A crisis of neoliberalism has been redefined as one of the so-called "European social model", and neoliberalism is hailed as the answer.' Colin Crouch uncovers the fiction at the heart of austerity politics.

For the EU's leaders, an intelligent response to the plight of Greece and the other southern European debtor countries would be to offer an extension of debt repayment timetables in exchange for their shifting their welfare states away from their current stress on pensions and some other transfer payments, and towards services that improve the quality of the workforce and economic performance, and meet the needs of dual-earner families. Instead, the austerity being imposed on them works in exactly the opposite direction.

The only plausible justification for this course of action is that by exposing labour to an extreme level of insecurity and forcing wages down, these countries' goods will start to compete effectively with very low-cost producers in central and eastern Europe, if not also in the far east. It is one thing for workers in the Baltic states, Bulgaria or Romania to pursue such a approach – they are starting off with very low incomes, and welcome the prospect of gradually earning more. Workers in the south-west European countries, however, would first have to accept a very major decline in their living and social standards, and it is not clear that populations can accept this without serious dislocation and social disorder.

Misunderstanding the European social model

There are two major flaws in the chain of reasoning that has led to this point. First, there is a false perception that the problems of Greece, Italy, Portugal and Spain began either with excessive social spending or at the moment they joined the eurozone. But, on the contrary, these countries' economies had thrived as the low-cost producers of a protected western European economy. That role was doomed to end, first with the loss of protection against cheap textile and clothing products from the far east, and then with the entry of the countries of central Europe into the world economy. Both of these events happened during the 1990s. Now, pursuing the traditional southern strategy of repeated currency devaluations to keep their export prices lower than their competitors' promised nothing better than a future of deteriorating living standards. By taking away the devaluation option, joining the euro was supposed to incentivise these economies to move up- rather than downmarket. For two reasons, with exceptions in some regions of Italy and Spain, this did not happen. First, the dominant neoclassical economic thinking simply assumed that these incentives would work, with no thought for the social investment strategies that would be needed to actually bring about the implied changes. Second, financial deregulation was enabling the world's banks to engage in the irresponsible lending that culminated in the 2008 crash. Southern European governments, like many elsewhere, took advantage of this to build up high levels of public debt as an alternative to seeking substantive improvement in their economies.

The second flaw in the austerity reasoning is the insistent claim that the failure of these south-eastern economies marks a failure of the so-called 'European social model'. However, the southern economies have never been examples of what is usually understood by this model. Their welfare states are among the least generous in the advanced world, and their tax systems among the least redistributive. Their levels of inequality are high, more like that of the United States and quite unlike those of the north-western European countries that are historically associated with a strong social model. Furthermore, unlike those countries, their labour markets do not feature strong, coordinated collective bargaining; wage bargaining is highly fragmented and unions are weak. This false diagnosis – that their problems are those of strong welfare states and labour rights – is another factor driving policymakers off in the wrong direction, away from what these economies really need.

Today we are at another stage in a process that has been going on for more than two decades. In the 1990s the most influential voices in policymaking in Europe and elsewhere insisted that there was only one way to achieve economic success, and that was the American or neoliberal way: a mean welfare state, weak trade unions, low taxes and a high level of inequality. This ignored the difficulty middle-sized and small economies might have in trying to imitate the only country that maintains a global currency and is therefore able to ease market constraints by printing money without risk. Arguments of this kind subsided during the early 2000s, when the success of the Nordic economies became impossible to ignore, and organisations like the EU and OECD began to accept that there was a variety of ways in which economies might find success. Particular emphasis was placed on combining labour market flexibility with new ways of achieving security for workers – what became known as 'flexicurity' – through ideas derived initially from Denmark and the Netherlands. There was also considerable enthusiasm for the idea of the social investment welfare state, which saw social policy not as a drag on the economy but as an instrument for improving education, upskilling the workforce, and helping two-earner families to balance work and the other aspects of their lives.

Neoliberalism lives: a crisis redefined

It is reasonable to think that this new perspective might have been intensified following the banking crisis of 2008. In the first instance the crisis was a neoliberal one, resulting from irresponsible banking behaviour enabled by market deregulation. States intervened to resolve the crisis, on the grounds that the sector was too important to the general economy to be allowed to collapse. This seemed to be a fivefold defeat for the neoliberal model. First, the earlier success of the neoliberal economic approach could be seen as having been based in part on consumer debt. Second, it clearly disproved the economic theory that failure of deregulated finance was impossible. Third, if firms could become so large that they could not be permitted to fail, then this was not a true market economy. Fourth, state intervention of the kind required for the bank rescue contradicted the tenets of free-market doctrine. And fifth, neoliberal economies do not in theory run up high debts, but the involvement of several of them in the crisis – including Ireland, the UK and US – meant that they were found among the world's major debtor states.

Meanwhile, the Nordic countries and some others with extensive welfare states were achieving a major reduction in their public debt. During the height of the crisis, many resorted to increases in social protection in order to ease its impact. There were also moves to use collective bargaining as a means of achieving some public policy goals, with unions and employers working together to reduce working hours and pay in order to avoid or lessen job losses. While this approach was most prominent in western Europe – including in the UK and particularly Germany, where it received government support – it also extended to several central European countries.

Overall, one might have expected moves not towards a general European social model, because there has never been one, but towards a north-western European model at least – but the opposite happened. On the back of expensive bank-rescue efforts, state debts grew dramatically. What had originally been a crisis of private debt and bank irresponsibility could be redefined as one of public debt and state irresponsibility, which was in turn redefined as a crisis of welfare state irresponsibility and excessively protective labour laws. The depth of the recession has enabled business interests to argue further that, unless they are given full freedom to operate, they will be unable to deliver prosperity and employment will suffer. This in turn is producing a reversal of EU policy on environmental damage and climate change. In short, a crisis of neoliberalism has been redefined as one of the so-called 'European social model', and neoliberalism is hailed as the answer.

Meanwhile, in those countries where such a social model really does exist, other major social and economic developments are working to undermine it. Trade union membership is declining; inequality is rising; welfare states are becoming less generous. In Germany, the major changes associated with unification after 1989 have accelerated existing trends away from shared decision-making (or codetermination) and coordinated collective bargaining. The decisions of the European Court, single-mindedly pursuing a competition agenda, are making it difficult for the Nordic unions to maintain the coordination and 'encompassingness' that have been an important feature of the successful labour market institutions in that part of the world. The overall change has been for stronger market governance, a move away from active labour market policies towards 'workfare', and a deteriorating position for the poor. One paradoxical consequence of this combined development is that, at a time when the capacity of societies for internal solidarity and collective capacity might seem to be most needed, its supports are being systematically opposed and undermined by those most responsible for their governance.

Colin Crouch is a sociologist and political scientist, and is currently emeritus professor at the University of Warwick. His new book, Governing Social Risks in Post-Crisis Europe, has just been published by Edward Elgar.