From: Foundation for Economic Growth

East versus West
Does the West Know Best?
By Gabriel Calzada
Nov 1, 2005, 11:39

How does EU enlargement affect the labour market and the social security systems of existing EU members?

Economic theory suggests enlargement should have at least two positive consequences. Since Thomas Aquinas’s writings, or at least since the late Scholastics, we have known that a larger labour market produces greater satisfaction of the needs of all individuals in society through the division of labour and knowledge. In the words of Juan de Mariana’s educational book for the Prince of Spain, known as De Rege: ‘If men had been strong enough to live in relatively isolated communities, we would still be living at the bare level of subsistence, satisfying a much reduced number of wants.’

A second reason to view enlargement positively is that the new countries have different and sometimes more market-oriented systems of social security. We will have the opportunity of watching the competition between systems, allowing for an assessment to be made of their relative merits.

I would now like to focus on the consequences of enlargement for social security systems.

Western European social security systems are nearing bankruptcy. It is possible that the addition of new countries into the European project, with new ideas and new people, will provide fresh impetus for reform. By witnessing the failings of an ageing system alongside a dynamic market-oriented alternative, I believe nations will be converted to the cause of reform.

Enlargement could also gloss over the current failings of social security, however, because of an influx of labour from the accession states into the countries of Western Europe. Such immigration would help to stave off the effects of needing to support an increasingly ageing population. A stay of execution would probably be celebrated by a great majority of politicians, but for most of us the extension of social security should never be celebrated as a success. To elaborate on this I would like to take a look at the pyramid financial scheme for social security in most of the western European countries.

Pyramid selling is illegal in most developed countries because it is rightly considered as fraud. In the 1990s, the implementation of the near-perfect pyramid banking system in Albania stole the savings of hundreds of thousands of families and left the country on the verge of civil war.

These fraudulent systems typically promise to make a huge profit without risking anything. All you have to do is to purchase the last position on the list by paying a small sum to the first person on the list, who, in return, abandons the list in favour of the second-ranking person, and the process continues in this way. The newcomer would recover their money by selling two copies of the list to two new people occupying the last two positions. At least, this is what new investors are told will happen.

In the scheme, designed in its modern version by Mr Ponzi, the people situated at the bottom of the pyramid are financing the people situated at the top and cannot ascend the structure of the pyramid unless they find enough buyers to occupy their places and expand the base of the structure.

The fraud is self-evident. There is always a great mass of sellers who will not find buyers. This scheme, which is rightly considered fraud when an individual or private company launches it, is considered to be a social good when the state is its organiser. As Frédéric Bastiat, the great French economist, said: ‘If you want to know something about the moral status of a state action, you have to think, “What would we think about it if a private person did the same thing?”’

The best-known, large-scale frauds based on the Ponzi scheme are the social security systems of Western Europe. In this context, the arrival of thousands of eastern European immigrants into Spain and other European countries has provided fresh oxygen to an ailing system. The eastern newcomers, together with a young generation of domestic citizens entering the social security system, are not saving or investing anything of value. They are not capitalising on their efforts or contributions. They are just coerced into the pyramid with a vague promise that the state will find another large cohort of new victims by the time they become old.

Let me now turn to the consequences of European enlargement for the labour market.

Ideally, the extension of the market will allow a greater division of labour and, thus, an increase in productivity and enrichment of all Europeans. This only holds, however, under free market conditions. In Cuba, for example, an enlargement of the labour market would not be of great consequence, except for the black market.

The Spanish labour market, as well as other European labour markets, is far from being completely free. In fact, an even more regulated European labour market is a possibility if the president of the European Parliament, Josep Borrell, has his way in introducing an EU minimum wage. His desire is to avoid competition between western and eastern European workers competing for jobs and reducing wages post-enlargement.

It is almost unbelievable that Borrell was once an economics professor. If employers are obliged to pay the same monthly wage in countries where, for institutional or economic reasons, the productivity of labour is different, the only thing you are going to attain is massive unemployment in those countries where the productivity of labour lies below the minimum European wage.

This will condemn hundreds of thousands of people, if not millions, mostly in the East, to choose between long-term unemployment or emigration: an emigration that would also serve to prop up the welfare states of the West.

Since I have not yet met a politician who wants to establish a minimum wage that is below the minimum market wage, let us suppose that Borrell and his friends establish a European minimum wage of around 600 euros a month to be implemented in Spain.

The Polish or Slovak employer whose workers earn more than 300 euros per month is not going to raise his wages up to 600 euros because of the whims of Mr Borrell and other interventionist politicians. What the Polish employer is going to do is to fire everybody who does not produce at least 600 euros a month. He is going to do this not because he is evil but because the consumer is not going to pay for those wages.

If significant numbers of workers cannot be that productive he will have to close down the business and try either to get a public job or come to the west of Europe where, thanks to the high accumulation of capital, the productivity of labour may allow him to contribute more than 600 euros a month to the production process. Such a situation would see capital along with labour fleeing from the East to the West, leaving behind a sorry state of unemployment and economic stagnation.

I would like to conclude on a more positive note. Enlargement could lead to the abolition of social security systems and the complete liberalisation of labour markets throughout Western Europe. By learning from eastern European societies, Western leaders may be convinced to embark on a course of reforms. If, however, they fail to take heed of the examples laid before them there is potential for enlargement to disguise the failings of the welfare state from the European public as a whole.

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