The effect that the process of globalization is having on the European welfare states has been the subject of much debate. The source of this debate lies in the fact that there has been a positive correlation between economic openness and the size of the welfare state in European countries. This directly contradicts liberal economic theory that increased economic openness will require the retrenchment of the welfare state in order for national economies to remain competitive in the international market. There are some that argue that this relationship proves that increased trade and capital mobility have no meaningful effect on the viability of European welfare states, whilst there are those that attribute this relationship to the fact that globalization places greater social security demands on the state. It is my argument that the forces of globalization are posing a fundamental dilemma for European welfare states. Free trade and capital mobility are altering the structure of European economies and posing greater risks for individuals, which are placing greater demands on the welfare state, whilst also simultaneously limiting the ability of the state to provide such assistance. In order for European economies to remain strong, and thus their welfare states to remain sustainable, there will have to be a change in policy that allows European countries to remain competitive in the global economy. I will begin by outlining the liberal theory, before discussing the argument against the process of globalization affecting European welfare states. I will then go on to show how globalization does in fact affect European welfare states, both through the increased demands and constraints its effects place upon them. Finally, I will analyse the implications for the future of European welfare states and how they will have to adapt in order to sustain strong economies and thus their own viability.
According to liberal economic theory the welfare state is considered to be uncompetitive. “Income transfer programs distort labour markets and bias inter-temporal investment decisions” (Garrett & Mitchell 2001, p.150). The higher levels of taxation required to fund the welfare state increase the relative cost of labour thus also increasing the cost of production. The process of globalization should therefore result in pressure to reduce the size of the welfare state in order for the national economy to remain competitive. Increased trade liberalization means that domestic goods and services become subject to price competition, in which only the most efficient firms will survive. Firms that have high costs of production, such as those derived from higher wages and labour market regulation will be driven from the market. Similarly, increased capital mobility allows firms to move locations and invest in countries in which they will receive the highest rate of return. High level of taxation and social contributions reduce the rate of return for firms and investors and thus make for a less attractive investment environment. Liberal theory holds that in order for countries to retain domestic capital and attract foreign capital, they will have to compete through tax competition, which necessitates the retrenchment of the welfare state. The cost of funding the welfare state through borrowing becomes higher as this increases the real interest rate, which depresses investment. Furthermore, this will result in an appreciation of the exchange rate, which reduces the competitiveness of domestic producers in the world market (Garrett 2001, p.6). Increased economic openness should therefore be related to a decrease in taxation and government consumption. However, what has actually occurred is the opposite. There has been a positive correlation between the levels of government consumption and social transfers as a share of GDP, and increased economic openness beginning...