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Equality, Employment, and Budgetary Restraint: The Trilemma of the Service Economy

Published online by Cambridge University Press:  13 June 2011

Torben Iversen
Harvard University
Anne Wren
Harvard University
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This article presents an analysis of the postindustrial economy from a political economy perspective. It identifies a set of specific distributional trade-offs associated with the new role played by the services sector as the chief source of employment growth in advanced democracies over the last three decades. It is argued that three core policy objectives—budgetary restraint, wage equality, and expansion of employment—constitute a political “trilemma” that allows only two of the goals to be successfully pursued at the same time. Using a combination of statistical and caseoriented analysis, the authors demonstrate the political and economic salience of the trilemma, the distributional tensions inherent in each strategy to cope with it, and the political-institutional constraints under which these strategies are chosen.

Research Article
Copyright © Trustees of Princeton University 1998

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1 See Scharpf, Fritz, Crisis and Choice in European Social Democracy (Ithaca, N.Y.: Cornell University Press, 1991)Google Scholar; Helleiner, Eric, States and the Reemergence of Global Finance: From Bretton Woods to the 1990s (Ithaca, N.Y.: Cornell University Press, 1994)Google Scholar.

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4 The relationship between tradedness and type of sector is almost perfect except for transportation services. Thus, only about 2 percent of production in services is exported, compared with almost 50 percent in manufacturing. Contrary to popular belief, there are also no signs of an increase in service tradedness. See Gregorio, Jose De, Giovannini, Alberto, and Wolf, Holger C., “International Evidence on Tradables and Nontradables Inflation,” European Economic Review 38 (June 1994)CrossRefGoogle Scholar.

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7 For excellent expositions of the argument and the evidence, see Appelbaum, Eileen and Schettkat, Ronald, “The End of Full Employment? On Economic Development in Industrialized Countries,” Intereconomics 29 (May—June 1994)CrossRefGoogle Scholar; and idem, , “Employment and Productivity in Industrialized Countries,” International Labor Review 134, no. 4–5 (1995)Google Scholar.

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11 See, for example, Gordon, Robert J., “Productivity, Wages and Prices Inside and Outside of Manufacturing in the U.S., Japan, and Europe,” European Economic Review 31 (April 1987)CrossRefGoogle Scholar; and Ark, Bart Van, “Structural Growth Accounting and Structural Change in Post-War Europe,” in Ark, Bart Van and Crafts, Nicholas, Quantitative Aspects of Post-War European Economic Growth (Cambridge: Cambridge University Press, 1996)Google Scholar. There is also evidence for a productivity gap between services and manufacturing in the sizable economic literature on the link between real exchange rates and differential productivity growth across sectors. For recent contributions to this literature, see De Gregorio, Giovannini, and Wolf (fn. 4); and Rogoff, Kenneth, “The Purchasing Power Parity Puzzle,” Journal of Economic Literature 34 (June 1996)Google Scholar.

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15 Here and throughout the article the term “budgetary restraint” is used to indicate no or little government provision of services, and hence lower spending, taxes, and/or deficits.

16 Swenson, Peter, Fair Shares: Unions, Pay, and Politics in Sweden and Germany (Ithaca, N.Y.: Cornell University Press, 1989)Google Scholar.

17 Esping-Andersen (fn. 9)

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21 It has been suggested to us that social democratic parties have a positive preference for expanding public provision of services and that budgetary restraint is therefore not a concern. We disagree for two reasons. First, despite the rhetorical commitment to socialization of production, mainstream social democrats recognize that such socialization creates incentive problems and economic inefficiencies. Second, public provision implies higher prices on services (paid through taxes), and although the median voter may willingly sacrifice lower prices to support a certain measure of equality, this represents a trade-off where the utility-maximizing level of provision and taxes places an electoral constraint on government spending policies. We are grateful to Geoffrey Garrett for helping us to clarify these issues.

22 Jessop, Bob, Thatcherhm: A Tale of Two Nations (Cambridge, England: Polity Press, 1988)Google Scholar. The deep-seated Christian democratic suspicion of the state goes back to the “national revolution” in the eighteenth century, when church privileges were being challenged. See Lipset, Seymor M. and Rokkan, Stein, “Cleavage Structures, Party Systems, and Voter Alignments: An Introduction,” in Lipset, and Rokkan, , eds., Party Systems and Voter Alignments (New York: Free Press, 1967)Google Scholar.

23 In the U.S. case, where the worst paid and most insecure jobs are concentrated among minority groups, ethnic divisions generate demands for labor-market regulations (such as affirmative action) that are clearly contrary to the neoliberal ideal of efficiency and self-reliance. See also the discussion of dualism in Goldthorpe, John, “The End of Convergence: Corporatist and Dualist Tendencies in Modern Western Societies,” in Goldthorpe, , ed., Order and Conflict in Contemporary Capitalism (Oxford: Clarendon Press, 1984)Google Scholar.

24 Swenson, Peter, “Labor and the Limits of the Welfare State,” Comparative Politics 23, no. 4 (1991)Google Scholar. See also Garrett, Geoffrey and Way, Christopher, “The Sectoral Composition of Trade Unions, Cor-poratism and Economic Performance,” in Eichengreen, Barry, Frieden, Jeffry, and Hagen, Jürgen von, eds., Monetary and Fiscal Policy in an Integrated Europe (New York: Springer, 1995)Google Scholar.

25 OECD, , The OECD International Sectoral Data Base (Paris: OECD, 1993)Google Scholar.

26 The thirteen countries are Australia, Belgium, Canada, Denmark, Finland, France, Germany, Japan, the Netherlands, Norway, Sweden, the United Kingdom, and the United States. The study also includes Italy, but that case presents intractable data problems. Our suspicion was raised by the results for wage dispersion, which indicate that dispersion in Italy is nearly twice that of the country with the next highest score. In view of other data pointing to a relatively compressed wage structure, this is simply inconceivable; see Rowthorn, Robert “Corporatism and Labour Market Performance,” in Pekkarinen, Jukka, Pohjola, Matti, and Rowthorn, Bob, eds., Social Corporatism (Oxford: Clarendon Press, 1992)Google Scholar; and Jonas Pontusson “Labor Market Institutions and Wage Distribution,” in Torben Iversen, Jonas Pontusson, and David Soskice, eds., Unions, Employers and Central Banks: Wage Bargaining and Macroeconomic Regimes in an Integrating Europe (Cambridge: Cambridge University Press, forthcoming). As it turns out, some sectors have wages that are much higher but employment that is much lower than in comparable countries. This suggest that some of the wage data in Italy refer to small and relatively well-paid segments of all employees in certain sectors. In lieu of detailed documentation that could help us to pinpoint the problems, we had to exclude the Italian case.

27 Some data are also available for 1990–92, but they are incomplete.

28 For a fairly detailed account of sources and methods, see Meyer-zu-Schlochtern, , “An International Sectoral Database for Thirteen OECD Countries,” Economics and Statistics Department Working Paper (Paris: OECD, 1988)Google Scholar.

29 This similarity also holds for the tradedness of this sector. See De Gregorio, Giovannini, and Wolf(fn,4).

30 For some countries only a subcategory is available, while for others data are provided only for the whole sector.

31 The effect of excluding Japan points to another methodological problem, since it is well known that many financial and producer services are provided in house in Japan and counted as manufacturing, whereas in countries like Britain and the U.S. outsourcing has been very widespread since the early 1980s. See Cohen, Stephen S. and Zysman, John, Manufacturing Matters (New York: Basic Books, 1987)Google Scholar, chap. 4.

32 It is not clear that it is meaningful to assess public growth sectors in terms of their wage rates since these are politically determined; see Garrert and Way (fn. 24). Yet in countries where public employment grew fast, public wages were generally lower than in the rest of the economy.

33 The employment ratio is distinct from the more familiar concept of the employment rate (the number of employees divided by the total labor force). While the latter is highly correlated with the former, we are primarily interested in the capacity of the economy to generate jobs for those in the working-age population, not just for those registered as seeking employment

34 A more practical reason is that some pairs of figures are identical, suggesting that these are not truly independent observations.

35 Because we used lagged variables in the regression analysis, the effective number of cases is reduced to seventy-eight.

36 The branch-level data are nearly complete for twelve of the thirteen countries; for Australia earnings data are missing for several sectors. In order to obtain comparable earnings equality figures for this country, we first calculated the level of equality in all countries based on the restricted set of branches available for the Australian case. Using the relative levels of Australian earnings equality (measured against overall annual means), we then inferred the absolute levels from figures calculated on the basis of all branches in the twelve remaining countries. The procedure assumes that relative earnings equality in Australia is the same for the full set of branches as for the restricted set, an assumption that would appear fairly innocuous.

37 In a related paper we show that the trade-offs between earnings equality and employment also hold when using decile ratios. See Anne Wren and Torben Iversen, “Choosing Paths: Explaining Distributional Outcomes in the Post-Industrial Economy” (Paper presented at the annual meeting of the American Political Science Association, Washington D.C., August 28–31, 1997).

38 On average, the government wage bill constituted 14 percent of GDP in 1985, which is equivalent to about three-fourths of total civilian government consumption and somewhat less than half the total average government budget (the rest going to military spending and a variety of subsidies and transfer programs).

39 There is an analogy here to the second-generation literature on the Phillips curve, which likewise allowed for differences in the location of the trade-off between unemployment and inflation depending on national institutions (especially wage-bargaining institutions). Unlike this literature, however, our argument is not vulnerable to the rational expectations critique.

40 The argument by trade economists that competition from low-wage countries has created a negative link between wage equality and manufacturing employment would make the equality-employment trade-off in the trilemma even more severe; see Wood (fn. 3); Learner (fn. 3). However, we do not find any evidence in the data that this has occurred.

41 Important exceptions are Garrett and Way (fn. 24); and Swenson (fn. 24).

42 For details, see Beck, Nathaniel, “Comparing Dynamic Specifications: The Case of Presidential Approval,” in Stimson, James, ed., Political Analysis (Ann Arbor: University of Michigan Press, 1992)Google Scholar.

43 Ibid.

44 Only change in equality should be treated as an endogenous variable since change in employment at time t cannot affect equality at time t-1. We estimated the instrumental variable for change in equality by using all exogenous variables (both levels and change) except country dummies. Country dummies were left out to avoid problems of multicollinearity in the second-stage regression.

45 Durbin's h and m tests did not indicate problems of serially correlated error terms.

46 In fact, while the parameters are nearly identical, the t-scores for the theoretical variables (especially equality) are considerably increased if the dummies are excluded. (The ones reported in Table 3 can thus be considered lower bounds.) However, excluding the dummies has the unfortunate consequence of rendering the model no longer stationary, because different country intercepts affect the estimated parameter for the lagged dependent variable. Fortunately, multicollinearity problems are not severe enough to preclude the use of a full set of dummies.

47 Our interindustry measure of wage equality refers to the economy as a whole, which raises the logical possibility that the employment effect of equality is an unexplained consequence of wage leveling within manufacturing. To check this we tried to control for the level of interindustry equality within manufacturing. This did not substantially affect either the parameters or the t-scores. The parameter for economy-wide wage equality was in fact slightly raised, to -0.104, while the parameter for intramanufacturing leveling was small, positive, and statistically insignificant. All other parameters were essentially unchanged. In other words, what seems to matter is the degree to which wages in services are tied to wages in manufacturing—precisely what the theory tells us.

48 These simulations are logically simple (they simply employ the regression results reported in Table 3), but they are computationally quite complex because of the need for backward induction in the presence of permanent and transitory effects in three separate equations. We have devised a spreadsheet program to make the calculations more manageable; this program is available from the authors upon request.

49 The data on NAIRU and actual unemployment rates were obtained from the OECD, Fiscal Position and Business Cycles Data Base (Paris: OECD, 1996)Google Scholar.

50 The trade data are measured as exports plus imports divided by GDP, and are calculated from the OECD, Historical Tables (various years). Capital market liberalization is measured by an index of the absence of restrictions on the free movement of capital as reported in Quinn, Denis P. and Inclan, Carla, “The Origins of Financial Openness: A Study of Current and Capital Market Account Liberalization,” American Journal of Political Science 3 (July 1997)Google Scholar. Capital flow is measured as the total cross-border flows of all types of capital as percentage of GDP and is reported in Duane Swank, “Funding the Welfare State, Part I: Global Capital and the Taxation of Business in Advanced Market Economies” (Paper presented at the annual meeting of the American Political Science Association, San Francisco, 1996). We are grateful to these authors for making their data available.

51 Data on the tradedness of services also show no signs of growth. See De Gregorio, Giovannini, and Wolf (fn. 4).

52 These figures are similar to those estimated in one of the most comprehensive studies of productivity by Gordon (fn. 11), 714–16. Gordon finds that services productivity lagged manufacturing productivity in Europe and the U.S. by a factor of about 2–4 from the early 1970s to the mid-1980s. The gap was greater for Japan.

53 A likely reason is that high-productivity workers in manufacturing will seek to recapture the “productivity rent” by raising real wages, with deleterious consequences for competitiveness and employment. This is similar to the argument by Garrett and Way that cross-sectoral coordination of wages undermines wage restraint and competitiveness (fn. 24).

54 For a similar argument, see Scharpf (fn. 1), chap. 10.

55 As noted above, these simulations are logically straightforward but computationally complex. Readers who would like to make similar simulations on results derived from the same or different data can acquire a simple but useful spreadsheet program from the authors.

56 Hall, Peter, Governing the Economy (Oxford: Oxford University Press, 1986)Google Scholar, chap. 4; Ward, Terry, “From Mounting Tension to Open Confrontation: The Case of the UK,” in Boyer, Robert, ed., The Search for Labour Market Flexibility (Oxford: Clarendon Press, 1988)Google Scholar.

57 Hall (fn. 56), chap. 4; Ward (fn. 56); Compston, Hugh, “Union Participation in Economic Policy Making in France, Italy, Germany and Britain, 1970–1993,” West European Politics 18, no. 2 (1995)Google Scholar.

58 Flanagan, Robert J., Soskice, David W., and Ullman, Lloyd, Unionism, Economic Stabilisation and Incomes Policies: European Experience (Washington, D.C.: Brookings Institution, 1983)Google Scholar; Brown, William, “Incomes Policy in Britain: Lessons from Experience,” in Dore, Ronald, Boyer, Robert, and Mars, Zoe, eds., The Return to Incomes Policy (London: Pinter Publishers, 1994)Google Scholar.

59 Scharpf (fn.l), chap. 5; Hall (fn. 57), chap. 4; Brown (fn. 58).

60 Garrett, Geoffrey, “The Politics of Structural Change: Swedish Social Democracy and Thatcherism in Comparative Perspective,” Comparative Political Studies 25, no. 4 (1993)CrossRefGoogle Scholar

61 Crouch, Colin, “United Kingdom: The Rejection of Compromise,” in Baglioni, Guido and Crouch, Colin, eds., European Industrial Relations (London: Sage, 1990)Google Scholar; Hall (fn. 56) chap. 4.

62 See Ward (fn. 56); Brown, Alice and King, Desmond, “Economic Change and Labour Market Policy: Corporatist and Dualist Tendencies in Britain and Sweden,” West European Politics 11 (July 1988)CrossRefGoogle Scholar; Falkner, Gerda and Talos, Emmerich, “The Role of the State within Social Policy,” in Muller, Wolfgang and Wright, Vincent, eds., special issue, The State in Western Europe: Retreat or Redefinition? Western European Politics 17 (July 1994)CrossRefGoogle Scholar; Lane, Christel, “From ‘Welfare Capitalism' to ‘Market Capitalism’: A Comparative Review of Trends towards Employment Flexibility in the Labour Markets of Three Major European Societies,” Sociology 23, no. 4, (1989)CrossRefGoogle Scholar.

63 Ward (fn. 56).

64 Garrett (fn. 60); Crouch (fn. 61); Hall (fn. 56).

65 See, for example, Rowthorn (fn. 26); and Pontusson (fn. 26).

66 Brown and King (fn. 62); Lane (fn. 62); Falkner and Talos (fn. 62).

67 Jessop (fn. 22).

68 Calculations are based on data published in Dansk Arbejdsgiverforening, Lønstatistikken (Copenhagen, various years).

69 See Ibsen, Flemming and Stamhus, Jörgen, Fra Central til Decentral Lønfastsættelse (From centralized to decentralized wage setting) (Copenhagen: Jurist- og Økonomforbundets Forlag, 1993)Google Scholar; Iversen, Torben, “Power, Flexibility and the Breakdown of Centralized Wage Bargaining: The Cases of Denmark and Sweden in Comparative Perspectivem,” Comparative Politics (1996)Google Scholar.

70 Iversen, Torben and Thygesen, Niels, “Denmark: From External to Internal Adjustment,” in Jones, Erik, Frieden, Jeffry, and Torres, Francisco, eds., Joining Europe's Monetary Club: The Challengefor Smaller Member States (New York: St. Martin's Press, 1998)Google Scholar.

71 See Due, Jesper and Madsen, Jörgen Steen, Når der slås søm i: overenskomstforhandlinger og organisationslrukiur (Sealing the deal: Wage bargaining and organizational structure) (Copenhagen: Jurist-og Økonomforbundets Forlag, 1988)Google Scholar; Schwartz, Herman, “Small States in Big Trouble: State Reorganization in Australia, Denmark, New Zealand, and Sweden in the 1980s,” World Politics 46 (July 1994)CrossRefGoogle Scholar.

72 See Nannestad, Peter, Danish Design or British Disease? Danish Economic Crisis Policy 1974 in Comparative Perspective (Århus: Århus University Press, 1991)Google Scholar; Due and Madsen (fn. 71), 41, 55.

73 The figures are based on national election data. The growing electoral salience of the public-private sector division has been analyzed extensively in Goul-Andersen, Jørgen “Social Klasse og Parti,” in Elklit, Jørgen and Tonsgaard, Ole, eds., To Folketingsvalg (Århus: Politica, 1989)Google Scholar; and idem, , “The Decline of Class Voting Revisited,” in Gundelach, Peter and Siune, Karen, eds., From Voters to Participants (Copenhagen: Politica, 1992)Google Scholar.

74 A primary target for the reforms was the extremely generous unemployment benefit system. The center-right government was particularly keen to eliminate what it regarded as union disincentives to engage in responsible wage behavior and to reduce the overall financial burden of the system. The result has been a substantial reduction in average replacement rates; see Scheuer, Steen, “Denmark: Return to Decentralization,” in Ferner, Anthony and Hyman, Richard, eds., Industrial Relations in the New Europe (Oxford: Basil Blackwell, 1992)Google Scholar.

75 Christian parties dominated every postwar government until the early 1970s.

76 Wolinetz, Steven B., “Socio-economic Bargaining in the Netherlands: Redefining the Post-War Policy Coalition,” West European Politics 12, no. 1 (1989)CrossRefGoogle Scholar.

77 Ibid.; Kersbergen, Kees Van and Becker, Uwe, “The Netherlands: A Passive Social Democratic Welfare State in a Christian Democratic Ruled” Society, Journal of Social Policy 17, no. 4 (1988)Google Scholar.

78 Braun, Dietmar, “Political Immobilism and Labor Market Performance: The Dutch Road to Mass Unemployment,” Journal of Public Policy 7, no. 3 (1987)CrossRefGoogle Scholar; van Kersbergen and Becker (fn. 77).

79 Jones, Erik, “The Netherlands: Top of the Class,” in Jones, Erik, Frieden, Jeffry, and Torres, Francisco, eds., Joining Europe's Monetary Club: The Challengefor Smaller Member States (New York: St. Martin's Press, 1998)Google Scholar.

80 With the election of a socialist government in 1990, minimum wages were recoupled with average wages.

81 The remarkable stability of earnings differentials over the last decade is also noted in Jelle Visser, “Two Cheers for Corporatism, One for the Market: Industrial Relations, Unions, Wages and Labour Markets in the Netherlands,” British Journal of Industrial Relations (forthcoming).

82 Ibid.

83 Seventy-five percent of the increase in service sector employment between 1985 and 1990 was part time. With the exception of Belgium, no other EC country recorded a value of more than 43 percent (Germany). Eighty-six percent of part-time employees in the Netherlands are female. Cf. Meulders, Daniele, Plasman, Olivier, and Plasman, Robert, Atypical Employment in the EC (Brookfield, Vt.: Dartmouth Publishing Co., 1994)Google Scholar.

84 By 1989 an astonishing 13 percent of the total labor force was listed as worker disabled; Jones (fn. 79).

85 Kloosterman, Robert C.“Three Worlds of Welfare Capitalism? The Welfare State and the Post-Industrial Employment Trajectory in the Netherlands after 1980,” West European Politics 17, no. 4 (1994)CrossRefGoogle Scholar.