Sunday, 7 November 2004

It's the Incentive Structure, Stupid

On November 3rd the EU published a report entitled: ‘Facing the Challenge. The Lisbon Strategy for Growth and Employment’. It was written by a High Level Group (HLG), chaired by the former prime minister of the Netherlands, Wim Kok (‘Kok’ is the Dutch word for ‘cook’). Its mandate was to ‘ … identify measures which together form a consistent strategy for the European economies to achieve the Lisbon objectives and targets.’ In the Lisbon strategy, which was launched in March 2004, European leaders committed the EU to become by 2010 ‘the most dynamic and competitive knowledge-based economy in the world capable of sustainable economic growth with more and better jobs and greater social cohesion, and respect for the environment’. It included a comprehensive but interdependent series of reforms. Actions by any one Member State, ran the argument, would be all the more effective if other Member States acted in concert. Or, as the HLG put it: ‘A rising European tide lifts every European boat.’

But the HLG acknowledges that halfway to 2010 the overall picture is very mixed and much needs to be done ‘in order to prevent Lisbon from becoming a synonym for missed objectives and failed promises.’ Of course, external events since 2000 have not helped achieving the objectives. More seriously, however, the HLG blames the European Union and its Members States for a lack of determined political action and disappointing delivery.

The HLG raises the question whether the ambition was wrong. Its answer is no. ‘The ambition is needed more than ever, whether to meet the challenges of enlargement, an ageing population or the intensified global competition – let alone the need to lower current levels of unemployment.’

According to the HLG Europe has built a distinctive economic and social model that has combined productivity, social cohesion and a growing commitment to environmental sustainability. In other words: capitalism with a human and green face. The HLG admits that there is no magic bullet that will deliver the higher growth and jobs that Europe urgently needs. But it still believes that the Lisbon strategy, refocused on growth and employment in the way its report suggests, offers Europe a new frontier for that economic and social model.

The HLG insists that the Lisbon strategy is even more urgent today as the growth gap with North America and Asia has widened, while Europe must meet the combined challenges of low population growth and ageing. Time is running out and there can be no room for complacency. Better implementation is needed now to make up for lost time.

It recommends urgent action across five areas of policy:

– the knowledge society: increasing Europe’s attractiveness for researchers and scientists, making R & D a top priority and promoting the use of information and communication technologies (ICTs);

– the internal market: completion of the internal market for the free movement of goods and capital, and urgent action to create a single market for services;

– the business climate: reducing the total administrative burden; improving the quality of legislation; facilitating the rapid start-up of new enterprises; and creating an environment more supportive to businesses;

– the labour market: rapid delivery on the recommendations of the European Employment Taskforce; developing strategies for lifelong leaning and active ageing; and underpinning partnerships for growth and employment;

– environmental sustainability: spreading eco-innovations and building leadership in eco-industry; pursuing policies which lead to long-term and sustained improvements in productivity through eco-efficiency.

Well … will it help Europe to achieve its ambitious goals? I do not believe it will. The diagnosis is not that bad, but the remedies are flawed. Let me substantiate my feeling by highlighting a few elements in the report.

The HLG acknowledges the role of entrepreneurs. It believes that increased knowledge and an open internal market do not automatically drive innovation, competitiveness and growth. It requires entrepreneurship to design new products and services and take advantage of market opportunities to create value for customers. Increasingly, new firms and SMEs are the major sources of growth and new jobs. Entrepreneurship is thus a vocation of fundamental importance, but Europe is not ‘entrepreneur-minded’ enough. It is not attractive enough as a place in which to do business. There are too many obstacles for entrepreneurs and therefore Europe misses many opportunities for growth and employment. Much can and must be done to improve the climate for business.

As a major obstacle for entrepreneurs the HLG highlights the overall burden of rules and

regulations imposed on businesses. Although regulation is often launched with the best of intentions, there is now a growing feeling that a tipping point has been reached in which the gains from incremental regulation are outweighed by the costs — especially among manufacturers. There needs to be a gear change. The present situation leaves insufficient room for risk taking and demands too much attention and resources from the entrepreneur. Removing this obstacle calls for less regulation, but even more importantly better and smarter regulation. A balance must be struck between regulation and competition.

It should, however, be recalled that the cry for deregulation is nothing new. It was a major element in the supply side revolution in the seventies of the previous century. Subsequently, it has popped up time and again in the economic policy discourse over the decades. Unfortunately, it got stuck in rhetoric. Will it be different this time?

A major element of the Lisbon process has been the use of indicators. More than a hundred indicators have been designed, which makes it likely that every country will be ranked as best at one indicator or another. This makes this instrument ineffective. Member States are not challenged to improve their record. According tot the HLG simplification is vital. The establishment by the European Council of a more limited framework of 14 targets and indicators offers the opportunity to improve the working of the instrument of peer pressure. The HLG considers this list to represent the best trade-off between keeping Lisbon simple and capturing its ambition and comprehensiveness. The European Commission should present to the Heads of State or Government and the wider public annual updates on these key 14 Lisbon indicators in the format of league tables with rankings (1 to 25), praising good performance and castigating bad performance – naming, shaming and faming. These 14 indicators offer the opportunity for Member States to further emphasise the growth and employment dimension of Lisbon if they choose.

The HLG calls upon each Member State under the leadership of its Head of State or Government to formulate a national action programme, setting out roadmaps, including milestones, about how it is going to achieve the Lisbon targets. This approach serves three purposes: it corrects the absence of national involvement in the Lisbon strategy, it helps ensure coherence and consistency between measures taken, and it involves all stakeholders.

Will this help? Probably not. It will most likely degenerate into bureaucratic ‘Spielerei’ without having any impact on the real economy.

As regards the labour market the HLG observes that high levels of employment are essential for achieving greater social cohesion and eradicating poverty within the European Union. Having more people in employment is the best way of safeguarding the social and financial sustainability and further development of European welfare systems. Demographic ageing and globalization will have increasing consequences on the sustainability of the European social model and specifically on our labour markets. To achieve stronger and more sustainable growth, Europe – in other words its Member States – must face th
ose challenges. Increasing the level of employment requires providing people and companies with the tools and opportunities to exploit these changing conditions positively. The call for more reform is too frequently seen as no more than code for more flexibility which in turn is seen as code for weakening worker rights and protections; this is wrong. The HLG understands that flexibility is about agility, adaptability and employability for which the key is the ability for workers constantly to acquire and renew skills, and for a combination of active labour market policies, training and social support to make moving from job to job as easy as possible. Nor should reform mean that the social dialogue is taken out of the heart of Europe’s labour market. It is essential to its productivity and ability to adapt to change. Modern and efficient social policies make an important contribution.

Well … do they? It is funny that one basic element of the market economy, the price mechanism as a means to clear markets, including the labour market, has been conspicuously absent from the report. As the Swedish economist Assar Lindbeck once observed: ‘A market economy cannot function well if one of the most important markets, that for labour, is not allowed to function simply as a market, rather than as a tightly regulated administrative system.’ Conversely, much emphasis is put on hobnobbing with the trade unions, which are being handled with velvet gloves. Unfortunately, that does not augur well for the success of the Lisbon strategy, because recent experience shows abundantly clear that reforms meet fierce resistance from them. In various European countries, including France, Germany and Italy, reform proposals by governments had to be wholly or partly withdrawn. Against this background it is interesting to note that minority interest groups – often representing less than a quarter of the labour force – can get away with challenging the authority of the democratically elected government, trampling on the interests of the (silent) majority. In their effort to protect their ‘acquired social rights’ they are conveniently forgetting that for guaranteeing the social rights of one person, there is always another person who, in one way or the other, has to foot the bill.

As regards the obligatory tribute to the Kyoto Protocol, aimed at the reduction of the emission of man-made greenhouse gasses, the HLG is completely ignoring the recent spate of articles in peer-reviewed journals, refuting one of the basic tenets of the man-made global warming paradigm: the hockey stick graph by Mann et al. This graph dramatically depicts temperature trends over the past thousand years, with three distinct parts: a flat ‘shaft’ extending from A.D. 1000 to 1900, a ‘blade’ shooting up from A.D. 1900 to 2002, and a range of uncertainty in temperature estimates that envelops the shaft like a ‘sheath’. It is this curve which substantiates the IPCC’s claim that global warming is alarming and that mankind is to blame for it. Both are wrong. It is highly unlikely that there would have been sufficient political support for Kyoto without the hockey stick. Now that it has become clear that this graph is misleading and the result of scientific malpractice, it is only logical to assume that Kyoto would be called off. However, so far the climate issue has proved to be pretty impervious to logic. In this field Europe surely suffers form a chronic cognitive dissonance syndrome. While the HLG rightly points at the adverse impact of regulation in general, it turns a blind eye to far more serious impact of the regulation which is part and parcel of Kyoto.

More generally I venture the thought that the ‘distinctive European model’ or Rhineland model is not the solution but the problem. With its overgenerous welfare state, where the social safety net seem to have turned into a social hammock, it is fundamentally at odds with economic dynamism and flexibility. In case of success, rewards are too modest, while in case of failure penalties are not sufficiently severe. The peoples of Europe may be attached to their model because of the protection it offers. But you can’t have your cake and eat it. If Europe wants to stick to its model, it has to acquiesce in a loss of a fair amount of dynamism and flexibility. As the ageing of the population continues, the cost of foregone growth which this entails will rise.

In the past the West, including Europe, has prodded the non-market economies everywhere in the world to transform and to adopt the free enterprise system. It is high time that Europe follows suit. If not, one could better stop shedding crocodile about Europe’s perennial lagging behind the US and say farewell to the lofty but unattainable ambitions of the Lisbon strategy.

‘It’s the incentive structure stupid!’

By Hans Labohm
This article first appeared on TechCentralStation.