Tuesday, April 19, 2005

Why We Can’t Switch -The U.S. economic model versus the European Union’s.

The level of disparity between the rich and the poor in the United States stands at an all time high. Calls have been made on both sides of the aisle to address this issue as a matter of moral import. The European economic model, which emphasizes social welfare over economic growth is increasingly touted as a viable alternative to the semi-libertarian free market model currently extant in the United States. Should the U.S. move to actively redistribute wealth “equitably” and if so, how would this be performed? Or, are economic classes simply the byproduct of an open market where humanity is viewed as a resource with varying degrees of utility and thus, value. It does not follow from the fact that some people in the United States may not have marketable skills that they should be allowed to remain below an objective poverty line (Insert Hume’s Guillotine here). The question remains though, is the European model a viable alternative and if not, why?

While it is true that the distribution of wealth in the United States is much less "equitable" than its European counterparts it is worthwhile to note that the average standard of living enjoyed by U.S. citizens is much higher than every country in the EU (excepting Luxembourg). For example, the standard of living (as measured by the average GDP per capita) in the United States allows the average American to spend $9,700 more per year in consumables (cars, electronics, etc..) than their average European counterpart. In 1959 22% of Americans were considered to be living below the poverty line while today that figure stands at 12%. In addition, in 1999 25% of Americans were classified as “low income” while if Sweden, widely considered to be the model of a successful welfare state, were held to the same standards 40% of all households would be placed in the "low income" category. The emphasis on absolute economic equality as a measure of the health of a society is wrong-headed and counterproductive. Opportunity theory, or the knowledge that social and class mobility is achievable through effort, functions to provide incentive for progress at all levels of society. The European model certainly homogenizes income distribution via various social welfare/tax programs but also has the unintended consequence of reducing the impetus for productivity over all levels. European politicians rationalize this disparity as emphasis of “intangible” economic goals such as leisure and quality of life over the goals promoted in the American model such as increases in per capita GDP. Of course, these things are not unrelated.

The ability of the European economies to focus on those “quality of life” issues such as 6 weeks of annual vacation, 35 hour work weeks, and “universal” health care is possible only by accepting a de fact lower standard of living and, even then, is only enabled via huge indirect subsidies from the U.S. economy. These soft subsidies are transmitted in several ways. The most often cited is the United States total defense expenditure which is almost twice that of the entire EU combined. Although many disagree with the policies of the U.S. it is difficult to argue that the enormous military advantage it maintains does not deter aggression and, indeed war, in many parts of the world. Bosnia and Kosovo are two examples of conflicts which may have devolved further in the absence of American military intervention. It is also doubtful that the Korean stalemate would have been maintained without an American military presence. The outcome of the Iraqi invasion is still to be determined but the spread of democracy in the Middle East, if it should occur, is likely to produce tangible social and economic results. The rise of democratic movements/institutions in the Mid-east also would have been unlikely to have progressed at the current pace without military intervention by the United States. (Disclaimer: By stating that the U.S. does provide a global military subsidy I am not discounting the implied responsibility that the U.S. should intervene militarily in conflicts which may be less directly germane to its interests i.e. Darfur).Fortunately, many conflicts are addressed diplomatically but it is understood that the threat of potential U.S. military intervention provides the “stick” that has prodded many aggressors to the negotiating table. This disparity in defense spending allows a higher proportion of the EU’s total budget to be earmarked for social welfare programs. (An excellent detailed discussion of this disparity is given in Robert Kagan’s book “The Paradise and the Power”).

In addition to defense spending, the healthcare system in the United States also provides a large subsidy to the world in terms of innovation stimulus and profit recoup. Most countries in the EU, and indeed in the world, have instituted either legislative or de facto price controls on medications, medical procedures, and medical devices. It is of no surprise therefore, that much of the profit required to recoup the cost of development and provide profit incentive for further investment and innovation is made in the U.S. marketplace. It is popular to condemn pharmaceutical companies for predatory pricing in the American market but unfortunately the R&D costs of drug discovery are so high (Pfizer alone spent 7.1 billion dollars on R&D in 2004) they require a significant investment stream which, in turn, requires an incentive to invest. The profits achieved by pharmaceutical companies in the U.S. allow them to attract investment and, in turn, utilize that capital to support the manufacture of newer, improved medications. The drugs thus produced are used to improve the lives of people the world over. Theoretically the U.S. could institute price controls on prescription and non-prescription medications but we would be economically inhibiting the very research that has so greatly improved the living standards of people the world over (Many would argue that the profit margins of pharmaceutical companies are too high to allow for the market pricing of medications. This discounts the assumed risk that these companies annually face in terms of loss of pipeline and product liability/litigation exposure. I would admit, though, that some protection methods often utilized by pharmaceutical companies, such as frivolous additional patent claims, should be overhauled). The majority of novel medical devices (such as coated cardiac stents, joint replacements, pacemakers, and advanced surgical navigation units) are either pioneered by U.S. companies or are only developed due to the market available in the United States. In effect, the healthcare systems of the entire world depend on the U.S. market to provide innovation incentive so that new and improved products can be discovered and utilized.

Yet another major subsidy provided by the U.S. is the R&D products of our national research institutions which are in large part funded by grants from governmental agencies. The U.S. government has requested a total of 132 billion dollars for the total science and technology research budget in 2005 with 28.6 billion allocated for basic research. This is the first time since 1993 that the R&D budget has been over 1% of GDP. The vast majority of research produced via this investment will be published in freely available journals. Scientists in France, China, and South Korea comb through the governmentally funded research of American institutions to support their own academic, industrial, and governmental pursuits. While it is true that this research is often enabled by foreign researchers it is a testament to the incentive provided in the form of capital investment (bestowed by the government through the largess of the American taxpayer) that the best and brightest from other countries come to the U.S. to pursue scientific careers.

Thus, the “leisure” and “quality of life” emphases of the “European model” discount the fact that the E.U. can afford to have high unemployment rates and “generous” social welfare systems as they are handing off many of the costs to the U.S. marketplace and, in effect, to United States taxpayers. So, should the U.S. choose to disincentivize production and innovation via an attempt to create an absolute equality of wealth distribution the question must be asked, who would provide the market necessary to induce the innovations on which the world relies to maintain the constant increase in quality of life? I submit that the market would stagnate, that innovation across all industrial/service sectors would be significantly curtailed, and that we would soon have to make due with life “as it is” rather than “how it could be”.

The moral case against market dynamism and the resultant wealth distribution asymmetry argues that society should completely provide for the least able before allowing investment in products which may be deemed to be superfluous. This argument is valid although it assumes that the provision of goods and services to the least able would be adequate in an economy without the market incentives present in the U.S. This is rather unlikely. Although the relative poverty rate in the United States is high, and should be brought to zero, it is unlikely that by increasing taxation we could sufficiently provide for the indigent while maintaining GDP. Put another way, if we significantly increased taxation in order to better the services provided to lower social classes total government income would likely be reduced and the ability of the government to provide those very services would be curtailed. This would occur as a result of the removal of potential investment capital from the private sector, provision of a disincentive for productivity, and the inherent inefficiency of institutions which lack a profit motive. Legislation instituted in the EU effectively ensures that there is little disparity in wealth distribution by instituting a steep progressive taxation. This policy ensures that income over a certain level is heavily taxed. The revenue obtained from these levies is then filtered through the government and redistributed through the social welfare system to the “needy” in society. This form of taxation inhibits real innovation and wealth creation by removing the economic stimulus to succeed. Thus the European model improves the relative lifestyles of the lower classes not by significantly increasing their economic standing but by significantly decreasing the assets of the “rich”.

I must emphasize though, even if the U.S. decided that the “less tangible” assets are preferable they would not be achievable if the U.S. adopted the European economic model. The European model depends on a separate marketplace to provide the incentive for the majority of innovation and production (as well as defense etc...). There is no other economy which could provide us with the indirect market subsidies we currently provide to the rest of the world (Although I would allow that due to our recent fiscal profligacy Asian central banks have been very effective in maintaining U.S. liquidity in the face of a large current account deficit.). Thus, not only could we not increase our social welfare spending while maintaining our very significant advantage in the economic measures of quality of life, we could not adopt the European model and realistically expect to maintain even the much lower standards currently enjoyed in the EU. The wealth distribution problem in the U.S. is institutional and a result of the overarching positive of vast wealth creation. The lower classes in the U.S. enjoy a standard of living similar to those of the members of the middle class in European countries. Although, in its current form, tax and social policy do not allow for a form of wealth redistribution which would positively affect the U.S. economy the issue of the disparity should be addressed. Equality of opportunity should be prioritized and maintained while economic alternatives, such as a consumption tax, should be considered to address some of the root causes of the wealth distribution asymmetry extant in the U.S. economy. The European model is not a viable alternative to the United States free market although methods of reducing income disparity while maintaining market incentives should be explored.


Anonymous Blue Cross of California said...

Interesting to see the entire worlds healthcare system depends on the U.S. market. As the U.S. has more than 45 million which lack coverage.

1:50 AM  

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