian Olive Tree governments pursued privatisation of a substantial proportion of the state holding company’s, IRIs, shareholdings in 1998, albeit that their motivation was to weaken the control of economic assets by a small elite comprised of private interests and party factions that gained influence through the long years of Christian Democratic rule (Sassoon, 1997: 87; Sala, 2002: 126–128; Favretto, 2003: 141). One potential weakness with this market-orientated approach to industrial policy can be illustrated by close examination of the record of manufacturing industry during the New Labour governments. Whilst the economy as a whole has been growing at a reasonable rate, and

Evaluation of Third Way Economics in Practice 189

unemployment has been reduced to the lowest rate for decades, nevertheless, the number of manufacturing jobs in Britain fell by one million, from 1997 to 2004, with only 3.5 million people still being employed in this sector of activity.2 Reasons include the high value of sterling, high comparative real interest rates and a general rise in unit costs that has not been ameliorated through a rise in productivity and capacity utilisation (Annesley and Gamble, 2004: 150). Nevertheless, the absence of an industrial policy targeted at restoring a viable manufacturing industry is a weakness in this scenario.

Productivity The approach of Third Way economics towards the promotion of productivity combines a neo-liberal emphasis upon maximising the efficiency of market allocation and distribution of resources, and derivation from endogenous growth theory regarding the potential inherent in human capital investment in terms of raising productivity and economic growth rates. Although it is early to make a final judgement upon the ability of this Third Way programme to raise productivity, the initial data is mixed at best. During the period after (and including) 1997, Euro-zone economies, Germany, Italy and the Netherlands, increased productivity by an annual average of 1.1 per cent, 0.9 per cent and 0.4 per cent respectively, whereas the UK managed 1.7 per cent, Sweden 2 per cent and US 2.5 per cent (see Figure 8.8). Comparator OECD productivity averaged 1.9 per cent during the same period. Comparisons of US, German and UK productivity indicates that the US benefits disproportionally from the quantity and quality (through higher education) of labour, and a superior ability to realise innovation, whilst Germany relied upon higher physical capital investment and institutional support for vocational training (Hutton, 1994; HM Treasury, 2000: 1; Coates and Hay, 2001). The record of the Clinton administration on productivity, namely an average rate of 1.9 per cent throughout the 1990s, has been a considerable improvement upon the poor 1.4 per cent average between 1973 and 1989, but never threatened to reach the 3 per cent annual average achieved during the Keynesian ‘Golden Era’, between 1950 and 1973 (Baker, 2000: 210). The claim that the US economy had sifted to a higher level of structural productivity due to the impact of a ‘new economy’, characterised by information technology, was found to be largely spurious (Gordon, 1998).

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Germany Netherlands Italy Sweden UK USA OECD Euro-area

6

Labour productivity (%)

5 4 3 2 1 0 1994

1995

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2001

2002

–1 –2 Figure 8.8

Labour productivity in the business sector (per cent change), selected nations, 1994–2004

Source: OECD Economic Outlook, various issues.

2003

2004

Evaluation of Third Way Economics in Practice 191

Welfare reform The reform of welfare state provision was intended to promote employability through provision of incentives to encourage individuals to return to work. The ‘strong state’ would downsize its activities and expenditure in this field, through privatisation, contracting-out of services and the introduction of marketisation of public services. The proposal is that globalisation has undermined the idea of using the welfare state to decommodify workers, and therefore governments should empower individuals to succeed in the international market and not to be isolated from market forces. Welfare reform therefore removes former support, whilst labour market policy facilitates the second element – the empowerment of workers through human capital investment intended to develop skills and therefore raise productivity. In practice, however, this proved to be a difficult area for Third Way reformers. For example, in the US, the Clinton administration set itself a number of challenging targets, not least the proposal to introduce low cost health insurance coverage for all American citizens, and yet scholars remain undecided whether eight years of office produce a small improvement or deterioration in public welfare. As Faux (1999: 70) states, ‘what is undeniable is that, either way, the change is small’. The healthcare insurance initiative failed because of the insistence to forge a compromise with private health care providers rather than increase state involvement, with the result that the proposal became too complicated and confusing that private health insurance corporations were able to portray it as a ‘bureaucratic monster’ (Faux, 1999: 70). The lack of a Democratic Party majority in Congress during the majority of the Clinton administration may have further complicated evaluation of what the administration would have pursued if unimpeded by political opposition. Thus, whilst Clinton generally defended Medicare and Medicaid programmes from expenditure cuts proposed by Republican majorities in Congress, at certain periods of his tenancy in office, he nevertheless later agreed to substantial cuts in both health care programmes in order to balance the federal budget (Clinton, 1999: 2–3; Jaenicke, 2000: 41). The most obvious example of this approach related to Clinton signing Republican welfare legislation, the Personal Responsibility and Work Opportunity Reconciliation Act (PRWORA), in August 1996, which reduced welfare expenditure by US$54.1 billion over a six-year period and introduced variations in state support on the basis of largely arbitrary criteria (Jaenicke, 2000: 43–44). The measure did introduce time-limited benefits, an innovation supported by Clinton

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to ‘end welfare as we know it’ (Clinton, 1996c; Jencks, 1997: 2; Jaenicke, 2000: 44–45). However, its presumption that the unemployed could easily get a job takes little account of problems encountered in a slack labour market, amidst a recession. In other words, the legislation either ignored or rejected the possibility of demand-deficient unemployment. Thus, the unfortunate consequence of these changes has been to transfer a counter-cyclical public support system – that is one which provides the greatest assistance to individuals when they are unemployed – to a pro-cyclical alternative. The Clinton-era approach appears to work well because it has been sustained by a persistently strong economy, but the eventual effectiveness of the reforms will depend upon its ability to act as a social safety net during a recession, such as the one developing in the aftermath of the Clinton years and with the advent of the Bush(Junior) administration (Blank and Ellwood, 2002: 793–795). One additional weakness with Clinton’s welfare reforms relates to his prioritisation of budget deficit elimination ahead of expenditure necessary to re-shape the American welfare state to create work incentives, and human capital investment through education and training, and promote employability. Notable in his public statements, Clinton persistently discusses the problem in terms of ‘welfare reduction’ and not ‘poverty reduction’ (Clinton, 1996b, 1997: 1, 3, 1998: 1, 6, 1999: 1, 7; Democratic Party, 1996: 42; Jaenicke, 2000: 45). Welfare reforms introduced in the UK by the New Labour administrations have been more consistently applied, although like in the US, political opposition to specific reductions in welfare programmes and/ or entitlement, often centred within the Labour Party, has curtailed any greater reforming vision. As in the US, welfare reform is presented as work-centred policies aiming at rejuvenating the work ethic, and in that way tackling problems of poverty and social exclusion (Hills, 1998; Kelly and Oppenheim, 1998). Official pronouncements refer to the need to redesign welfare provision for the changed circumstances of the modern world since the ‘welfare needs of today are not being met by the welfare state of yesterday’ (Blair, 1996: 142; DSS, 1998). Indeed, in a move paralleled by the Swedish trade union movement, New Labour claimed that Britain had reached the limitation of public tolerance for funding an unreformed welfare system (Anderson and Mann, 1997: 224–225). Thus, cost-cutting and welfare reform were conflated in the New Labour programme (Callaghan, 2000: 142). The welfare reforms introduced by the Australian Labor Party were similar in nature, through their preference to encourage people to seek work, utilise means-tested benefits to target support at the poorest and

Evaluation of Third Way Economics in Practice 193

most vulnerable people whilst simultaneously reducing welfare costs through rationalising programmes and eligibility (Johnson and Tonkiss, 2002: 8). Moreover, citizens were encouraged to be ‘active’ recipients of welfare, with the state providing investment in education, training and job search schemes, as long as the unemployed individual accepted their ‘reciprocal obligation’ (Johnson and Tonkiss, 2002: 8). Throughout European social democratic regimes, elements of the Third Way reform agenda have been pursued, although with almost universally less enthusiasm and determination as in Anglo-Saxon nations. Thus, in Spain, a 1985 reform of the social security system involved the reduction in benefit payments and eligibility, whilst shifting costs from employers to the employees themselves. Thereafter, the emphasis has been placed upon increased investment in the Third Way priority areas of education and training (Royo, 2000: 189). Likewise, in Italy, the emphasis has been on the creation of ‘positive’ welfare (Sala, 2002: 128). The Netherlands and Denmark have both long pursued what Green-Pedersen et al. (2001: 309) describe as ‘employment-friendly and efficient tax and social policy’ as a core feature of their economic ‘models’. However, a recent deterioration in public finances has encouraged the Dutch government to pursue fundamental reform of the social security and pension systems, introducing a maximum duration for unemployment benefits and the improvement of incentives for individuals to take up work. Subsidies on low-paid labour are to be discontinued due to the deadweight loss that arises from these measures, whilst the disability scheme is to be reformed to prevent this route being used as a proxy for long-term unemployment, with the introduction of tougher entry criteria and the employer to pay sickness benefits for two years before an individual becomes eligible for state disability payments (EU Commission, 2005: 193–194). In contrast to certain other Third Way governments, German and Swedish social democrats have remained distinctly cautious about the wholesale reform of social policy. In this regard, although the Schröder government has introduced elements of pension reform, placed expenditure caps upon certain areas of health expenditure and has permitted individual contracting in limited areas of public sector provision, the 2002 election manifesto pledged to expand the generosity and breadth of social policy measures (EU Commission, 2005: 116–117). Indeed, Schröder has combined state subsidies for low-earning workers and the long-term unemployed with financial incentives offered to welfare recipients to accept low-paid employment (Clift, 2004: 44–45).

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The Swedish welfare state is in itself a fascinating case study by which to test the hyper-globalisation hypothesis, which argues that the competitive pressures of global markets should have forced the government to reduce social policy expenditure (through a dislike for high taxes and inflationary perceptions of government borrowing) and therefore radically restructure the welfare state (Pollin, 2000: 172). There are a number of changes that have occurred. In the field of taxation and social security transfers, a tax reform, introduced in the late 1980s, sought to reduce marginal taxation and thereby improve work incentives. Replacement rates were reduced for sickness benefit, from 90 per cent in 1980 to 80 per cent in 1990, although the replacement rates for pensions has remained largely unchanged (at 72 per cent of former salary), and the replacement rates for unemployment benefit increased in generosity from 72 per cent in 1985 to 77 per cent of former salary in 1998 (Pollin, 2000: 177–178). The generosity of Swedish social security was on average the same in 1998 as it was two decades earlier, although international comparisons demonstrate that neighbours Denmark and Norway have caught up in terms of the generosity of welfare transfers during these two decades (Pollin, 2000: 178). In terms of eligibility rules, the number of waiting days (five) and the maximum duration of the Swedish unemployment benefit scheme remained unchanged in 1998 as they had been in 1980, although the number of weeks of employment required prior to qualification was raised from 20 to 26 weeks. Rules for sickness benefits are similar to those pertaining in 1980. Where they have occurred, reductions in transfer payment levels have been justified on the basis that ‘most households can withstand a temporary cut in household income to develop a long-term, sustainable welfare system’ (Lindgren, 1998: 89). Furthermore, the SAP governments have made efforts to reverse some of these former cuts in benefits once the budget deficit problem had been brought under control, during its second administration, particularly in the area of child support. Thus, the bulk of the available evidence suggests that welfare reforms have been incremental rather than wholesale, and Sweden retains a high score, if measured on an international comparative decommodification index, suggesting that the Swedish welfare state remains amongst the most generous (Pollin, 2000: 179). To the extent that reforms liberalised the Swedish welfare state, this occurred only at the margins, thus preserving the structure of existing programmes and failing to justify claims of significant retrenchment (Pollin, 2000: 187). This is despite the advent of conditions highly favourable to a radical restructuring of

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social policy, particularly the dramatic rise in unemployment rates and commensurate fiscal crisis that arose in the aftermath of the election of a monetarist-inspired bourgeois coalition, together with the supposed weakness of national economic policy following the strengthening of globalisation during this period (Pierson, 1996: 171–172; Weiss, 1998: 87). Ladrech (2000: 67) concludes that Swedish social policy has been ‘reconfigured’ rather than being replaced. Likewise, Pollin (2000: 187) concludes that the cuts that were made in the 1990s have not changed ‘the basic character of the Swedish welfare state’ – a conclusion that appears to be difficult to reconcile with the hyper-globalisation thesis which has done much to motivate the Third Way economic strategy. An alternative viewpoint, expressed by Ryner (1999: 39), states that reductions in social insurance entitlements indicate that the Swedish welfare state has been ‘hollowed out to facilitate “self-regulating markets” ’. Indeed, focusing upon ownership and the provision of service, rather than the generosity of those public services, does present a significantly different picture of the reforms pursued over the past decade, as the continuation of the privatisation programmes of the previous bourgeois administration has resulted in an increasing private sector presence in formerly core areas of public provision and which therefore represents a significant marketisation of Swedish society in little over a decade. Income inequality One of the consequences of growing emphasis upon market solutions, reductions in the general and particularly corporate levels of taxations, and pressures to limit welfare expenditure, have all contributed towards a growing trend towards inequality in income, wealth and power in modern industrialised economies. However, Third Way economics places little priority upon redistribution measures, and nor do leading policymakers associated with the Third Way appear to be particularly concerned with issues of equality and redistribution. One reaction has been for Third Way advocates to seek to redefine the issue in terms of social exclusion, ‘fairness’ and ‘inclusiveness’, together with creating greater individual equality of opportunity in terms education and access to other public services (Blair, 1998d: 5; Driver and Martell, 1998: 30, 160; Gamble and Kelly, 2001: 182). Even in Sweden the emphasis upon income redistribution ‘seems to be shifting towards “redistribution of possibilities” ’ (Lindgren, 1998: 89). Although this approach has been accused of creating a ‘false dichotomy’ between the redistribution of income and opportunity – most notably by an open letter published in the Financial Times having been signed by 54 social policy

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professors – and stimulated demands for fiscal redistribution policies to be given more emphasis by ‘new’ social democratic movements (Lister, 1998: 14; Annesley, 2001: 214). A second reaction from supporters of the Third Way has been to simply ignore the issue completely, or to accept the argument that economic growth necessitates increasing economic inequality. Thus, Reich (2002: 743) notes that the widening inequality of both income and wealth in the USA, during the 1980s and 1990s, was of concern to many of Clinton’s advisors, but ‘was never a central focus of Bill Clinton’s policy agenda’. Whilst in Australia, Keating had claimed that no alternative policy existed than to facilitate a redistribution of income from labour to capital, through stimulation of profitability and reducing wage costs, in order to promote international competitiveness in a global economy ( Johnson and Tonkiss, 2002: 11). Accordingly, Hawke–Keating policies led to a ‘substantial transfer of wealth between labour and capital’, as the corporate profit share in GDP at factor cost rose from 12.4 per cent of GDP in 1982 to 17 per cent in 1993 (Keating, 1993: 27; Stilwell, 1993: 19; Johnson and Tonkiss, 2002: 11). Due in large part to neglect, whether by design or resulting from a belief in government powerlessness against the forces of hyperglobalisation, income inequality has tended to continue to rise despite the election of Third Way administrations. Thus, Figure 8.9 indicates 0.40

1980–81 1985–87 1989–91 1995–97 1999–2000

0.35

Gini coefficient

0.30 0.25 0.20 0.15 0.10 0.05 0.00 Australia

Germany

Italy

Netherlands Spain

Sweden

UK

USA

Figure 8.9 Comparative degrees of inequality utilising the Luxembourg survey to assign Gini coefficients, various countries, 1979–2000 Source: Luxembourg Income Study, 2000.

Evaluation of Third Way Economics in Practice 197

that inequality grew throughout the Hawke–Keating period of government (Scott, 2000: 226), whilst in the US, Clinton’s tax changes did lessen the highly regressive policies pursued during the Reagan–Bush (senior) administrations, however the changes did not restore the degree of progressivity that existed prior to Reagan’s election (Mishel et al., 2002; Pollin, 2003: 27). Moreover, the distribution of wealth grew more unequal under Clinton than it had done during the previous four decades (Pollin, 2003: 9). Thus, inequality was higher at the end of the Clinton period of office, but had declined slightly during the latter years. One reason for this has been that productivity increases have outstripped wage rises, leading to a redistribution of income away from labour and towards capital. Thus, in 1997 the share of total corporate income accruing to profits was 21.6 per cent, compared to cyclical highs under Nixon of 18 per cent in 1973, Carter of 17.4 per cent in 1979 and Reagan of 18.4 per cent in 1989 (Mishel et al., 1999; Pollin, 2000: 42). Freeman and Katz (1994) sought to identify the relative significance of various factors that they deemed to be potentially associated with the rise in inequality, and their study found that perhaps 25–33 per cent of this increase in inequality arose due to deindustrialisation, 7–25 per cent technological change, 15–25 per cent due to low wages and immigration, 20 per cent resulting from a fall in unionisation and was due to deindustrialisation, 15 per cent arising from the US trade deficit. A second feature arising from Figure 8.9 concerns the relative success that different nations have had with respect to reducing inequality. Thus, it is notable that US, UK, Italy and Spain have relatively higher levels of inequality, relative to Sweden, Germany and the Netherlands. It is probably no coincidence that it is these nations that, amongst those interested in ‘new’ social democratic thinking, have also been the more reticent to dismantle the essence of the traditional social democratic welfare state. Moreover, reference to Figure 8.4 indicates that those nations with higher proportions of GDP accounted for by taxation and public expenditure appear to be those most able to maintain lower levels of inequality. Nevertheless, it is interesting that the level of inequality has risen in Sweden during the most recent time period, although this merely raises the Gini coefficient to similar levels to Germany and the Netherlands. Figure 8.10 suggests that in Britain the New Labour administrations have made little impression upon reversing the legacy of inequality created by the Thatcher–Major governments, when the average real

198 Third Way Economics 0.365 0.360 0.355 0.350 0.345 0.340 0.335 0.330

Actual Gini

0.325

Simulated Gini

0.320 0.315 1997

1998

1999

2000

2001

2002

2003

Figure 8.10 Simulated and actual Gini coefficient for the UK, 1997–2003 Source: Brewer et al. (2004: 22).

income of the bottom tenth of the population fell by 14 per cent between 1979 and 1991 while that of the richest rose by 50 per cent (IPPR, 1993: 44–45; Brewer et al., 2004: 17; Goodman and Oldfield, 2004: 10). Wealth inequality has, likewise, increased slightly during the New Labour administrations (Paxton and Dixon, 2004: 26). Moreover, using slightly different methodology and data time periods, Brewer et al. (2004) found that the Gini coefficient rose from 0.33 to 0.345, between 1997 and 2003, compared to a 0.09 increase (from 0.25 to 0.34) during the Thatcher governments. An alternative method of assessing the impact of a government’s fiscal policies upon income inequality is to compare how the actual change in inequality would compare with what would have occurred if tax and benefit systems had remained unchanged, apart from annual up-rating for inflation. Brewer et al. (2004: 21–23) estimated that the introduction of tax credits and means-tested benefits introduced since the tax year 2000–2001 has made a notable difference to what would have happened to inequality had the tax and benefit system remained unchanged from the Major administration (see Figure 8.10). Browne (1999) suggested that Brown’s early budgets had raised the incomes of the poorest 20 per cent of households with children by around 15 per cent, whereas they benefited the richest 10 per cent of the population by only 1 per cent. Targeted (i.e. means tested) tax credits and experimentation with indirect taxation have achieved a degree of ‘redistribution by stealth’ in so far as New Labour have slowed the trend towards

Evaluation of Third Way Economics in Practice 199

increasing inequality without actually halting or reversing it (Moran and Alexander, 2000: 115; Keegan, 2003: 258; Favretto, 2003: 154).

Labour markets Third Way economics places great emphasis upon the achievement of supply-side reforms in the labour market to facilitate greater flexibility, channelling market forces and reducing regulation, in order to release the potential for superior allocation of resources and thereby increasing economic efficiency whilst simultaneously responding more swiftly to changes in the international economic environment. Moreover, endogenous growth theory indicates that investment in human capital will both empower individuals within the global marketplace, whilst a more highly skilled workforce will advance productivity and growth rates. All social democratic movements associated with the Third Way promoted this combination of labour market flexibilisation and investment in training and skills. However, once again not all were as successful in implementing the reform agenda, and not all nations and/or parties were in agreement regarding how far down this particular policy path they were prepared to travel. Labour market flexibility In the US, for example, the labour market has long been relatively deregulated, with trade unions having little influence upon the determination of wages, except in certain sectors – that is transportation, metalworking, steel production and in the public sector. Therefore, the Clinton period of office was not particularly associated with further reforms in this area. Indeed, Greenspan pointed to the weakness of organised labour as one of the key criteria which allowed the Fed to maintain relatively expansive monetary policy during the second Clinton administration since they were not predicting tight labour markets resulting in wage-push inflationary pressures. The data here is quite startling that, despite rapid growth in top earners’ incomes, when examining the median wage, this declined from US$11.35 in 1989 to US$11.29 in 1998, despite a decade of productivity growth (Palley, 1998: xix). Australia, by contrast, had been traditionally a very regulated economy, with statutory wage setting and judicial oversight of the process (Pierson, 2002: 183). Furthermore, the Australian Labor Party economic programme was, at least initially, based upon a high degree of corporatist co-operation from the trade union movement, which it did not wish to damage

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prematurely (Pierson, 2002: 184). Nevertheless, the Hawke–Keating administrations shifted wage bargaining towards enterprise-level bargaining, extensively deregulated the labour market and introduced a range of initiatives to reduce unemployment by both improving individuals’ skills through investment in skills training programmes, whilst simultaneously reducing the effective cost of labour (Pierson, 2002: 193). These measures had considerable impact, with 75 per cent of job growth in Australia in the 1990s being on a part-time, and 62 per cent on a casual, basis (Glover and Patmore, 1999: 4). This was a rate of expansion even higher than in Spain, where labour market deregulation has led to fixed-term contracts coming to represent 30 per cent of total employment (EU Commission, 2005: 133). Italy, Germany and Sweden, by contrast, have started from a position characterised by relatively regulated labour markets (OECD, 1994b: 92–95; Streeck, 1993: 146–148), but where reform initiatives have been rather more cautious in nature. The Swedish SAP, for example, have introduced a number of initiatives aimed at flexibilising the labour market, but remain determined to ensure that its labour markets remain regulated, to provide objective protection and empower workers to utilise voice within the employment situation (Clift, 2004: 47). The Italian Olive Tree coalition governments stated their willingness to dismantle elements of the 1970 Statuto dei Lavoratori (Statute of Workers) series of labour laws conceded in the wake of the ‘Hot Autumn’ of industrial action, and yet much of this regulation remained in place (Favretto, 2003: 139). Moreover, the 1998 D’Alema administration preferred to rely upon the negotiation of a social pact with social partners to forcing through a radical deregulatory agenda (Contarino, 2000). In Germany, labour market reforms have been in gestation for a long time and have required the utilisation of an independent government commission, chaired by Volkswagen executive Peter Hartz, in order to circumvent political and industrial opposition to the proposed reform agenda. Nevertheless, the second-term Schröder administration is on track to implement its Agenda 2010 reform package. Specifically, the Hartz I to IV labour market reforms involve a moderate relaxation of dismissal protection rules, reduced unemployment benefit (from 60 per cent of former pay to a flat rate of £232 per month for the long-term unemployed), reductions in housing benefits, new restrictions upon eligibility so that the unemployed will be forced to accept any job offer paying up to 30 per cent less than the prevailing local wage or lose benefit, the introduction of a new category of low skilled jobs subject to reduced social security contributions, together with

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investment into increased job search and provision of personal service agents to facilitate this process for the L/T unemployed (EU Commission, 2005: 110–115). Fears have been expressed that the desire to maintain the consensual approach to industrial relations that characterises the German ‘social market’ economy is impeding the flexibility of the German labour market (Albert, 1993: 110–113; Bowley and Studemann, 1997: iv). Indeed, some of the largest German employers, including Siemans and Mercades, have independently negotiated separate deals with their employees to work longer hours for the same money, to prevent the relocation of investment to the East European nations, whilst faced with this threat, IG Metall has conceded a national wage freeze until 2007 and has accepted more flexible working arrangements.3 Moreover, critics argue that Germany characterises the classic insider–outsider economy, where those in employment are well paid and also enjoy reasonable job security through employment protection laws and institutionalised collective bargaining, whilst the unemployed find it difficult to get a job but thus far at least have been fairly generously compensated (Esping-Andersen, 1996b: 70, 79–80; Greider, 1998: 365–366). Nevertheless, the SPD remain unconvinced that labour market flexibility is a necessary condition of international competitiveness within the global economy (Clift, 2004: 47). Even though current changes remain relatively minor (Neyer and Seeleib-Kaiser, 1995: 33), it has been suggested that the pressure for reform will continue due to the high level of German unemployment and the potential for a secondary labour market in ‘non-standard’ jobs is apparently growing in the informal economy, reinforcing trends towards a dualistic labour market (Greider, 1998: 373; Norman, 1997: 1) It is perhaps in the Netherlands (and Denmark) that the most interesting labour market reforms have occurred, and where efforts to encourage labour market flexibility have focused upon the ‘de-institutionalization’ rather than deregulation per se (Flynn and Strehl, 1996: 105; Spithoven, 2002: 338). Traditional full time working has been progressively superseded by a part-time model, as the share of part-time workers has risen from 5 per cent to 35 per cent of the Dutch labour market since the 1970s – a share easily exceeding any other OECD nation – but where workers retain a high level of job security (OECD, 1999b; Hombach, 2000: 93). Agency working has also increased to 11.3 per cent of the labour force in 1999 – a development that may be functionally equivalent to low levels of employment protection in other nations (Ferrera et al., 2001: 124; Spithoven, 2002: 353). Encouragement of

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labour market flexibility has facilitated the development of labourintensive service industries. The most significant result of the Dutch approach has been a dramatic reduction in unemployment, at a quicker rate on average than in most OECD states. This recovery began before the social democrats returned to power in 1989, but the greatest success coincided with social democratic government (Merkel, 2001: 63). Of this employment growth, part-time employees account for 75 per cent of the total increase since 1983 (Hemerijck and Visser, 2001: 190). Part-time service-sector employment expansion has additionally facilitated a rapid rise in female labour force participation, from 35 per cent in 1983 to 63 per cent in 1998 (Hemerijck and Visser, 2001: 191; Ferrera et al., 2001: 125). However, it is important to note that the job sharing-‘flexicurity’ strategy has been greatly aided by the Dutch system of concertation, in that reforms have been negotiated between social partners and therefore have been widely accepted. Moreover, wage moderation released resources that were able to be utilised to raise investment, and in the process improve international competitiveness and boost net exports, stimulate employment expansion and ultimately economic growth (Merkel, 2001: 63). The Dutch strategy has demonstrated the possibility to reduce unemployment through alternative means than a neo-liberal deregulation of the labour market (Merkel, 2001: 63). Its promotion of ‘flexicurity’ offers the possibility for promoting elements of labour market flexibilisation, for example functional flexibility, whilst retaining other elements of job protection regulation to provide a stable working environment for employees. The 1995 ‘flexicurity’ accord, for example, strengthens the rights of temporary workers in return for the loosening of dismissal protection for core workers, thereby ensuring that employers have greater labour supply flexibility but that this does not lead to the development of a low wage industry since temporary and part-time workers have the same proportional wages and working rights as full-time employees (Ferrera et al., 2001: 121). Trade unions have sought to champion the equalisation of wages and rights for the peripheral workforce, thereby further protecting against the development of a low cost production strategy. Moreover, through its job sharing approach, the Dutch economy might not have created as large a number of low-paid jobs as can be achieved by the US model, but neither has the maintenance of a generous welfare state and relatively low levels of inequality led to a high level of (albeit well compensated) unemployment (Visser and

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Hemerijck, 1997: Hemerijck and Schludi, 1999; Hemerijck and Visser, 2001: 191). There are, however, a number of weaknesses with the Dutch approach to job sharing. First, although the open unemployment rate remains around 4 per cent, the level of ‘structural inactivity’ relating to inactive persons of working age receiving a social security benefit and persons enrolled in special job creation programmes remains at 20 per cent of the labour force (OECD, 1998; Hemerijck and Visser, 2001: 191). Thus, the Netherlands suffers from a tendency for the unemployed to be re-categorised as unable to work, or near-permanent participants in re-training schemes, rather than finding permanent employment opportunities. Secondly, labour force participation rates of older males is amongst the lowest in Europe and long-term unemployment accounts for half of the open rate (Hemerijck and Visser, 2001: 192). Thirdly, Spithoven (2002: 360) argues that, because the unemployed tend to have lower marginal productivity than those in full-time employment, the policy of job sharing hampered productivity growth. Thus, despite its international plaudits, Notermans (2000: 246–247) argues that the Dutch approach has few lessons for other nations to absorb. This approach has not created full employment in any meaningful form and therefore it has realised a second-best solution (Hemerijck and Visser, 2001: 192). Active labour market policy The replacement of passive welfare policy by a more active investment programme, intending to provide individuals with skills and facilitating their job search to realise a more rapid transition from one job to another, is a central feature of Third Way economics. In Italy, Olive Tree policy emphasised the provision of education and training as ‘chief means of their fight against unemployment’ and particularly youth unemployment (Parket, 1997; Favretto, 2003: 150). In Australia, similar examples include the Jobs, Education and Training (JET) scheme, which was introduced in 1989 with the intent to encourage lone parents into the labour market by providing training, employment advice and access to childcare (Johnson and Tonkiss, 2002: 8–9). Moreover, the emphasis upon training rather than other forms of job creation measure grew in emphasis throughout the Hawke–Keating period in office (Kerr and Savelsberg, 1999: 241; Keating, cited in Johnson, 2000: 128; Johnson and Tonkiss, 2002: 8). In his 1993 Vision of Change for America, Clinton repeatedly emphasised the importance of investment in human capital formation to

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promote the international competitiveness of US industry, and thereby elevate social mobility (Woodward, 1994; Meerpol, 1998: 227–279). However, because of his prioritisation of reducing the budget deficit, together with the fact that state and local governments are primarily responsible for school education, the Clinton administration was only able to affect the quality of education and training at the margins (Reich, 1997: 146–147, 155–156, 213–214, 1999a: 50; Jaenicke, 2000: 36–40). Furthermore, Clinton found it to be difficult to fashion a durable supporting coalition around his skills training reform agenda, because trade unions were ambivalent, with few business organisations having vested interests (Green and Wilson, 2000: 428; Reich, 2002: 742). Indeed, frustrated from enacting his full investment programme, Clinton’s second term became noted for what Reich called ‘tiny symbolic gestures’ (TSGs), such as backing school uniforms, than for sophisticated Third Way policy programmes (Weir, 2001: 140). In Britain, the New Labour ‘New Deal’ sought to combine job specific training schemes with investment in job search services and welfare reform which provided benefit recipients with a greater incentive to participate in these programmes and/or secure employment. This approach came to be more widely accepted by the EU as a whole, since it favours a shift from a largely passive welfare state, intended to meet people’s needs when these were not met through the market, to an active welfare state, which enhances the competitive position of the country. [It] puts much emphasis on spending on education and active labour market policies, which constitute investment, as opposed to mere compensation. (Bonoli et al., 2000: 137) This approach was based upon the economic analysis proposed most notably by Richard Layard, in that ‘the main thing that determines the number of jobs is the number of “employable” people in the economy’ (Finn, 2000: 387). This is a distinctly non-Keynesian viewpoint, because it regards individual characteristics as more important than aggregate demand in determining the number of people employed and unemployed in a given economy. Thus, in the absence of complementary action to stimulate effective demand, the New Deal will lack credibility in those depressed regions where unemployment remains high even when the national labour market is tight (Peck, 1998; Purdy, 2000: 189). Sweden has long been the nation that has placed the greatest emphasis upon active labour market policy in its efforts to combine full

Evaluation of Third Way Economics in Practice 205

employment with industrial restructuring. Accordingly, it has absorbed a sizeable 6–7 per cent of the government budget, or 2–3 per cent of GNP, with two-thirds of expenditure allocated to active policies and only a third towards passive support for the unemployed (Weiss, 1998: 88). The proportionately greater emphasis devoted by Sweden to active than passive measures is illustrated in Figure 8.11. Moreover, despite the emphasis placed upon the ‘New Deal’ active labour market measures by New Labour in Britain, the actual expenditure upon such schemes is only a fraction of the spending allocated to similar schemes by other nations surveyed and this lack of generosity is only partially accounted for by the fact that unemployment is lower in Britain than most of the other featured nations. One fact which has changed over the years, however, relates to the increasing importance of training and job search measures in the Swedish system and less significance being given to measures such as public works schemes which sought to stimulate aggregate demand in a targeted manner. Nevertheless, it remains the case that the founders of the Rehn–Meidner ‘Swedish Model’ were committed to the proposal that active labour market policy will work effectively only if it is introduced alongside accommodative macroeconomic demand management policies (Meidner, 1983: 15, 1987).

LMP as % GDP, 2002 4.0

Passive LMP Programmes Active LMP Programmes

3.5 3.0

% GDP

2.5 2.0 1.5 1.0 0.5 0 Denmark Germany

Spain

Italy

Netherlands Portugal

Sweden

UK

EU-15

Figure 8.11 Public expenditure on labour market policy (LMP) measures in selected nations as a percentage of GDP, 2002 Source: Eurostat (2004: 91).

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Industrial relations, wage bargaining and concertation Third Way economics is perhaps unusual amongst progressive economic approaches in that it has little to say about industrial relations and wage bargaining. In so far as this subject matter is treated as part of the labour market flexibilisation agenda, the Third Way prefers the decentralisation of wage bargaining, preferably to firm, plant or even individual level, in order to maximise the flexible response for employers to changes in global demand. Accordingly, just like the neo-liberal economics from which much of it is derived, Third Way economics perceives little effective role for trade unions. Moreover, whilst it might not adopt measures designed to undermine trade union membership and activity, as occurred under Reagan and Thatcher, there is equally little positive policy designed to support trade unionism (Ludlam, 2001: 116). It is therefore not surprising that trade union membership continued to decline in Britain, where the vast majority of ‘Thatcher’ anti-union laws were retained by the Blair administration, and where the few additional progressive measures were inherited from former leaders, Kinnock and John Smith, rather than representing a detailed strain of Third Way thinking (Hughes and Wintour, 1990: 143–152; McSmith, 1996: 313–323; Ludlam, 2001: 116, 124). Despite the TUC’s adoption of its ‘new realism’ strategy, emphasising participation rather than conflict with employers (McIlroy, 1995: 313–348; Monks, 1996, 1998), New Labour were more concerned in emphasising their distance from the industrial wing of the labour movement, stating that there would be no going back ‘to the days of Industrial warfare, strikes without ballots, mass and flying pickets, secondary action and the rest’ (Blair cited in Coates, 2000a: 6). Furthermore, trade union membership similarly declined during the Hawke–Keating administrations in Australia and under the Clinton presidency in the USA (Glover and Patmore, 1999: 4; Phillimore, 2000: 558; Pollin, 2000: 22, 2003: 26; Harbridge and Walsh, 2002). Wage bargaining The last two decades have resulted in a partial convergence between those national economies where wage bargaining has been decentralised towards sector, firm and/or plant level negotiations, whilst an increasing number of employees have found themselves outside a trade union negotiated wage sphere. Simultaneously, however, there has been a counter-tendency for other nations to experiment with more centralised, quasi-corporatist negotiations designed to moderate wages and secure wider social acceptance of reform measures that have been necessitated by increasingly competitive international environment – whether due

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to globalisation per se or the demands made upon national economies by membership of EMU. The experience of the countries most closely associated with the application of Third Way economics is similarly disparate. For example, wage formation in the US and UK is largely decentralised, with few examples of national wage bargaining excepting public sector employees, and even here New Labour have sought to weaken what it perceives as a lack of flexibility through the introduction of market incentives and regional cost-of-living variations. In Spain, successive governments have sought to decentralise collective bargaining so that it better reflects local labour markets and circumstances at the level of the firm in order to increase the flexibility of labour laws, lower the cost of dismissal and thereby both increase the international competitiveness of Spanish companies and induce additional FDI into the economy (Royo, 2000: 189; EU Commission, 2005: 133). Pérez (1997: 12) argues that the Spanish government were ‘willing to incur a heavy loss of competitiveness in order to break the will of the unions in wage negotiations’. Moreover, participation in EMU is perceived to strengthen this shift towards the decentralisation of wage bargaining across the EU since unions will be less inclusive and have fewer incentives to internalise the inflationary pressures of wage increases (Royo, 2000: 242–243). In Italy, by contrast, institutions retain a predisposition towards centralised wage bargaining and the occasional use of national social pacts (EU Commission, 2005: 154–155). Similarly, in Portugal, concertation agreements have steered economic policy during 1987, 1988, 1990, 1992, 1996 and an Agreement of Strategic Concertation for the 1997–99 period (Royo, 2000: 159–160). These initiatives have sought to promote productivity and competitiveness among Portuguese companies, together with moderating wage rises consistent with the integration of Portugal into the European Monetary Union. Furthermore, concertation has included discussion of macroeconomic, welfare and other supply-side policy reform. Inflation has been reduced from 13.4 per cent in 1990 to less than 3 per cent in 1999, at the same time as unemployment rates were maintained at around the EU average rate of 7 per cent. The Netherland ‘polder model’ involves the creation of consensual tripartite institutionalised co-operation through the medium of a two-level wage bargaining system, placing sectoral or decentralised negotiations within the confines of a broader national framework accord. It has proven to be comparatively successful in combining macroeconomic objectives with micro-level adjustment to facilitate service-sector employment expansion (Ferrera et al., 2001: 129). This example of ‘organised decentralisation’ allows local agreements over productivity,

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training and job opportunities for less productive workers, to coexist within the framework of a long-term commitment to macroeconomic stability. Moreover, the desire to reduce unemployment led to wage moderation (and a regressive redistribution of income towards capital) being traded for higher levels of investment out of solidarity and the unemployed (Hemerijck, 1992: 187–190; Kleinknecht, 1998: 387–388; Bout, 1999: 39; Hemerijck and Visser, 2001: 194; Spithoven, 2002: 337). Indeed, after 1982, ‘Wassenaar’ wage restraint developed into the primary policy instrument for the creation of new job opportunities, together with the improvement of productivity (Spithoven, 2002: 338). The Dutch ‘polder model’ therefore represents one variant of successful neo-corporatism (Vandenbroucke, 2001: 166). Indeed, in 1999 it was described as one of the positive experiences of the Third Way by President Clinton in the United States, by Premier D’Alema in Italy, by Chancellor Schröder in Germany, by Prime Minister Blair in Britain and of course by Prime Minister Kok in the Netherlands (Spithoven, 2002: 334). The Dutch approach, however, has its weaknesses. First, its dedication to the creation of consensus arises in part from the fact that no political party has succeeded in winning more than one quarter of the votes in elections during the past twenty years, and therefore policymaking is hampered by the necessity to establish and maintain political coalitions (Hombach, 2000: 91; Merkel, 2001: 62). This may be of little consequence during favourable economic periods, but might prove problematic when decisive reform is needed. Secondly, the policy of wage restrain has been criticised on the basis that it may delay the replacement of aged machinery, resulting in the longer utilisation of a less productive and technologically less capital stock, thereby inhibiting the Schumpeterian process of ‘creative destruction’ and degrading long-term growth prospects (Kleinknecht, 1998: 393). The stylistic fact that productivity rates have declined in the Netherlands during the period of job sharing and wage moderation may, therefore, be pertinent when considering the success of the ‘polder model’ (Wolff, 1996; Spithoven, 2002: 341). Centralised wage bargaining collapsed in Sweden, during the 1980s, due to the determined opposition of the Swedish employers’ federation and differences of interest within and between individual trade unions within the peak organisations representing blue-collar, white-collar and graduate workers respectively. Peak level bargaining was replaced by sectoral bargaining and occasional national tripartite initiatives, but despite the efforts of the unions to co-ordinate wage formation, wage

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settlements tended to be more sporadic than previously, although wage drift had signified a problem with the lack of local level flexibility under the previous centralised system. Wage formation therefore remains under consideration by all social partners and a long-term pattern has not necessarily been developed (Whyman, 2003). The experimentation with corporatism in Australia through the negotiation of a social contract between government and trade unions was based upon the Statement of Accord by the Australian Labor Party and the Australian Council of Trade Unions Regarding Economic Policy and was in essence a proposal to moderate wages and deal with the contemporary problem of stagflation, when both unemployment and inflation were hovering close to 10 per cent (ALP/ACTU, 1983; Archer, 1992: 378, 392; Kriesler and Halevi, 1995: 225; Mitchell, 1998: 2; Phillimore, 2000: 564). It was framed according to post-Keynesian principles, so that preventing wage-push inflation would facilitate the expansion of demand. In this way, the ‘Accord’ was intended to be a ‘fundamental prerequisite for “the parties” prime objective of full employment’, whilst the promotion of productivity growth would improve the international competitiveness of Australian industry and generate resources for raising the standard of living (ALP/ACTU, 1983: 1, 4; Argy, 1992: 203). This approach appeared to be initially successful, with unemployment falling below 6 per cent by 1989 and average GDP growth between 1984 and 1990 of 3.4 per cent easily exceeding the OECD average of 1.1 per cent during the same period (Scott, 2000: 220). Furthermore, wage moderation released considerable sums of money that could have been invested in productive capacity, since the wage share of national income declined from 63.3 per cent in 1983 to 56.4 per cent in 1989, although the absence of a mechanism to ensure that worker restraint was not squandered on asset inflation, takeovers and large executive remuneration packages was to undermine the entire policy approach (King, 1990: 168; Green et al., 1992; Kriesler and Halevi, 1995: 230; Mitchell, 1998: 9, 11, 18). Thus, the ‘Accord’ ‘created the climate for co-operative change’. However, progress was patchy at best, with industrial capital losing out to financial capital and ultimately union membership declining to the point where corporatism was no longer sustainable (Phillimore, 2000: 566, 579). Moreover, the rightward-drift of the Labour Party in office, and in particular its deregulatory drive, indicated a preference for a more decentralised wage bargaining system. In the event, the Australian version of ‘progressive competitiveness’ provided only a ‘kinder road to hell’ (Wiseman cited in Pierson, 2002: 188).

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Attempts to establish concertation in Spain were unstable and incomplete, despite the negotiation of a series of agreements running from 1979 to 1986, which sought to moderate wages growth and control inflation. These resulted in a high degree of success with inflation declining from 26.4 per cent in 1977 to 8.8 per cent in 1986, and productivity rose by an average 3.5 per cent between 1977 and 1984. However, the beneficial effects of concertation in the economy were not equally shared. Rising unemployment during this period, from 7 per cent in 1978 to 21 per cent in 1986, together with the fact that real wages fell by 1.2 per cent between 1979 and 1986 and wages falling as a proportion of national income from 58 per cent in 1976 to 49.9 per cent in 1986 (Royo, 2000: 108). In Germany, the wage bargaining system has remained largely unchanged, with negotiations establishing sectoral norms, adjusted according to local agreements. However, upon taking office, the Schröder government sought to establish a corporatist forum to further an ‘Alliance for Jobs, Training and Competitiveness’ (Blair and Schröder, 2000: 165; Busch and Manow, 2001: 184). The problem for this initiative concerned the very different approaches that the unions and business representatives wanted to pursue to reduce unemployment and boost economic growth. The former urged a reduction of labour supply through early retirement and reduction in working time, whilst the latter pressed for deregulation, reductions in taxation and wage restraint to release resources which could then be used to increase investment and generate additional employment opportunities (Bispinck, 1997; French, 1999: 103). This is a problem of trust for the trade unions, as was noted in the Australian example. Moreover, a further problem for Schröder’s support for ‘staged corporatism’ is that employer organisations are in decline and even if they abandoned their neo-liberal rhetoric and returned to the social market consensus, they would find it difficult to achieve organisational compliance with any agreement they reach with the other social partners (Hombach, 2000: 75–78). Trade unions have similarly lost membership, although not at the same rate as employer organisations, but it is difficult to see how corporatism and indeed organised form of wage bargaining can be sustained in the long term without partners willing and able to bargain with each other and then deliver on their promises.

Conclusion This chapter has sought to provide an evaluation of Third Way economics in so far as it has been implemented by various ‘new’ social

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democratic parties during the last two decades. First, this is a challenging endeavour since most of these parties were only in office for a fraction of this time period, and therefore it is difficult to categorically identify with a particular party and ideology the longer-term macroeconomic and microeconomic consequences of these policy choices. Secondly, it is often difficult to distinguish between Third Way economic and a more general neo-liberal consensus that permeates most of the international community at present (Arestis and Sawyer, 2001b, 2004). Furthermore, even when in office and dedicated to the introduction of Third Way reforms, social democratic parties may be constrained by electoral considerations (i.e. the likelihood of having to form a coalition government), political or industrial opposition, and ability of the existing institutional framework to facilitate the new policy agenda. Thus, it would be far easier to seek to establish a corporatist social pact in a nation such as the Netherlands of Germany, where there is a history of such activities, rather than the US or the UK where there is not. In terms of the macroeconomic elements of the Third Way, some countries have clearly been more active in adapting economic policy to pursue a Third Way fiscal and monetary policy than others. The Clinton administration is usually singled out as providing the best advertisement for the advantages of the Third Way approach, due to the favourable economic growth, productivity and unemployment– inflation trade-off figures arising from this period. However, closer inspection of the figures indicates that the Clinton period was not particularly exceptional when comparing it with previous presidential periods in office. Nor was it likely to be sustainable due to the perilous nature of the consumer debt overhand and stock market asset price bubble that had been driving the consumer-led economic growth during the Clinton period of office. The New Labour record in Britain suffers from similar weaknesses, certainly in so far as the housing market asset price bubble has yet to burst, and therefore the Blair– Brown record is probably over-inflated as a consequence. Nevertheless, the fortunate coincidence of the rise in public spending during Labour’s second term of office with an economic downturn meant that Brown’s macroeconomic policy became far more Keynesian in terms of providing a counter-cyclical fiscal boost to the economy, than ever intended. Other macroeconomic records are perhaps more contentious. The rapid Australian economic growth rates during the 1980s were associated with deregulation but also with the final residue of Keynesian

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demand management and a corporatist approach to wage setting and macroeconomic policy. German and Dutch macroeconomic policy do not appear particularly close to the Third Way model, apart from the superficial similarities necessitated by the adoption of a single currency, and therefore all participating nations will experience a common interest and exchange rate. Furthermore, the operation of the stability and growth pact is effectively restraining fiscal policy in most EMU nations. Finally, the performance of Sweden has been commendable, but here macroeconomic policy has remained more of an amalgam of ideas taken from both Third Way and traditional social democraticKeynesian thought. As such, it is difficult to identify the more stable, export-orientated growth model, together with a successful trade-off between inflation and unemployment, as being ostensibly Third Way in origin. Turning to supply-side measures, Spain, the UK and US certainly appear to have sought to introduce ever-more flexible labour markets in the anticipation that this will reduce unemployment and stimulate productivity growth. This appears to have had some success, although at the cost of a rising trend in income and wealth inequality. Other nations who have remained more cautious on this element of the reform agenda, such as Germany, Netherlands and Sweden, have all significantly more equal societies, larger and more generous welfare states and government spends a higher proportion of the national income. However, it is difficult to distinguish which group has adopted the superior strategy. The Netherlands has produced a low rate of unemployment and good rate of growth for the best part of two decades, but has a problem with labour productivity and therefore the long-term viability of the job-share strategy is questionable. Germany has struggled to introduce its labour reform package and has performed relatively poorly during the past decade, but this is at least partially due to exceptional circumstances that arose out of a mistaken mode of reunification implemented by the previous Kohl (bourgeois) government, and therefore it is difficult to draw a final conclusion on the relative success of the German economy until the reform agenda has been given chance to succeed. Similarly, it is perhaps too early to draw definitive conclusions relating to how the flexible labour markets created by the US and UK truly compare to the consensual, negotiated economies developed by Germany, the Netherlands and Sweden. A number of points can, however, be made. First, it appears to be the case that whenever ostensibly ‘Keynesian’ measures have been introduced, they have largely succeeded. Examples include the early

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years of the Australian ‘Accord’, residual elements of post-Keynesian policy in Sweden and even increases in demand resulting from debtfinanced consumer expenditure in the US and UK, together with the stimulative fiscal policy pursued in the second New Labour administration. Therefore, whether or not parties are really dealing with ‘social democracy on the back foot’, the ‘death of Keynesianism’ has certainly been exaggerated (Pierson, 2002: 189). Moreover, the fact that Sweden, the Netherlands and, to a lesser extent, Germany have all managed to produce a decent set of macroeconomic results suggests that the maintenance of a well developed, largely unreformed welfare state does not seem to be a barrier to economic success as the hyper-globalists claim (Weiss, 1998: 84). Thus, alternative economic policies do exist and ideology does appear to matter (Pollin, 2000: 187). This is explored in a little more detail in Chapter 9.

Notes 1. The Guardian, 7 September 2004, p. 14; The Observer, 7 November 2004, p. 7. 2. The Guardian, 9 February 2005, p. 22. 3. The Observer, 7 November 2004, p. 7.

9 ‘Real’ Social Democratic Alternatives

Introduction Thus far, this book has presented the policies, theoretical foundations and applications of Third Way economics, before evaluating the relative success of the approach in the previous chapter. The conclusion of this endeavour is that the Third Way represents an innovative response to globalisation and the rise of neo-liberalism that has been drawn upon, albeit to differing degrees, by a significant proportion of the progressive-social democratic movements in democratic industrialised nations. This economic programme has had a number of successes, primarily the ability to sustain simultaneously falling inflation and unemployment, temporarily stretching the period of economic expansion without recession, and the prominence given to supply-side reforms that invest in and empower people in competitive markets. However, Third Way economics is not without its critics. From the neo-liberal Right, the argument is made that the Third Way is a weak version of neo-liberalism and therefore it would be more optimum to have the ‘real thing’. From the Left, the criticism revolves around the fact that alternative policies and approaches to economic management exist, and the Third Way is almost as doctrinaire as neo-liberalism in its outright rejection of multiple alternate paths for economic development. This chapter will seek to examine this latter critique in a little greater detail than has been the case elsewhere in this volume, and outline a number of these alternative progressive economic strategies. 214

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A progressive alternative Social democracy is a political movement rather than a fixed ideology. In that sense, at least, the Third Way corresponds to previous periods of revisionism, where progressive thinkers sought to construct sustainable democratic majorities that facilitate the construction of economic and social institutions, and implementation of economic policy programmes that encouraged economic development and full employment alongside reductions in injustice and inequality (Gamble and Wright, 1999: 2; Marquand, 1999: 10). At its heart, social democracy is transformative in nature, and rarely flourishes when it becomes technocratic and conforms to market forces rather than master the economy (Hirst, 1999: 88; Hall, 2002: 53). Furthermore, traditional forms of social democracy have always shared certain key principles, including a commitment to: • Promoting sustainable economic development, embracing economic growth and full employment. • Democratic economic governance, through government intervention in the macroeconomy, the promotion of democratic accountability of companies and encouragement of economic democratisation of working life. • Facilitating social solidarity, through advancement of equal opportunities and the redistribution of income, wealth and power. • Providing social protection for citizens through the welfare state (Hay, 1999: 57; Hirst, 1999: 87–89). The Third Way claims to share common philosophical roots with this traditional form of social democracy, but changed circumstances have meant that the old ideas and policies no longer work as effectively, and therefore ‘new times’ require innovative solutions to old programmes. Hence, the Third Way contends that, rather than build welfare states to defend citizens from the brutality of market forces, the state should invest in human capital, skills and training to equip individuals to thrive in that marketplace. However, this vision of an empowered working class, embracing globalisation and deregulation, can only ever be a partial view of the world. There will always be those individuals who are excluded (or marginalised) in the employment context, such as the disabled, pensioners, students and other groups who experience discrimination within the employment relationship (i.e. on the grounds of ethnicity, gender, sexual orientation, religion, etc.).

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This view of market forces is, moreover, extraordinarily benign for a progressive-radical viewpoint, which might be expected to support the use of the power of the state, perhaps reinforced by industrial muscle, to impose democratic accountability upon the actions of industrial and particularly financial capital. Whilst the Third Way emphasises the existence of positive-sum relationships between labour, the wider society and capital, the traditional social democratic critique recognises the existence of an irreducible basic conflict of interest that lies at the heart of society, where profits represent wages paid less than the value of the goods workers produce. Thus, the Third Way can be described as an outlier form of social democracy – one that does not so much seek to provide a ‘middle path’ between ‘wild west’ capitalism and command communism, but rather between the former and traditional forms of social democracy. Therefore, the Third Way is not so much a middle-of-the-road strategy, but a deliberate shift of left-of-centre economics to the Right. Rejecting the hyper-globalisation thesis The essence of the appeal presented by the Third Way lies in its insistence that globalisation has undermined traditional forms of national economic management and therefore progressive-social democratic thought has had to move beyond the Keynesian-corporatist model and embrace elements of neo-liberalism in order to forge a new Left consensus compatible with contemporary reality. To the extent that this mantra is repeated and accepted by social democrats, then the alternatives to Third Way economics are naturally narrowed. However, the evidence does not support this point of view. Chapter 2 explored the weaknesses of the hyper-globalisation thesis, upon which much of the Third Way case is based, and concluded that, although active government may be more constrained in terms of the range of policy options open to it in today’s world, the fact remains that real options do still exist. Cotty (2000: 283) suggests that it is ‘perhaps counter-intuitive’ that the Third Way should become so influential amongst the leaders of progressive political parties at the very time that two decades of neoliberal hegemony has produced such unsatisfactory consequences. What Palley (1998: 23) terms the ‘silent depression’ of the past two decades has ‘produced too many job losses, too much economic insecurity, and too many years of stagnant wages and declining prospects’. The high real interest rates associated with monetarism have exacerbated income inequality as larger shares of national income are transferred from workers to capital owners, whilst productive investment (and hence

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economic growth rates) has slowed noticeably during the neo-liberal era (Cotty, 2000: 284). This is despite the claim that inequality was necessary for growth and development (Lewis, 1954; Kuznets, 1955). The facts speak for themselves. The years from 1950 to 1973 were years of unparalleled growth for the whole Western world, with unprecedented high rates of growth and productivity (Armstrong et al., 1991: 117). Annual real world GDP growth averaged 4.9 per cent between 1950 and 1973, before slowing to 3 per cent between 1973 and 1992; for western Europe, this decline was more dramatic, falling from an average growth rate of 4.7 per cent to 2.2 per cent (Maddison, 1995: 60). It was only in the Asian nations persisting with state-led economic development that growth rates rose from 5 per cent to 6 per cent over the same period. Moreover, the world’s per capita income expanded by only 2 per cent during the neo-liberal period of 1980–2000 (Chang, 2002). This is rather embarrassing for an economic school of thought that claims to promote economic growth through the facilitation of market forces (Chang, 2003: 3). Moreover, OECD unemployment averaged 3.25 per cent and annual economic growth a spectacular 4.9 per cent per annum between 1960 and 1973 (OECD, 1988: 39). Palley (2004) argues that the experience of globalisation in practice is far removed from producing a self-regulating world economy, characterised by high and more equally shared growth rates, as predicted by neo-classical economic theory. Instead, globalisation has been associated with increased instability, with the world economy suffering 69 banking crises and 87 currency crises between 1975 and 1996 (Rodrik and Velasco, 1999). Moreover, rising inequality has been documented both within developed nations (Bernstein and Mishel, 1995; Mishel et al., 1999) and on a global basis (Milanovic, cited in Palley, 2004). The UNCTAD (1997: 65–66) evaluation of global economic performance in the neo-liberal era found that inequality had increased between skilled and unskilled workers, in addition to there having been a general redistribution of income shares from labour to capital, with profit shares rising in developed and developing countries alike, and moreover, a shift from productive to financial capital. Furthermore, UNCTAD concluded that the world economy is growing too slowly to generate sufficient employment with adequate pay or to alleviate poverty, hence accentuating existing divergence between developed and developing companies. Another example of the failure of neo-liberalism, and the arrogance of its advocates in the immediate aftermath of the collapse of communism in the Soviet Union, relates to the encouragement given to Russia and other post-communist states to plunge their economies into a

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supposedly rapid transition to capitalism resulting in an inflationary surge wiping out savings, as prices were deregulated overnight and privatisation resulting in asset stripping not wealth creation (Stiglitz, 2002: 141–144,157–158). These economies had enough challenges facing their economies, in terms of establishing the rule of law, creating a market price system and the institutional infrastructure that provides the foundations upon which a market economy operates (Stiglitz, 2002: 140). Yet, advocates of a ‘shock therapy’ method of transition to capitalism underestimated these practical problems and relied too heavily upon the superiority of market forces to solve all problems, with the inevitable consequence of stagflation, mass unemployment and rising inequality. The economic chaos resulting from this mistaken method of transition resulted in Russian industrial production falling by almost 60 per cent and GDP by 54 per cent; a rate more than double the drop in industrial production during the Second World War. Moreover, only a few of the former communist nations have a national income equal to that of a decade ago (i.e. Poland, Hungary, Slovenia and Slovakia), whereas both Ukraine and Moldova have a GDP today of only a third of its value in 1989 (Stiglitz, 2002: 142, 151–152). Russia has experienced one of the largest increases in poverty in a similar short time period, outside of war and famine. This stands in stark contrast to the example of China where, from an admittedly much lower base, growth rates averaging 5.6 per cent during the 1990s, and in the process drove one of the largest reduction in poverty in world history in a relatively short time period (Stiglitz, 2002: 153, 181). The failure of neo-liberalism has encouraged a reconsideration of its main tenants, including the assumption that large government is associated with an inferior macroeconomic performance. Indeed, the evidence points the other way, with fiscal policy remaining effective, capital spending by government remains ‘the most effective way to reduce unemployment’ (Dow, 1992: 258–281; Battin, 1993: 237). Similarly, examination of the economic performance of the UK, Italy and Sweden illustrate that devaluation still retains its potential for engineering an export-led boost to growth rates, whilst monetary policy retains its effectiveness in terms of achieving internal balance. Thus, viable alternatives to neo-liberalism continue to exist. Moreover, although a number of theorists do not necessarily accept that social democracy could simply return wholesale to the Keynesian-corporatist policy framework utilised in the past, nevertheless the reaction of Third Way economics has been to unnecessarily restrict the range of possible policy options (Hall, 1995; Hay, 1999: 11). Indeed, this all appears to

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stem from a failure of confidence in the ability to create a distinctive progressive-social democratic form of economic strategy that would work in twenty-first century conditions (Palan and Abbott, 1999: xiii; Whyman, 2003: 129). Different models of national capitalisms Far from there being a dearth of evidence relating to the continued existence of different institutional and policy patterns inherent within different groups of nations, the literature is full of such examples. Indeed, the hyper-globalisation assumption of a general convergence towards a more common, neo-liberal, market-orientated pattern is not verified by this material (Hall and Soskice, 2001; Perraton and Clift, 2004). Typically, this literature suggests that there are between two and four distinct variants of national capitalism, with a distinction between AngloSaxon ‘liberal market economies’ and ‘co-ordinated market economies’ lying at its heart. The prime difference being that the former utilise formal contracting within competitive markets to facilitate the co-ordination of corporate activities, whereas the latter place greater emphasis upon non-market forms of co-ordination that necessitate strategic interaction with other economic actors (Hall and Soskice, 2001: 8; Hall, 2002: 40). Moreover, the literature draws additional distinctions between different forms of co-ordinated economy, namely the Japanese (or East Asian), German (or Rheinland) and Scandinavian models (Driver and Martell, 1998: 47). The emphasis upon the significance of institutions in facilitating corporate competitiveness, industrial relations and the co-ordination of macroeconomic policy draws inspiration from North (1990) and Hodgson (1988). Hall (2002: 40) explains the differences in the following way: The kind of coordination in which the firms of a nation will engage depends on the presence of institutional support for that type of coordination in the national political economy. Co-ordinated market economies typically contain dense inter-corporate networks based on cross-shareholding, powerful business associations and trade unions capable of providing the network monitoring that strategic coordination demands. Liberal market economies provide the legal systems and regulatory regimes that render markets more competitive and generate the effective price signals important to coordination there. Thus, the organization of the political economy gives rise to systematic variations in corporate strategy across nations and comparative national advantages for undertaking certain kinds of economic endeavours.

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Thus, whilst liberal market economies rely upon capital market financing for industrial expansion, with recurrent claims of short termism as a result, co-ordinated economies are primarily bank based (Zysman, 1983; Albert, 1993; Pollin, 1995, 1997; Porter, 1996; Woolcock, 1996; Cerny, 1997). In Hirschman’s (1970) terms, the latter arrangements would be characterised by voice whereas the former by exit. Thus, Pollin (1995: 35) estimates that bank-based systems secure superior performance in promoting longer time horizons, encouraging financial stability and facilitating superior macroeconomic co-ordination of government economic policy. The significance of the literature is that it points to the national institutional and policy differences as being potentially rational, perhaps arising due to differences in culture and/or history of industrialisation, the development of democracy and/or the political realities within nation states. Moreover, once a particular model has been created over time, it may be rather resistant to radical change, whilst the attempt to introduce a new framework upon an economy may be difficult to achieve because of the lack of a supportive rationale. This body of literature points to alternatives to the neo-liberal version of globalisation and demonstrates that many of these work effectively, creating what Garrett (2000: 457) described as ‘institutional comparative advantage’ for a nation and its industries. However, it simultaneously demonstrates the difficulties in simply imposing one successful model upon a distinctly different type of economy and expecting similar results. Thus, the experience of the past two decades is that import substitution and state-led development policies pursued by East Asian economies demonstrates that high rates of economic growth can be combined with low levels of inequality. This conclusion lies in contradiction of the tenants of neo-liberalism. Furthermore, individual case study evidence does not necessarily imply that these same measures can be successful in all economies due to their reliance upon institutional factors for part of their success (Stiglitz, 2002: 79; Chang, 2003: 3).

Rediscovering a Keynesian macroeconomic policy The revitalisation and evolution of Keynesian macroeconomic strategy is quite simply a prerequisite for a successful progressive-social democratic approach to economics. The management of aggregate demand is necessary though not sufficient for the achievement and maintenance of full employment, simultaneously with a reasonable rate of economic

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growth. Moreover, this provides the foundation for the development of a social partnership (or corporatist agreement) between trade unions, governments and plausibly organised businesses. It therefore facilitates the development of a system of wage formation that promotes a reasonable degree of redistribution and social solidarity, whilst accommodating international competitiveness and dampening inflationary impulses. Thus, Hutton (2003: 119) is correct when he argues that: In the long run there is no future in creating a progressive coalition that is not progressive. And there is no liberal social democratic position possible that does not incorporate the political economy of Keynes. Evidence adduced throughout this book has demonstrated the continued vitality of an active fiscal and monetary policy, exchange rate management, public investment programmes and wage bargaining co-ordination. Moreover, there is a large and growing literature that claims that productive capacity has a large, statistically significant impact upon employment (Bean, 1989, 1994; Rowthorn, 1995, 1999; Arestis and Mariscal, 1997: 191; Miaouli, 2001: 23; Alexiou and Pitelis, 2003: 628; Baddeley, 2003: 214). Thus, a considerable body of evidence indicates that aggregate demand impacts directly upon the real economy because it influences, and in turn is influenced by, the rate of investment, which in turn changes the stock of capital and thereby affects productive capacity. A larger capital stock will permit a higher level of aggregate demand – and hence higher output and employment – without resulting in an increase in inflation. Keynesianism can therefore prevent the disruption to economic development caused by economic recessions, and reinforced by hysteresis, and in the process can therefore have a significant impact upon investment rates, industrial capacity, output and productivity. Indeed, the best evidence indicates that public investment in infrastructure projects is up to four times as potent in its impact upon the macroeconomy as private investment (Aschauer, 1990). Moreover, the stability produced through a combination of Keynesian macroeconomics, corporatist accommodation and the development of the welfare state can have a positive impact upon economic growth through reducing the oscillation of the business cycle and thereby reducing the degree of uncertainty so damaging investment prospects. The fact that Keynesianism remains indispensable to progressive economists does not, however, imply that nothing can be learnt in

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terms of the design and implementation of economic policy during the past three ‘neo-liberal’ decades. Nor does it suggest that postKeynesian evolution is incapable of improving upon more traditional approaches to Keynesian macroeconomics. Thus, one variant that a progressive-social democratic government might wish to try concerns the ‘Austro-Keynesianism’ strategy, which seeks to maintain low rates of unemployment by the stimulation of growth without generating inflationary consequences. The combination of policies adopted include an expansionary fiscal policy, targeted through investment promotion and public investment packages, together with a high exchange rate to counter-inflation, an income policy backed by social partnership to secure wage moderation consistent with international competitiveness and the public ownership of a significant proportion of capital-intensive industry which assists in stabilising national output and facilitates the rest of the macroeconomic strategy (Guger and Walterskirchen, 1988: 128). A second variant that might be considered relates to the Swedish or ‘Scandinavian Model’, which combines similar policy instruments but produces a strategy with a more redistributive focus. In this scenario, aggregate demand is maintained just short of the full employment level, primarily through fiscal policy but supported by a low interest rate approach, and an active labour market policy is utilised to target additional concentration upon residual unemployment to secure full employment without inflation. A peak level co-ordinated solidarity wages policy forms part of the traditional version of the Swedish Model, and this promotes a narrowing of wage differentials at the same time as advancing structural change through a strict operation of equal pay for equal work irrespective of the employers ability to pay. Hence, successful, productive firms have additional resources to expand, whilst less productive firms cannot rely upon a low wage competitive subsidy and leave the market, thereby ensuring an efficient reallocation of resources in favour of the most productive uses. Finally, the lower-thanfull employment level of aggregate demand might hamper a sufficient growth of profits to finance sufficient capital formation to maintain this model into the long run, and therefore public or social investment funds are made available to finance private investment. Exchange rate management One policy stance that progressive-social democratic economists have had amongst the most difficulty with in the past is in the determination of what type of exchange rate regime the government will choose

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to pursue in the interests of its objectives of full employment, the promotion of economic growth, low inflation and a sustainable balance of payments. This choice has long dogged social democrats, from the failure of the first British Labour governments over the inability to reject the Gold Standard, to the more recent support of the same party for ERM entry which proved to be a disaster for the country and almost undermined the entire EMS arrangements. Yet, fixed exchange rates do provide advantages, and the Bretton Woods system proved to be a model of positive exchange rate relationships until undermined by the chaotic conditions of the early 1970s. Indeed, fixed exchange rates offer less uncertainty in terms of future exchange rates, due to their being fixed in value, and this it is argued promotes investment and trade. It may also prevent the speculative over-shooting that occurs in any market where speculation is evident, but which is particularly significant for firms’ competitiveness when currency markets determine the value of a currency, and therefore the goods denominated in that currency. Floating exchange rates have the advantage that they enable countries to pursue domestic balance and unhindered international trade (Krugman, 1999: 108). One aspect of this increased freedom of action relates to the fact that governments do not have to immediately deflate their economies in the face of relatively minor trade deficits. Another relates to the fact that fixed rate systems find it difficult to cope with the fact that countries differ markedly in terms of both productivity growth and tendency towards inflation, and therefore over time some nations gain international competitiveness whilst others become less competitive – a reality which will be reflected in growing trade problems if exchange rates are not allowed to readjust to take account of these changed economic fundamentals (Palley, 1998: 184–185). Alternatives would involve nations pursuing a common inflation rate, to avoid loss of competitiveness, but this would require the loss of national control over monetary policy in favour of the maintenance of an exchange rate peg. Another possibility would be to combine shortterm fixed exchange rates with long-term flexibility, through regular revisions of the exchange rate pegs. However, this would require agreement between nations with opposing competitive interests, and might be difficult to achieve without the impetus created by economic crisis. Palley (1998: 185–186) argues that the optimum combination for a progressive nation to follow is flexible exchange rates and capital controls, since this facilitates an independent monetary policies where

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interest rates are set according to national and not external requirements. Capital controls would additionally lessen the influence of short-term speculative capital flows over the exchange rate, and therefore provide a degree of insulation for the conduct of macroeconomic policy (Griffith-Jones, 1998: 18). The advent of EMU within the EU means that, for European social democratic movements, the determination must encompass not simply the advantages of fixed versus floating exchange rate regimes, but whether or not to participate within the single currency. Advantages include the fact that exchange rates are permanently pegged, and in a way that does not encourage speculation to seek to break the system apart in search of profit. The additional certainty over comparative (internal) exchange rates should also facilitate trade and investment. However, the fact remains that, unless or until radical structural reform is completed across the entire design of EMU, the SGP and ECB, these institutional factors are monetarist in nature, constrain Keynesian policy and act to deflate the EMU economy when it should be stimulated to lower unemployment and raise economic growth rates. As Dyson (1999: 196) notes, progressive-social democratic economic strategy amongst participating nation states is limited by a ‘system of institutional governance for EMU that is rooted in neo-liberal values of sound money’. The relevance of this consideration is revealed by the persistently high levels of unemployment in continental Europe that are often ascribed to problems with structural unemployment and/or labour market rigidities. Yet Krugman (1999: 160) points out that not all economic problems are structural in nature, and that ‘sometimes all a stalled car needs is a jump start’ which can be supplied by a boost to aggregate demand in traditional Keynesian style. Indeed, there seems sufficient evidence to suppose that a crucial feature is that the European area has suffered from low levels of aggregate demand over the past three decades (Eatwell, 2000: 349; Stockhammer, 2004d). Part of this problem lies in the monetarist framework designed as the basis for a ‘hard’ version of the EMS, which drained much of the EU economic area of its vitality during the second half of the 1980s, together with the constraints placed upon fiscal and monetary policy by the adoption of EMU by twelve of the fifteen EU member states. Stiglitz (2003: 298) notes that at the very time that balanced-budget amendments were rejected in the US, the continental European economies ‘enthusiastically agreed to have their hands tied’ by the combination of these measures. Thus, whereas the US economic success

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was built upon the foundation of a buoyant demand side of the economy, the continental European economy remained demand deficient (Driver and Martell, 1998: 112). Reintroducing democratic control over capital flows One variant in the development of the post-Keynesian strategy that has been indicated in this chapter relates to the question of whether this would be better taking place at national or super-national level. The ‘national capitalisms’ literature, referred to earlier, demonstrates that plenty of scope remains to design a national Keynesian strategy. Indeed, the success stories relating to individual economies discussed elsewhere in this book indicate the potential for this approach. Nevertheless, there are many who, whilst not accepting the hyper-globalisation thesis, remain concerned about the potential for mobile capital to disrupt and undermine a truly progressive economic programme as occurred in the UK in 1976 and France in 1983 (Sassoon, 1996; Newman and de Zoysa, 2001: 35). Keynes was concerned at the destabilising potential arising from speculation which, amidst conditions of uncertainty, seeks to profit by anticipating future market trends and not through any calculation of objective economic realities that are supposed to underlay market values. In the manner of a beauty contest, speculators do not try and determine the most objectively beautiful candidate, but rather they try and predict which entrant the judges will select, and then they will speculate on this basis. Thus, speculation is divorced from the real economy and becomes increasingly like the casino economy Keynes railed against, on the basis that this would destabilise the global economy and has the potential to undermine the solid performance of a company, if its share price is pushed too low, or a nation’s economic management if speculation triggers a run on the currency. As Keynes (1936: 159) explained: Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes the by-product of the activities of a casino, the job is likely to be ill-done. The optimum response to this problem would be for progressivesocial democratic forces to press for the establishment of an international system of financial regulation of the type introduced by

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governments in all industrial capitalist economies in the aftermath of the Great Depression and two world wars. There are a number of alternatives that could be considered. For example, one option would be to impose a small transaction ‘Tobin tax’ upon all spot foreign exchange transactions (Eichengreen et al., 1995; Haq et al., 1996). If tax rates were established at a mere 0.5 per cent per transaction, this would equate to an annual rate of 4 per cent on a threemonth round trip, or 12 per cent over a month and 365 per cent for a day round trip, where a currency is first sold and subsequently repurchased, with the speculator anticipating an interim price fall generating a profit on the deal. The shorter the exchange transaction turnabout, the greater the marginal impact of the Tobin tax, and therefore the larger the deterrent effect. Thus, even a small tax of this nature is capable of creating room for interest rates to be set with internal macroeconomic priorities in mind (Eichengreen et al., 1995: 164–165). Smith (1997: 766) argues that a ‘Tobin tax’ is a plausible means of raising substantial official revenues and potentially reduce the volume of currency transactions, but, in his opinion, is feasible only if introduced through international co-ordination, with prior agreement over the distribution of the revenue generated. Moreover, it should be perceived as only one instrument utilised to deter destabilising speculation and unsustainable short-term capital flows. However, Davidson (1997: 685) introduces a note of caution, namely that, in ‘normal’ periods, a Tobin tax may restrict international trade and arbitrage activities, in addition to reducing speculation, whereas during periods of instability the sands of the Tobin tax will be merely swept away in whirlpools of speculation. Boulders are needed to stop the destructive currency speculation from destroying global enterprise patterns. Instead, Davidson prefers an updated version of Keynes’ famous ‘bancor’ system, where ‘hot money’ flows were prohibited and an international monetary system was established with the intention to maintain sufficient international liquidity and global effective aggregate demand (Keynes, 1980; Davidson, 1997: 680–687). Orthodox economists claimed that segmentation of financial services frustrated allocative efficiency and reduced market incentives to improve operational efficiency. However, from a macroeconomic perspective this approach promoted economic stability by limiting fraud, speculation and financial crises. Indeed, Greenspan (2004b) argues that deregulation

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combined with innovation in information technology has advanced ‘financial flexibility’, has created ‘a more flexible, efficient, and hence resilient financial system’, and thereby enabling the global economy to exhibit ‘a remarkable ability to absorb and recover from shocks’. It is notable that financial deregulation has led to successive financial crises throughout the global economy (Howard and King, 2004: 61). Unfortunately, the reaction of the Clinton administration was to veto the international introduction of even modest regulatory proposals, arguing that although financial market liberalisation was imperfect, regulation would be worse. This reaction undermines the difficulty that supporters of international re-regulation face in attempting to achieve consensus amongst a majority of powerful nations, many of whom benefit in terms of their own financial sectors from the lack of regulation or have become dependent upon international borrowing to finance large budget and trade deficits. Were the introduction of a new financial regulatory framework to prove to be practically difficult or impossible to realise, progressivesocial democratic movements retain the ability to unilaterally introduce financial sector regulation, including capital controls, in order to stem short-term speculatory flows of financial capital from undermining a progressive economic policy platform. Capital controls would partially disengage national financial markets from international markets in order to provide enhanced room for national measures to be enacted. Thus, they could facilitate a ‘cheap money’ monetary policy, where interest rates are deliberately set beneath the rates of international competitors, thereby providing a competitive bonus and promoting enhanced investment in productive capital, domestically located. Restrictions imposed upon capital mobility would enable a greater use of fiscal policy as part of a counter-cyclical economic strategy. This would additionally encourage a corporatist consensus combining wage moderation in return for greater domestic investment, income growth and enhanced employment opportunities. Furthermore, through enhancing national economic policy alternatives, capital controls can be viewed as empowering national democratic selfdetermination. In view of these positive aspects to capital controls, it would appear perverse that virtually all OECD countries abolished these controls during the 1980s. Yet, conventional opinion holds that the re-imposition of exchange controls is unlikely, due to the balance of political forces, and it is this which helps to explain why this option remains subject to very little serious analysis. Indeed, exchange

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controls are often dismissed because of a number of economic reasons, including: • Advances in information technology increase the potential to evade controls – This is a strange argument, because this very same technology could be used to increase the efficiency of national supervision of financial organisations. Indeed, Block (1987: 216) claims that ‘the reality is that such electronic transfers leave more traces than traditional currency transactions’. • The domestic financial sector will be placed at a disadvantage in terms of global competition – This may be true for the UK, which has a significant international financial market share, although even here the use of exchange controls as part of a strategy to revitalise industry would be likely to provide a net benefit to the economy as a whole. However, this is less of a factor in smaller nations. • Neo-liberal claims that all forms of controls are economically inefficient because unhindered market forces would produce optimal allocation, utilisation and distribution of scarce resource – This argument ignores the distributional consequences of regulations, which would benefit domestic productive industry, employees and government, although at the cost to financiers. Therefore, governments might prefer a theoretical ‘second best’ solution, but one which is most likely to boost domestic investment, productivity, growth, jobs and rising incomes for most of its citizens. • The introduction of capital controls would be likely to provoke capital flight, thereby causing the very problems the measures were intended to prevent – A rapid imposition of controls would leave less time for capital flight momentum. Furthermore, the fact remains that exchange controls were introduced during the depression years of the 1930s, when international capital integration was arguably as extensive, and government economic policy as market sensitive, as it is today. A third option does exist, however, in that nations may pursue supernational policy co-ordination at a regional level, in order to circumvent political and economic resistance from powerful groups intent upon maintaining the status quo. An obvious example would be for European social democrats to press for EU regulation of the financial sector in order to control capital flows sufficiently to be able to introduce Euro-Keynesian policies at Euro-federal level (Sassoon, 1996; Callinicos, 2001: 124; Newman and de Zoysa, 2001: 35). Leakages out of the

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European economy would be substantially lower than for individual, constituent member states, and therefore Euro-Keynesianism might prove to be more effective if attempting reflation against the grain of the international community. This strategy motivated the 1993 Delors proposals for an internationally coordinated demand stimulus through investment in public works schemes, intended to create 15 million new jobs by the year 2000, and to be financed by the introduction of European ‘Union bonds’ (Coates, 1998). Despite Euro-Keynesianism remaining a significant feature of the French Socialist Party’s economic platform, the problem with this option lies in the current balance of political power elsewhere within the EU. Moreover, the institutional design of EMU and the ECB, and the current emphasis emerging from the EU Commission sound closer to neo-liberal or Third Way thought than demonstrating any kind of enthusiasm for Euro-Keynesianism. All of these elements would have to be overcome by social democrats, and to do this they need as a minimum to win a majority of the European parliament (only achieved for a few scant years in its history) and form governments in most member states. Even then, it is doubtful that sufficient hegemony could be created to popularise these ideas sufficiently to overcome inevitable opposition to these measures. Accordingly, unless or until this struggle for public opinion could be brought to a successful conclusion, and major institutional reform completed within the EU economic space, Euro-Keynesianism will remain an unfulfilled dream.

Supply-side policy There is no contradiction between the operation of a Keynesian macroeconomic policy and supply-side intervention. Indeed, post-Keynesian economists have long argued that the two elements of economic strategy should augment and reinforce each other. Wage formation The development of corporatist, co-ordinated wage formation, within an overall consensual ‘negotiated’ economy, characterised many (but not all) traditional social democratic economic strategies through the 1960s and 1970s. Indeed, the large literature on corporatism indicates that the combination of interventionist government and highly organised labour have the ability to facilitate macroeconomic outcomes superior to those pertaining in more decentralised, market-oriented systems (Alvarez et al., 1991; Garrett, 1998). The advantages of this approach

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include the fact that peak co-ordination of wage formation could better take account of its effect upon inflation and international competitiveness, and be able to promote productivity and structural change. Wage co-ordination can, as in Scandinavia, promote wage equalisation, the narrowing of differentials and equal pay for equal work independent of the employers’ ability to pay. It can, equally, promote wage moderation to the extent that income is redistributed towards capital, whilst wage differentials remain wide, as in Austria during the 1980s. Thus, wage co-ordination facilitates the macroeconomic control over aggregate wage growth, whilst the specific impact upon the distribution of income can be progressive or regressive depending upon the economic environment, ideology and relative power of the social partners. Its largest disadvantage is that the setting of central or sectoral wages inhibits wage flexibility, and therefore critics argue it contributes to the rigidity of the economy, with resulting costs in terms of structural unemployment. However, advocates of wage bargaining co-ordination point to the fact that it advances macro, as opposed to micro, flexibility, and therefore labour market flexibility can be pursued through alternative, less damaging measures than reducing wages for already poorly paid workers. The co-ordination of wage bargaining has not, however, been successfully instituted in all social democratic economies. The UK labour movement, for example, failed to construct a sustainable version of ‘social contract’ in the 1970s. Moreover, the shift in balance of power resources in favour of internationally mobile financial capital implies that representatives of capital are likely to be more resistive of contemporary approaches relying upon a corporatist approach, since capital is currently stronger when relying upon market allocation than negotiated alternatives. Thus, the super-national employer organisation operating at EU level, UNICE, vigorously opposes tripartite negotiations with representatives of government and trade unions, and only concedes agreements when the threat of legislation is both real and more radical in content. Critics, furthermore, suggest that centralised wage setting is less applicable in a post-Fordist world, where remuneration should be based upon individual incentives and bound within a wider human resources strategy. Iversen (1998: 64–65), for example, argues that a redistributive version of wage co-ordination has the potential to frustrate job growth in the low wage, low productivity, labour intensive personal service sector due to their being over-priced. However, this is dealt with by a less redistributive wage policy, which tolerates the existence of wider

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wage differentials, which lies closer to the Austrian model to the Swedish. Alternatively, wage co-ordination could be pursued in a more relaxed manner, with minimum conditions set at national or sectoral level, yet with greater emphasis placed upon firm or workplace negotiations for supplementary variations to comply with local conditions. The Dutch ‘flexi-curity’ model represents one variant of this approach. Developing an active industrial policy A national Keynesian macroeconomic strategy could be reinforced by a microeconomic strategy to promote domestic industrial expansion. This may involve the creation of new industries, as practised by Japan, South Korea and Taiwan, together with the provision of low-cost capital to corporations to finance capital accumulation through a state-owned banking network or other source of public capital (Henderson, 1993: 34). Industrial policy can become more effective than simply engaging in competitive subsidisation of footloose trans-national capital because factors such as large sunk-fixed costs, pools of specialist labour, supportive institutions, specialist suppliers and benefits deriving from inter-firm information flows are all facilitated by physical proximity and therefore all mitigate against the relocation of production (Krugman, 1991; Kleinknecht and ter Wengel, 1998: 645). Harding (1999: 77) argues that, in the global era, networks are more important to firms than markets, and it is through the ‘provision of stable and innovative factor conditions’ that nation states can enhance the competitive advantage of domestic enterprises. Furthermore, the principle of cumulative causation indicates that unfettered market forces produce a persistent divergence in GDP per capita, and therefore government intervention is required to create a more virtuous cycle (Myrdal, 1963). Therefore the state can induce firms to engage in activities where high risk would otherwise deter firms acting individually (Weiss, 1998: 6). State co-ordination can additionally reduce transaction costs in the economy (Chang, 1994). Industrial policy should be focused upon the development, or revitalisation, of domestic industrial production. Reliance upon service industries is not a sufficient basis for a nation’s economic development because many of these are non-tradable – for example, governmental services, legal services, child care, elementary and secondary education. Or they have a large non-tradable component, for example transportation and distribution. Although, it is fair to concede that others, namely financial service, management consultancy and higher education, have considerable potential in this regard. However, the fact remains that services

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tend to have inferior productivity growth to manufacturing industry and as a result there is a structural shift towards a rise in the employment share of non-tradable services due to its relatively higher cost inflation (Chang, 2003: 108). This is a phenomenon that is not necessarily related to a weakness in industrial competitiveness as successful manufacturing exporters, such as Germany and Japan, have experienced a similar trend. Nevertheless, with services accounting for a rising share of national income, a revitalisation of manufacturing industry is required, assuming that a rapid and sustained increase in productivity in the service sector is not possible to achieve, if a nation wants to maintain a healthy rate of economic growth without experiencing balance of payment concerns. One variant of industrial strategy is to pursue import substitution, whereby goods are produced domestically which could be produced more cheaply (in relative terms) in other countries. The strategy rests upon the potential that the theoretical welfare loss, from trade forgone, might be more than compensated for by developing strategically important ‘infant’ industries, which will grow to develop their own competitive advantage over time. The measures may be reinforced by promoting high skill domestic employment, increasing the innovative potential deriving from research and development expenditure and eliminating balance of payments weaknesses which may inhibit potential growth rates (Thirwall, 1979, 1982; World Bank, 1987, 1991). State-led development or ‘state entrepreneurship’ may involve the state direction of resources towards sectors of the economy seen as crucial to the development process, together with state control over interest rates, taxes and government spending focused upon the pursuit of high growth (Cotty, 2000: 280; Chang, 2003: 53). Stiglitz (2001: 341, 2002: 16) states that most of the advanced industrial countries, including the US and Japan, have utilised selective protection for some of their industries until they were strong enough to compete with foreign companies. Critics of import-substitution claim that there is a tendency for protected industries to develop monopolistic tendencies by producing at suboptimal scales, possibly below full capacity, whilst weak competitive pressures are insufficient to compel rapid improvements in productivity. Moreover, the availability of cheap capital may cause a decline in national savings and lead to the adoption of excessively capital-intensive technologies, thereby misallocating scarce resources (Weiss, 1990; Singh cited in Chang, 2003: 28). In addition, the power concentrated in state agencies has encouraged corruption in certain circumstances, for example in Latin America. Nevertheless, the overall

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record of this strategy was positive in East Asia and many developing nations adopting this approach have recorded unprecedented growth records (Rodrik, 1999: 68). A related, but potentially separate form of industrial policy concerns the provision of public finance for capital accumulation. This could be achieved through a combination of ‘cheap money’ monetary policy strategy, whereby the interest rate is maintained at an artificially low rate through the use of capital controls and/or administrative regulation of the financial sector, and thereby private industry has the potential to borrow at low rates of interest. Unfortunately, this does not necessarily lead to an increase in productive investment as scarce resources can be borrowed to finance asset purchase in the stock and housing markets, amongst others. Therefore, state banks and/or employee investment funds have been utilised to provide targeted credit for industrial investment (Whyman, 2002, 2004). Norwegian ‘Credit Socialism’ is perhaps the clearest example of an active credit policy geared to enhance structural change, whilst German state involvement in banking is most evident in the development of long-term investment credit representing three quarters of total loans to manufacturing industry (Landesmann and Vartiainen, 1992: 226; Weiss, 1998: 122). In certain nations, such as Sweden in the 1960s and 1970s, the government sought to run a persistent budget surplus, with this being made available for private capital accumulation through the investment practices of the large state pension funds. This policy may be called forced saving through taxation adjustment (Taylor, 1983). In economies which operate at near to full capacity and where excessive foreign indebtedness is not considered feasible politically, a high public saving rate is almost the only viable way of closing the saving–investment gap (Kalecki, 1970). One potential weakness with the provision of preferential, cheap credit for industrial capital accumulation derives from the observation that German banks are often ‘risk-averse’ in encouraging the development of existing technologies but avoiding new technological innovation. Therefore, reliance upon public credit may stymy dynamic technological advance and be slower to respond to changes in the external environment, such as a shift in the pattern of demand against the product range currently in production. Moreover, democratic participation in credit provision may narrow the range of options for change, so that large-scale reorganisation may be deemed politically difficult due to the range of interests involved in the strategic decision. However, this need not prove fatal for the credit socialism approach.

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For example, the Swedish debate concerning Wage-Earner Funds demonstrated the ability to design a system that balanced local worker and national citizen interests, albeit at the cost of complicating the popularising of the reform (Whyman, 2004). Moreover, a similar reluctance amongst banks to share risk in order to develop a new range of industries has been identified in Japan, and as a result the state, through MITI, has directly sourced long-term funds at low cost to facilitate investment in new technologies in key industries (Weiss, 1998: 140). Alternative sources for risk capital funding could be provided through multiple risk capital funds, each dedicated to finance cutting-edge technological development in domestic manufacturing industry, or through a plethora of regional state banks given a similar mandate. Finally, it should be noted that Keynes proposed a significant socialisation of investment in order to counterbalance prospective fluctuations in private investment by capital expenditures of public and semi-public bodies in order to stabilise aggregate demand and maintain full employment (Keynes, 1936: 375–378; Whyman, 2004). This would additionally facilitate progressive redistribution, reduce the inherent instability in the accumulation of capital arising from uncertainty and speculative ‘animal spirits’, and maintain the level of investment necessary to sustain full employment irrespective of whether this reduced the long-term return on capital (Keynes, 1936: 373, 1980: 322; Smith, 1962: 151; Hyman, 1975: 360; Skidelsky, 1979: 57; Arestis, 1989: 62). Indeed, post-Keynesian theorists have suggested that a further refinement is to incorporate socialisation within a ‘social contract’ forged between the state, industry and trade unions to provide a potentially superior framework that ensures efficient capital formation and full employment (Tichy, 1984; Cowling, 1987; Arestis, 1989: 622, 1992: 267–271; Whyman and Burkitt, 1993). Public ownership There are many arguments that can be deployed in favour of public ownership. These include preventing the abuse of private monopoly power, realising the potential to deliver low cost, low price goods and services due to economies of scale, ensuring the security of supply of industries of vital national importance (i.e. energy and transportation), capturing economic rents, improving working conditions for employees, facilitating a progressive redistribution of power and income, advancing economic democratisation and facilitating government macroeconomic policy through controlling the ‘commanding heights’ of the (meso) economy (Holland, 1987a,b; Mayer, 1989; Holtham, 1999: 64).

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Moreover, public ownership may be justified due to the potential for market failure, whether due to imperfectly competitive markets leading to a misallocation of resources or the private capital market being too risk averse to finance high risk enterprise. Furthermore, the fact that the return on capital required by private shareholders is typically significantly higher than the cost of capital to the government means that, at least for capital intensive industries, it is unlikely that private owners can realise sufficient efficiency gains to overcome this fundamental cost factor. Finally, ownership and corporate governance have been found to influence the investment climate and, therefore, productive capacity and employment. Public ownership has been criticised, however, for inherent inefficiencies and, whilst some of this derives from a neo-liberal ideological preference for market determination, irrespective of the evidence, there are circumstances where public ownership has appeared to have problems securing sufficient management efficiency in order to make the public enterprises work efficiently. Critics claim that private industry would both empower and incentivise managers, through higher pay and closer scrutiny imposed by shareholders and capital markets. Governance may be a problem in public industries with only weak and arm’s length democratic control and accountability, whilst the absence of the discipline factor arising from the real fear of takeover implies that management or external scrutiny may be of even greater consequence for the efficient running of public corporations. Moreover, undue political interference in the running of the business may pose an equal threat to efficiency. Finally, the allocation of capital to public corporations is criticised for potential misallocation of resources, with government either providing too much capital through insufficient conditions imposed upon the borrower, or cash-strapped governments being unable to finance necessary investment due to pressure upon the PSBR. Whilst this criticism has the weakness of seeking to have it both ways, nevertheless, the public sector may not impose as greater scrutiny upon its potential investments as private capital markets. Stakeholding, mutuality and corporate social responsibility The concept of a participatory or ‘stakeholder’ society offers a potentially radical alternative to the market-orientation of Third Way economics. In essence, it seeks to empower all citizens through the enhancement of individual and collective rights in the spheres of politics and the economy, and therefore acts as a counterbalance to the power of global capital (Hutton, 1996). Stakeholding in the more general sense involves

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individuals having a stake in society (Driver and Martell, 1998: 55–56). However, it is in relation to corporate performance in such nations as Germany and certain East Asian economies that the concept is perhaps most developed. Here, rather than the firm acting in the sole interest of their shareowners, the stakeholder approach holds that the firm should have obligations to multiple groups with which it interacts as part of the production and sales process. Thus, a firm’s decisions reflect ‘a subtle web of reciprocal obligations’ (Norris, 1999: 29). Hence, alongside shareowners, other stakeholders in the company involve employees and managers, whose jobs and livelihoods are tied up with the success of the enterprise, customers, who have their separate interests in high quality produce, reliability and safety of use, and suppliers, who would prefer long-term relationships with the firm in question with trade conducted at a fair price. Banks or other financiers have an interest in the long-term success of the corporation in which they have sunk client’s money and therefore should seek to involve themselves in decision-making processes (Hutton, 1996). Marquand (The Independent, 15 January 1996) explains the concept as follows: At the heart of the stakeholder concept lies the simple proposition that property must discharge obligations to the wider community as well as to its owners. In Germany, stakeholding takes the form of capital–labour partnerships which are embodied in co-decision-making at board and works council level, whilst banks provide long-term finance to fund expansion and government seeks to build consensus with unions, regional government and the central bank. However, it is important to note that stakeholding is not directly equated to a revitalisation of corporatism, but rather emphasises a form of co-determination where no partner is dominant and where employees have a stake in the success of the enterprise through enhanced security, training and participation (Newman and de Zoysa, 2001: 146). Critics of stakeholding argue that it confuses property rights and that the multiplicity of voices confuses the direction of corporate strategy that the firm finds it difficult to respond to dynamic changes in market conditions and where lines of accountability become increasingly blurred (Newman and de Zoysa, 2001: 146). Moreover, for it to function effectively, stakeholding may require significant institutional reform of corporate law to facilitate its distinctive approach (Hutton, 1994: xi–xii, 323; Norris, 1999: 29). Furthermore, it is suggested that globalisation

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has empowered shareholder capitalism and therefore it might be perceived as perverse if progressive-social democratic movements turned for inspiration to stakeholding at a time when it is declining in importance and is under pressure (Mishra, 1999: 82; Giddens and Hutton, 2000: 31). Two alternative approaches that may deliver similar results may be to encourage the development of a mutual form of ownership alongside the promotion of corporate social responsibility (Kay, 1996). The former would be to revive an alternative form of ownership, where mutual organisations are established to fulfil a certain function for the benefit of its membership. Mutuality assumes the potential for advantageous co-operation between capital-holders and employees (Meade, 1991). It is argued that such ‘mutual gains’ enterprises are likely to be more efficient, especially in pursuing quality-centred product market strategies (Fernie and Metcalf, 1995; Levine, 1995; Layard, 1997). In this sense, mutuality can be viewed alongside various forms of co-operative enterprise, and certainly company law in different countries influences the development of non-standard forms of corporate ownership. The second alternative would be for government to promote Corporate Social Responsibility (CSR) amongst domestic private companies. Here, firms are encouraged (or pressured) to adopt ‘enlightened’ employment, environment, production and trading practices, to meet a number of ethical and other aspects of good practice. Thus, whether stakeholders are formally recognised or not, the CSR company should operate fair and transparent industrial relations practices with employees, encouraging participation where possible, whilst seeking to source materials from sustainable forests, avoid suppliers who employ child and/or sweatshop labour, and seek to provide benefits to the local community where they are situated rather than simply maximise returns from private business activities. To the extent that CSR is manifested in a real engagement with the issues and lead to a significant change in corporate culture and practice, it has the potential to have a significant impact upon corporate short-termism and its refusal to accept and deal with the wider, externalities of its production. However, this approach may require changes in national corporate laws to facilitate this change of objectives. For example, pension fund trustees in the UK have a statutory ‘fiduciary responsibility’ to act in the ‘best interests’ of those for whom the fund has either a current or future liability, and this has been interpreted by the courts as the pursuit of the best return on investments possible. This is even if this narrow definition of a rational investment strategy for the fund conflicts with ethical investment

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criteria and/or the desire to promote regional regeneration through employment-generating industrial production activities (Megarry, 1983; Blake, 1992: 33).

Conclusion Third Way economics, as demonstrated by this chapter, represents one aspect of wider policy arrangements available to progressive-social democratic movements. The range of potential policy positions may have been lessened by globalisation, and/or the effectiveness of certain policy tools weakened by the free flow of capital. Yet, it is certainly not the case, as some adherents of the Third Way would wish to portray, that there are no progressive alternatives to their specific policy programme as has formed the basis for this book. The Third Way remains a remarkable attempt made by ‘new’ social democratic practitioners and academics to forge a new economic consensus by grafting neo-liberalism together with certain aspects of New Keynesianism, and then seeking to utilise this approach to realise many (but not all) progressive-social democratic objectives in a new way. Nevertheless, this chapter has sought to demonstrate that social democrats are not constrained to pursue this particular approach to economic management if they would prefer to pursue more traditional objectives of full employment, a high level of sustainable growth, social solidarity, constructing a comprehensive welfare state and redistributing income and power to working people and their families. Globalisation and other changes in the external environment have not undermined the basis for Keynesian economic management. Although this may be slightly more constrained than during the Bretton Woods period, yet the instruments still work. Moreover, there is nothing to prevent social democrats from campaigning for a re-regulation of the global economy, to restore democratic control over the economic system and therefore re-energise even those economic instruments that have lost some of their former influence. A campaign waged on the basis of restoring the primacy of democracy over market forces, and/or people over speculative capital would provide the basis for a popular political movement and contribute towards eliminating many precarious aspects of the contemporary global economy. Yet, this requires an accurate understanding of the problem, realistic analysis relating to the available alternative solutions and, crucially, the political determination to realise the measures necessary to move towards a viable solution. One lesson that has arisen from the

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analysis of the Third Way contained in this book has been the notable paucity of all three of these pre-requisites amongst progressive-social democratic movements, at many periods during the past two decades. Consequently, many social democratic parties may have adopted Third Way economics out of desperation rather than as a primary choice. It is therefore vision, above all, that the progressive-social democratic movements of the world need to rediscover before they are able to make an educated choice concerning whether Third Way economics represents the saviour of the progressive political movements or a dead end.

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Index

Accord, The, 209, 213 asset bubbles, 181, 186, 211 asymmetric information, 74 Australian Labor Party, 2, 7, 164, 175, 199 behavioural flexibility, see flexibility ‘big government’, 6, 14, 173 Blair, Tony, 1, 20, 125, 135, 142, 147, 153, 208 Brown, Gordon, 143, 154, 174, 198 capacity, see productive capacity capital accumulation, 76, 231, 233 controls, 31, 52, 227–8 flight, 11, 51, 102, 118 flows, 12–13, 25, 31–4, 37, 42, 46, 51, 73, 92, 162, 226 formation, 83, 110, 188, 234 central bank, 93, 164 conservative, 99, 101–2 independent, 16–17, 64, 82, 89–90, 94–105, 181 cheap money, 92, 227, 232 class conflict, 23 Clinton, Bill, 2, 5, 79, 141, 146, 154, 162, 167, 170, 172–3, 178, 185, 189, 191–2, 196, 199, 203–4, 208, 211 Clintonomics, 186 constrained discretion, 76, 84 corporate governance, 70, 235–8 corporatism, 22, 102, 143, 151, 164, 170, 199, 206, 208–10, 216, 218, 220, 229, 236 credibility, 64, 73–4, 76, 84, 87, 89, 92–4, 99, 102 credit socialism, 233 crowding out, 80–3, 137

decommodification of labour, 19, 140, 152–3 demand aggregate, 16–17, 69, 80, 82–3, 101, 109, 113, 121, 145, 150, 185, 220, 226 coarse tuning, 16 effective, 69, 82 fine-tuning, 16, 59, 60, 64, 75–6 management, 44, 55, 58–60, 63, 148, 150, 164, 181 deregulation, 46, 51–2, 93, 114, 118, 143, 163–4, 184–7, 227 derivatives, 32 devaluation, 13, 92 disequilibrium analysis, 71–2 distribution of income, 20 economic democracy, 24 and monetary union (EMU), 20–1, 53, 79, 95, 106, 147, 154–62, 164, 178, 186, 207, 224, 229 self-management, see national economic self-management efficiency wages, 120 employability, 15, 124, 140–1, 204 EMU, see economic, and monetary union (EMU) endogenous growth theory, 85, 129, 139, 142, 187 money, 82, 91, 108 equilibrium rate of unemployment, see under unemployment ERM, see exchange rates Euro-Keynesianism, 8, 21, 114, 150, 163, 228–9 Euro-sclerosis, 18, 77, 137–8, 140 European Central Bank (ECB), 20, 95, 97–8, 154, 156, 158–9, 161 Commission, 21, 150, 153 281

282 Index European – continued ERM, see exchange rates integration, 20, 38, 146–63 Social Model (ESM), 38, 126, 151–4, 157, 162 exchange rates, 32, 156, 222 Exchange Rate Mechanism (ERM), 13, 62, 155, 182, 186, 223 fixed, 42, 52, 83, 110, 184, 223 floating, 60, 223 exogenous money, 91 expectations, 69, 110 rational, see rational expectations FDI, see Foreign direct investment (FDI) Federal Reserve (the ‘Fed’), 154, 181, 185 financial market integration, 10, 42 Fiscal policy, 16, 55, 64, 75, 80, 85, 102, 141, 151, 155, 165, 172–7, 228 consolidation, 76–80 flexibility behavioural, 121 functional, 115, 118, 120–2 labour cost, 116, 118, 121, 127 numerical, 115, 121–2 temporal, 115 wage, 116, 121, 230 ’flexicurity’, 202, 231 flexible specialisation, 2, 60 Fordism, 11, 60, 130, 134, 149 post-, see post-Fordism Foreign direct investment (FDI), 12, 27–8, 31, 33, 40, 48, 53, 83, 116–18, 129, 164, 207 Fortress Europe, 38, 149 full employment, 15–16, 18, 27, 51, 56–7, 64, 75–6, 89, 110, 140, 215, 220, 222, 234 functional flexibility, see flexibility globalisation, 10–12, 23, 26–54, 57–8, 62, 70, 78, 126, 146, 148, 217 hyper-, 11, 36–7, 55, 87, 131, 146, 195, 213, 216–19, 225 golden rule, 84 Great Depression, 4, 58, 150 Greenspan, Alan, 94, 172, 178, 185, 199

Hawke, Bob, 7, 196, 199, 203 human capital, 14, 18, 47, 86, 118, 120, 129, 143–4, 152, 188, 191 hysteresis, 69, 71, 101 import substitution, 232–3 industrial policy, 54–5, 188–9, 231–4 relations, 18, 70, 112, 116, 125–8 inequality, 22, 40, 118, 136, 142, 195–9, 202, 215, 217 inflation cost-push, 90 targeting, 90, 105–8 interest rates, 13, 76, 80, 84, 90, 92, 94, 110, 137, 156, 172, 177, 224 inter-governmentalism, 38–9, 147 international trade, 30–1, 33 irrational exuberance, 185 just-in-time-production, 116 Kaldor, 16 Kalecki, 16, 76 Keating, Paul, 7, 164, 196, 199, 203 Keynes, 16, 33, 68, 90, 95–6, 101, 177, 225–6, 234 Keynesianism, 4, 6, 10–12, 24, 211–12, 217–18, 220–9 new, 16, 57, 62, 64, 66, 71, 83, 110, 238 post-, 16, 25, 68–9, 80, 82–3, 101, 111, 145, 209, 225, 234 labour market flexibility, 11, 15, 18, 42, 56, 64, 112–28, 141, 143, 170, 187, 199–203, 212 policy (LMP), 112, 122–6, 154, 165, 203–5 standards, 122 marketisation, 132–4 middle way, 4 minimum wages, 17, 20, 113 Mitterand administration, 12, 43–4, 149 Modell Deutschland, see Rhineland Model

Index 283 monetary policy, 16, 64, 83, 87, 89, 111, 177–82, 223 rules, 73–4, 92–4, 102 money neutrality, 90, 101 supply, 91, 98 multiplier, 80 NAFTA, see North American Free Trade Agreement (NAFTA) NAIRU, see non-accelerating inflation rate of unemployment (NAIRU) nation state competition, 42 crisis, 36–7, 39–43, 47, 76 ’strong’, 14, 136 national economic self-management, 24, 38, 44–51, 89 natural rate of unemployment, see unemployment neo-liberalism, 2, 5, 10, 12, 17, 21–2, 24–5, 50, 61–72, 76, 214, 217–18, 224 neutrality of money, see under money New Classical economics, 82 Deal, 79, 124–6, 134 Democrat, 6, 141, 143 Keynesianism, see Keynesianism Labour, 2, 5, 8–9, 18, 20, 22–3, 25, 50, 59–60, 63, 65, 73, 84, 102, 106, 125, 139, 143, 147, 161, 167, 174, 182, 186, 192, 197 Public Management (NPM), 129–35, 144 Right, 2 Social Democracy, 5, 142, 187, 210–11 non-accelerating inflation rate of unemployment (NAIRU), 66–72, 82, 98, 106 North American Free Trade Agreement (NAFTA), 37, 146 NPM, see New, Public Management (NPM) numerical flexibility, see flexibility

PASOK, 7, 9 Persson, Torsten, 8, 165, 167 Phillips curve, 15 adaptive expectations, 65–6 polder model, 8, 144, 208 post-Fordism, 11 pre-commitment, 64, 84, 87, 89–90, 92–4, 99, 106 privatisation, 64, 78, 132, 144, 164 productive capacity, 70, 85, 109, 121, 138, 220 PSOE, 63 public ownership, 6, 55, 188, 234–5, see social, ownership purchaser-provider split, 129 PvdA, 7–8, 143 rational expectations, 62, 74–5, 83, 89, 99, 111 real wages, 69 redistribution, 11, 14, 20, 27, 37, 53, 141–2, 184, 195, 197, 217, 220, 234 regionalism, 37–8 regulation capital, 14, 24, 52–3, 56, 225, 238 labour market, 56, 114, 118, 143, 201 reputation, 92, 99, 102 Rhineland Model, 8, 219 SAP, see Swedish Say’s Law, 16–17, 68, 75, 106 Scandinavian model, 219, 221 Schröder, Gerhard, 7, 135, 142, 165, 193, 200, 208, 210 SGP, see Stability and Growth Pact (SGP) single internal market (SIM), 20, 38, 147, 157 social dimension, 21 dumping, 153 model, 151, 201 ownership, see public ownership partnership, 18, 21, 99, 152 policy, 19, 140–4, 195 sovereignty, 39, 155, 157

284 Index SPD, 7, 144, 164, 175, 186 speculation, 32, 75, 107, 223, 225–7, 234 Stability and Growth Pact (SGP), 79, 158, 161, 175, 224 stagflation, 65 stakeholding, 235–8 Stockholm School of Economics, 71–2 Swedish Model, 54, 138, 141, 205, 222 SAP, 87, 164, 182, 200 temporal flexibility, see flexibility Third Way, 1–25 time inconsistency, 62, 72–4, 99, 101 lags, 80–1 TNCs, see trans-national corporations (TNCs) Tobin tax, 13, 226 trade unions, 55, 60, 67, 99–100, 112, 114–15, 118, 120, 125–6, 161–2, 199, 202, 206, 210, 234 trans-national corporations (TNCs), 10, 13, 26–8, 31, 33, 35–6, 40, 48, 152

transparency, 84–9, 164 triadisation, 38 unemployment, 15, 17, 19, 58, 64, 66, 69, 71, 100–1, 122, 125, 137–8, 170, 194, 202–3 benefits, 19, 66, 112, 124, 137, 194, 203 equilibrium rate, 64–72, 98, 112 natural rate, 15, 21, 62, 65–6, 72, 80, 82, 98–9, 111 wage bargaining, 102, 109, 114, 121, 125–8, 152, 207, 220, 222, 225 co-ordination, 18, 27, 51, 118, 126–7, 206, 208, 229–30 decentralisation, 65, 113 Wage-Earner Funds (WEFs), 234 wages dumping, 127 efficiency, see efficiency wages flexibility, see flexibility welfare state, 12, 19, 21, 27, 42, 54–5, 58, 60, 75, 129, 138, 141, 194, 202, 215 crisis, 59–60, 78, 136, 138 reform, 135–40, 192 work reorganisation, 115