Europe's Social Cushion Is Looking Rather Frayed

Last April, on the eve of the Hanover Trade Fair, Germany's biggest industry expo, Chancellor Helmut Kohl got an earful from disgruntled German bosses. We're not paying one more pfennig in social welfare, they told their leader. Breaking with a century-old consensus that guaranteed the world's plushest social cushion--now costing $590 billion annually--Germany Inc. is in revolt.

The last straw is $9.4 billion a year in long-term nursing-care insurance Bonn plans to introduce next year, to be financed by a payroll tax. Usually, employers meekly split social charges equally with their workers. But this time, they're howling. New taxes, warns German Employers Federation President Klaus Murmann, will "impose an extra and dangerous dynamic to wage costs."

A sudden about-face is sweeping Europe. Only a few years back, Europeans were debating how to extend generous social protection across the new single market to balance sweeping deregulation. But a visionary social charter vanished under the weight of growing joblessness and soaring budget deficits. Universal coverage for health care, pensions, and unemployment gobbles up around 30% of gross domestic product across Europe (chart). Leaders are now agonizing over how to scale back the most expensive items. Some argue that high costs are choking off jobs and will prolong the recession. "It's time to redesign the systems," says Andrew Dilnot, director of London's Institute for Fiscal Studies. "All Western European governments are struggling with this."

From Milan to Manchester, a whipsaw effect is at work. Recession is draining government coffers as unemployment rates pass 10% in some countries, cleaning out benefit funds faster than sluggish tax revenues can replenish them. At the same time, structural problems cut ever deeper into spending. Across Europe, as in the U.S., demand for better and increasingly costly medical treatment has sent health expenditures soaring--in France, up 6.5% last year alone. And Europe's graying populations spell long-term problems for social security pensions systems. French officials warn that if current trends continue, France's pay-as-you-go pension system will be bankrupt by 2010. Britain's system, too, is on the brink, and politicians are considering postponing women's entitlement to full pensions until age 65, like men, instead of 60, as currently.

Companies are screaming, insisting their share of the levies is making them uncompetitive in global markets. In Italy, employers pick up more than half the costs, while German companies figure compulsory charges, plus other benefits such as paid vacations and maternity leave, nearly double hourly wage costs--making them the highest in the world. In France, companies such as auto maker Peugeot are struggling to compete with lower-cost producers around the world. "If we are required to compete with other countries that offer no social protection," says Peugeot Chairman Jacques Calvet, "we will continue to do away with jobs indefinitely."

VOTER BACKLASH? Adding to the crisis, Europe's governments are reeling under mounting budget deficits. Britain is facing a $75 billion gap, approaching 8% of GDP. German Finance Minister Theo Waigel warns that unless he finds $16 billion in spending cuts, Germany's federal deficit will careen to $53 billion next year, double the original target. "Expectations for constantly increasing prosperity must be revised," says Waigel.

Politicians aren't about to cut too deeply, though, fearing a voter backlash. So for now, the big savings will have to come from restricting benefits and making everyone cough up a little more. France is considering higher hospital charges and new user fees for its medical plan. Germany has strong-armed physicians into prescribing generic drugs whenever possible.

It's no surprise that most Europeans want to keep their social net but don't want to pay more for it. But as recession bears down and global competition heats up, that is proving unattainable. At best, Europeans will have to pay the same--or a bit more--for less service. Nobody is willing to foot the huge bills to keep the old system intact--certainly not Germany's bosses.

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