Economic Viewpoint
WHAT'S WRONG WITH A CENTRALIZED EUROPE? PLENTY
BY GARY S. BECKER

06/29/1998
Business Week
22
(Copyright 1998 McGraw-Hill, Inc.)

Many political leaders in Europe consider the euro to be a major step toward greater concentration of power by European Community bureaucrats in Brussels. I fear that further centralization of power would be bad for their economies by reducing the competition among governments for business.

It is often claimed that government competition should be avoided because it produces a ``race to the bottom,'' with companies discouraging regulations and taxes by threatening to move to more pliable nations. Although migration of business sometimes does limit the ability of states to implement the right policies, there is little evidence that European taxes and regulations have been kept down excessively by intergovernmental competition. The average European country devotes about half its gross domestic product to the public sector, far more than enough to support proper government activities. It also extensively regulates business, labor markets, and other activities. LINGUA FRANCA. For example, these nations heavily penalize companies that reduce employment, and they have promoted union demands for rigid, centralized labor negotiations rather than more flexible local bargaining. Indeed, such excessive regulation of the labor market, combined with high taxes on labor, help explain why unemployment in Western Europe remains above 11% despite the healthy upturn in output during the past year, and why private employment has hardly grown in 20 years.

However, unions, industries, and other powerful groups are worried by the strong trends in Europe during the past couple of decades toward greatly increased mobility of capital across borders. It has become much easier for capital to choose the most favorable location in the European Community.

Labor mobility is also increasing, because citizens can now take jobs anywhere in the common market and are usually taxed by the country of employment rather than of citizenship. Moreover, the growth of English as a common language among more educated Europeans has made it easier for them to hop borders to work.

This greater integration of capital and labor markets has strengthened the competition among member nations for business. In this way, London has become the most powerful financial center in Europe because regulations on financial transactions, and income and other taxes, are lower in Britain than in France, Germany, and other countries. Many Continental investment and stock companies find they can reduce costs and increase flexibility by locating their activities in London.

A doctoral study being done by Jeanne-Mey Sun, a graduate student at the University of Chicago, suggests that the trend toward global capital markets has forced nations to reduce taxes and regulations on stock transactions. Companies now have the ability to choose to raise equity and float bonds in countries with relatively low taxes and few onerous regulations on financial transactions. WEASEL WORD. The increased competition among European governments for business helps explain why such interest groups as unions and steel companies, along with many politicians, are keen on further harmonization of policies. Politically powerful groups can more easily preserve their privileges if the capacity of these governments to compete against each other is weakened.

Harmonization in this context is a weasel word that really means centralization of tax and regulatory authority by imposing more uniform rules and taxes on member nations. Examples include the efforts by the Brussels authorities to have all member nations tax dividends and capital gains at the same rate, standardize regulations and taxes in labor markets, and have uniform value-added taxes.

Competition among states in the U.S. for business and labor has also weakened the power of interest groups to impose their will over state governments. The U.S. economy is fortunate in having more highly mobile labor and capital than Europe. Resources can more easily move out of the most excessively regulated and taxed states into those with more attractive economic environments.

Still, the U.S. would also be better off by decentralizing further and encouraging more competition among states. This can be accomplished by further devolution of regulatory and taxing powers toward state governments and away from the federal government.

Competition among nations tends to produce a race to the top rather than to the bottom by limiting the ability of powerful and voracious groups and politicians in each nation to impose their will at the expense of the interests of the vast majority of their populations.