The problem with models

This is a piece I wrote for Courtiers, a financial advice firm based in Henley.

One of the few virtues of the Soviet Union was that it helped keep things simple. Economic and political debate essentially boiled down to a stark choice between capitalism and the Soviet model.

Of course there was always some room to discuss details such as how best to tackle unemployment or curb inflation. But the most important question was where to stand in the battle over the relative merits of the Soviet Union and the market economies.

The demise of the Union of Soviet Socialist Republics (USSR) more than two decades ago decisively resolved this fundamental dilemma. Although western economies are troubled at present they remain intact. In contrast, the Soviet Union is long gone and almost entirely unlamented.

However, the debate on competing models has not disappeared. Instead it has switched to a heated exchange about the virtues and vices of different types of capitalism.

Indeed the new debate emerged in the 1980s, when the USSR was still intact, with Japan increasingly lauded as an attractive model. Numerous books, television programmes and newspaper articles predicted that Japan would surpass America as the world’s leading economic power by about 2000. Advocates of the Japanese model generally admired the way in which state institutions apparently helped to promote a dynamic industrial sector.

The appeal of the Japanese model lasted for only a few years. Just as Japan’s advocates were working themselves into an excited frenzy the economy entered a period of over two lost decades of sluggish growth. According to the International Monetary Fund its share of global output fell from 10.2% in 1991 to 5.6% in 2012 (figures calculated at purchasing power parity).

Nowadays the advanced economies are typically divided into two broad camps. On one side, are the Anglo-Saxon or “neo-American” economies led by America but with Britain also playing a prominent role. On the other, is what could be called the Rhine model led by Germany but including Austria, the Netherlands, Switzerland and arguably Scandinavia.

The term “Rhine model” was coined by Michel Albert, the chairman of a French insurance company and an economist, in a book first published in French in 1991. His concern then was to argue that, on balance, France should opt for Rhine capitalism rather than the neo-American variant.

Supporters of the Anglo-Saxon model argue that the free market is the most dynamic and innovative economic system. They acknowledge recent troubles but argue that the flexibility of the Anglo-Saxon economies bode well for recovery.

Critics of America and Britain identify what they consider several key weaknesses. They argue that these economies had become too dependent on credit and consumption. Both nations are accused of living beyond their means. Excessive inequality and individualism are also often seen as undermining social cohesion.

In contrast, supporters of the Rhine model argue that citizens of these countries have succeeded in living within their means. They also point to the export success of these economies – in Germany centred on the Mittelstand of medium-sized businesses – as well as their egalitarian ethos.

Proponents of the Rhine model stretch across the mainstream political spectrum. British admirers of Germany have ranged from Maurice Glasman, a former adviser to Ed Miliband, to John Cridland, the director-general of the Confederation of British Industry. The CBI chief was particularly keen for more government support of the “forgotten army” of medium-sized firms so they can be more like the Mittelstand.

Many admirers of the German economy are also particularly keen on its corporatist model of Mitbestimmung (codetermination) in which worker representatives sit on the supervisory boards of companies. In exchange unions have proved willing to accept lower wages and structural reforms. It is not widely recognised in Britain that real wages in Germany have stagnated since the early 1990s. In that sense austerity was apparent in Germany long before it was imposed here. Such wage moderation is not unique to Germany. In the Netherlands, for example, the “polder model” of consensus between employers, unions and the government has brought similar results.

Even from this brief survey it should be clear that there are significant economic differences between English-speaking countries and the German-centred bloc of Northern Europe. But there are several reasons to be wary of declaring these as distinct models.

To the extent that they have different features they are not easy to replicate. For instance, it would be difficult for British firms to follow Germany’s success in vocational training or in manufacturing machine tools. Declaring either one as a target would be easy enough but achieving the objective would be another matter.

More importantly the differences between the two sets of economies are routinely exaggerated. American and British business leaders might like the rhetoric of free markets and limited government but that is far from what they have in reality.   State spending in the English-speaking world is roughly on a par with that in the Rhine countries

At the same time the Rhine countries are in many respects becoming more like their Anglo-Saxon peers. Despite Germany’s industrial success the share of manufacturing in the economy has slumped since 1970. Even Sweden, renowned for its egalitarian ethos, has had a centre-right government since 2006 and has widening inequality.

Perhaps the best reason to be wary of following any particular model is the claims made by some of their followers. Any system in which popular living standards stagnate for many years clearly has serious problems. The goal should be to promote popular prosperity over the long-term. In that respect both the Anglo-Saxon and Rhine models look unattractive at present.