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The two big lessons for the UK from Germany and the Nordics

Social investment welfare spending is central to future prosperity and the state has to become a more active and assertive economic actor.

The Reichstag building housing the German parliament Bundestag. Photograph: Getty Images.

There are two big economic debates in Britain today. The first is the familiar one about whether austerity is the right response to the aftershocks of the global financial crisis that pushed so many countries around the world into deep recession, leaving a colossal debt overhang. The second, and no less important, is the question of whether Britain can craft a more sustainable growth model, if not a new political economy. To a large extent, the government seems intent on sidestepping this question, mainly resorting to quick fixes like subsidised mortgage credit, and sticking plasters, like timid banking reform and lower corporation tax, to recover the economic output that has been lost since 2008. Labour, in contrast, sounds more ambitious and has repeatedly advocated the need for deeper reform of the British economy.

The case for reform is indeed strong: despite hosting numerous leading edge companies and sectors, together with world class universities and a strong labour market, the UK remains a worryingly weak export nation gripped by excessive financialisation and rising consumer debt. Business investment is pitifully low and productivity failing to improve. Many companies struggle to offer decent, let alone quality, employment. From this perspective, the recovery looks far less impressive.

No wonder, therefore, that progressive policy-makers look for inspiration to countries that appear to offer a more attractive socio-economic model of development. For many on the British left, Germany provides the answers: its strong manufacturing base, ingenious system of apprenticeships and vocational education, and network of regional banking would guarantee a better balanced, more competitive, higher wage economy. Its record low youth unemployment rate, now below 8 per cent, is a case in point. Yet if Labour is right in wanting to pursue an agenda of radical economic change, is it also correct in singling out the German model as a beacon for Britain? The answer is: yes and no.

If policy emulation and international comparison are imperative for countries to improve their own policies, path dependency, long-standing traditions and all sorts of political obstacles put a clear limit to what can actually be transposed.  For instance, Germany’s system of municipal, non-for-profit banks (Sparkassen) goes back to the 18th century. Over more than 200 years they have built up a market share of nearly 40 per cent in retail and SME banking, generously aided by explicit state subsidies, now suspended. How to replicate such a system under present-day conditions, in which new entrants face formidable hurdles, is hard to imagine. And is Britain really dealing with a crisis of "safe lending"? The evidence remains inconclusive. In other words, mutual policy learning requires a much greater capacity for adaptation, experimentation and institutional renewal within set boundaries. Grand ambitions alone do not suffice.

There is another important caveat: as the political economist Kathleen Thelen has argued, the coordinated social market economies, like Germany, have been liberalising in recent decades too, creating new forms of dualism between low wage service sector employment and the high-skill export sectors. While precarious working conditions increased significantly, real productivity growth did not occur. Germany has its very own set of competitiveness weaknesses, ranging from highly unfavourable demographics (the highest median age in Europe) to, skill shortages in important export sectors and a creaking infrastructure.

We just cannot import a new political economy. This is all the more true given the enormous pressures that any successful economic model is currently facing. As in the case of Germany, the Nordic countries, the traditional standard bearers of centre-left aspiration, have their fair share of challenges – whether in the fight to combat unemployment, most notably in Sweden, the quest to maintain and secure educational excellence, or the economic integration of migrants. Moving on from the policy frameworks and partnerships of the 20th century to new, innovative forms of governance fit for the 21st century is proving difficult everywhere in the industrialised world.

Britain must learn selective lessons from northern Europe and beyond, adjusting reforms to its own particular institutions, geography and policy trajectories. Two immediate lessons stand out. First, social investment welfare spending remains absolutely central to future prosperity. Contrary to what many conservatives claim, strategic investments in childcare, welfare-to-work or retraining programmes underpin high employment rates, productive economic growth and fiscal resilience. The big challenge for Labour is how to increase the level of social investment while decisively cutting the deficit. Stark choices have to be made.

Second, the state has to become a more active and assertive economic actor. This can mean devising fine-grained industrial strategies for key sectors, coordinating employers to organise and invest in apprenticeships and skills, or sponsoring new links between leading edge SMEs and public sector agencies. But it should also be about empowering cities with tools for economic development as well as new forms of fiscal devolution. As the economist Wendy Carlin and others have shown, cleverly designed supply-side polices can promote dynamism and reduce inequality.

The bottom line is that the state will continue to evolve from the traditional welfare role towards an agent of modernisation and structural reform. Best practice from abroad will be an indispensable guide – but only if applied in the right way.

Olaf Cramme and Nick Pearce are, respectively, directors of Policy Network and the Institute for Public Policy Research. The conference “A New Political Economy for Britain’ takes place on 30 January