Column : Does Europe hold a lesson for India

Written by Michael Walton | Michael Walton | Updated: May 28 2010, 03:25am hrs
Europe looks sick these days. Greece is in a deep crisis that blends fiscal insolvency with ferocious social discontent. Loss in confidence is spreading to other countries hit by bursting asset bubblesnotably Ireland, Portugal and Spain. The euro has weakened sharply. The new UK government has promised draconian spending cuts to extricate itself from a massive debt build upstarting now.

So is the European model of a beneficent welfare state dying in a globalising world Did the crisis just bring this to a head And what does this imply for Indias aspirations Indias current political economy supports a mix of globalising capitalism and expanding social support, to foster inclusion and manage risks. Its a long way from a welfare state, but thats the direction. If the European welfare state is broken, does India (and other countries) need to think again No, and yes. It depends on whether the long-run road is towards Germany or Greece.

Lets look at Europes problems. They flow from two sources. First, there was excessive optimism in the heady pre-crisis days, optimism that poured resources into Irish, Spanish and British real estate, and in which risks were mispriced for a whole set of now-familiar reasons, just as in the US. For countries in the EU there was an added twistmembership was thought to confer German levels of sovereign risk. This was despite the official no-bailout clause the Germans imposed on the systemnow superseded by the Greek rescue package. The premium on Greek, Irish, Portuguese and Spanish sovereign debt only rose when the markets woke up to the depth of their short and long-run problems.

Second, most governments did a poor job on contra-cyclical fiscal policy. Or rather they correctly increased deficits in response to collapsing private demand when the crisis hit, but they hadnt prepared for rainy days in the good times. Thats why the public debt problem became so bad. But theres nothing European about this. Presidents George Bush of the US and Hugo Chvez of Venezuela had in common that they both blew healthy fiscal positions in good years. Running a surplus in upswings is politically hard. One of the few countries that managed this well was Chile, whose finance minister Andrs Velasco (who happens to be a colleague from the Harvard Kennedy School) was highly unpopular when he held back spending during the copper-fuelled boom years, but could then let spending flow when the crisis hitand became publicly celebrated.

The point is that current European woes have little or nothing to do with the welfare state. There is an older argument about productivity, but that is also weak. After adjusting for lower work hours (and so more leisure) productivity in France is comparable with the US, with other rich European countries close. Is this a puzzle Economic theory suggests high taxes and benefits would sap effort, and that distortions rise exponentially with the tax rate. By this account, Sweden should be wildly inefficient compared with the US. But Sweden is also highly productive because other things arent equal: it has designed a much less distortionary tax system than the US and faces strong political pressures for effective services, precisely because taxes and spending are so high. Thus, a blend of high productivity capitalism and social welfare is feasibleand a reasonable aspiration for an emerging market economy such as India.

But lets get back to Greece. Anger on the streets is in part focused on that favourite receptacle for rage, the IMF, but also expresses the feeling of betrayal by what is seen as an incompetent and corrupt political class. Greece has a public sector that is patronage-ridden and ineffective, has fostered unaffordable privileges, and is undercut by widespread tax avoidance. This cannot, in the long run, support the historically successful European blend of dynamism and social provisioning.

So what road should India travel All my instincts are that India needs comprehensive and equitable systems of social provisioning: in other words to construct, over time, an efficient modern welfare state, especially needed in a socially heterogeneous society with a vigorous democracy. And this is good for globalisation on grounds of both social morality, since households are better protected, and politics, since citizens are more likely to support dynamic capitalism. But if the future of Indias political class and public sector is more like Greece than Germany, that wont cut it in todays globalising world; and not least because India will unavoidably become more integrated financially, and so more vulnerable to herd-like shifts of market sentiment. European-style social provisioning is viable, and desirable, in the 21st century, but only if underpinned by an effective and accountable state.

The author is at the Harvard Kennedy School and the Centre for Policy Research