The Choice: Dynamic Capitalism vs. the Welfare State
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The Fiscal Times
April 24, 2012

Those who favor a free market approach to managing the economy often compare the U.S. to Europe. Europe, it is argued, is much less flexible and dynamic than the U.S. because of its heavier reliance on social insurance, worker protections, and the high tax rates needed to support these programs. Nobel Prize winning economist Edmund Phelps has argued, for example, that “the free enterprise system is structured in such a way that it facilitates and stimulates dynamism while the Continental system impedes and discourages it.” According to Phelps and others, the greater reliance on the free market system in the U.S. results in faster and more robust economic growth.

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There is an implied tradeoff here. In the U.S. system, workers have less protection and hence more insecurity than in countries where protection is more prevalent. In return for giving up security, there are two promised benefits. First, it is argued, economic growth will be higher. With less government interference, lower taxes, and unions all but absent, the economy will be free to reach its growth potential.

Second, the economy will be more stable. If a big shock hits the economy, the U.S. will be able to reestablish full employment in new, productive, high-paying jobs much faster than countries with greater social protections and the flexibility inhibiting institutions that come with them.
If these two benefits are large, then trading security for dynamism, flexibility, and higher growth will be more than worth it. So has the economy lived up to these promises?

Turning to growth first, there is reason to question whether it’s true that, before the Great Recession, the U.S. outperformed Europe. If it did, and there’s some evidence pointing in this direction, the difference is relatively small and has been diminishing over the last decade. But even if growth was a bit higher in the U.S., the benefits did not go to the households experiencing the greatest increase in insecurity, those at the lower end of the income distribution. Instead, the gains went mostly to those at the top.

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What about the other promised benefit of a general free market approach to managing the economy, a better ability to withstand and respond to shocks? Has the U.S. fared better than European countries during the Great Recession?

The U.S. did better than some European countries during the crisis, but worse than others. For example, harmonized unemployment rates from either the Bureau of Labor Statistics or from Eurostat show that the U.S. unemployment rate increased more than most European rates at the onset of the crisis, and that right now the U.S. unemployment rate is higher than in Germany, the Netherlands, Austria, Belgium, Denmark, Finland, and Sweden. But at the same time, the U.S. unemployment rate is quite a bit lower than in Greece, Spain, Ireland, and Portugal, a bit lower than in Italy, and very similar to the U.K. 

University of Oregon macroeconomist Mark Thoma writes primarily about monetary policy its effect on the economy. He has also worked on political business cycle models. Thoma blogs daily at Economist’s View.