Slowly but surely, stagnation is stalking some of the world’s biggest economies. Whether it is low growth, astronomical public debt, inflationary pressures, unimpressive productivity, affordability issues, housing shortages, high energy prices, or weak levels of entrepreneurship, Western economies are far from healthy.
Though specific events, like the wars in Iran and Ukraine, have contributed to these developments, many Western leaders persist in blaming their nations’ economic troubles on “neo-liberalism.” British Prime Minister Andy Burnham, for example, has asserted that the economic policies associated with the Thatcher era are responsible for his country’s present challenges.
Others recognize that the opposite of free markets—excessive government intervention—has contributed mightily to the economic problems facing Western countries. Back in 2024, former European Central Bank President Mario Draghi published an official European Union report that identified over-regulation and excessive bureaucracy as key to the economic sclerosis of many European nations.
Alas, many such admissions are accompanied by the insistence that more state intervention is part of the solution. Draghi’s report, for instance, argued for greater Brussels-driven regulation, the wider use of industrial policy, and increased government expenditures if the EU was to avoid becoming an economic backwater. It was as if, having grasped the essence of the problem, the report’s drafters felt compelled to make an act of faith in the curative economic powers of the state.
This is an example of the hold of the social democratic mindset on so many policymakers. But however strong that grip, it cannot disguise the fact that social democratic policies are presently imploding around the world under the weight of their own contradictions. Today, we are witnessing the clash between an increasingly redundant social democratic settlement and the political and economic facts of the early twenty-first century. Until we acknowledge that social democratic commitments are central to our present economic problems, they are likely to worsen.
Who’s a Social Democrat?
Clarity about the meaning of “social democracy” is important here. Contemporary expressions of social democracy do not mean socialism, let alone Soviet-style planned economies. Indeed, the roots of modern social democracy lie in the rejection of outright socialism by sections of the postwar left.
As early as the 1950s, some Western socialist and labor parties started rejecting reliance on Marxist analysis and began to excise commitments to the socialization of the economy from their platforms. This was exemplified by the German Social Democratic Party’s decision in 1959 to formally reject Marxism as one of its primary reference points and embrace what it called “liberal socialism.” Economically speaking, this translated into the position of “as much competition as possible—as much planning as necessary.”
The irony is that many center-right parties had already moved towards similar positions, albeit from the opposite direction. While continuing to denounce socialism, parties ranging from Britain’s Conservatives to Australia’s Liberal Party and large segments of the US Republican Party quietly accepted the postwar economic orthodoxies that stressed Keynesian macroeconomics, the necessity of large welfare programs, the application of industrial policy to many economic sectors, and strong regulatory agencies. The resignations from Britain’s Treasury of the Chancellor of the Exchequer, Peter Thorneycroft, and his collaborators Enoch Powell and Nigel Birch in January 1958 in opposition to the MacMillan Tory government’s decision to augment public expenditures underscored the marginalization of robust belief in free markets on the right.
What made this postwar bipartisan blend of markets and extensive government intervention “social democratic” is that it represented an effort to blend commitments to freedom (“democratic”) with a determination to use the state to meet specific collective needs (“social”). Many of the latter were ideologically premised on the idea of social rights to legitimize, as a matter of justice, interventionism and especially policies of unending redistributions of wealth.
Over time, the balance between the “freedom” and the “social” has waxed and waned. In the 1960s, economic liberty and its underlying institutional foundations were significantly diluted by Western governments seeking to realize assorted social rights. By the 1970s, it was recognized that these measures, such as full employment policies, were contributing to a widespread economic malaise. Free marketers were consequently given some scope to liberalize parts of the economy. This is much of the economic story of the 1980s and 1990s.
That said, no Western country—including America—has decisively rejected the social democratic emphasis on using government power to give effect to social rights. Despite generations of market liberals raising searching questions about, for example, the long-term viability of big welfare states, social democracy’s most significant institutional expressions have thus far defied systematic dismantling. In many ways, the period often labelled the “Age of Markets”—roughly 1980 until 2008—is better understood as one which demonstrated the resilience of social democratic priorities rather than the victory of market liberalism.
The Bill Comes Due
The capacity of social democratic agendas and institutions to resist efforts to shrink their importance cannot disguise the multiple ways in which they are faltering throughout the world. The unaffordability of the jewel in the social democratic crown—the welfare state—is the most obvious case.
In 2024, for instance, government expenditures on “social protection” in the EU added up to almost 40% of all state spending (19.6% of GDP), dwarfing spending on core state responsibilities like national defense. That same year, according to the OECD, France, Germany, Britain, Italy, and Japan spent respectively 30.6%, 27.9%, 27.6%, 24.7%, and 23% of their annual GDP on “public social spending.” This included health, old-age pensions, disability benefits, family allowances, labor market programs, unemployment payments, and housing assistance. When government expenditures on activities such as education, public utilities, or subsidies to assorted businesses and industries are added to the overall bill, the demand on the public purse—and therefore the need to extract more wealth from the private sector, and/or deepen public debt—becomes even more pressing.
Fundamentally rewriting the social contract will require, at a minimum, the subordination of social rights to the demands of liberty and wealth creation.
Among the consequences of these trends is a shifting of resources away from the more efficient private sector. That has implications for productivity. And when social programs like disability benefits become easier to access, the disincentives for people to work grow. This further diminishes an economy’s wealth-creating capacities.
The long-term effects of these and related developments are not difficult to identify. Governments that increasingly resort to borrowing to cover the costs of social programs find that an expanding share of their annual budgets goes toward interest payments. As the size of public debts grows, interest rates go up. Servicing the public debt thus becomes progressively more expensive. Some governments will raise taxes to try to cover their social spending costs. But that also disincentivizes people to be entrepreneurial or work, thereby further weakening productivity.
If you talk to enough policymakers, few will deny the reality of this vicious fiscal circle or its unsustainability. Why then are so many of them unwilling to pursue the type of reforms necessary to address these problems?
Efforts to scale back social democratic policies invariably encounter three obstacles today. One is the existence of large constituencies who will resist any effort to reduce what they regard as “their” entitlements by voting or rioting against anyone proposing substantive reforms. The second is the willingness of many political parties of all stripes to pander to these parts of the electorate by promising not to touch entitlements. The third is the ongoing popularity of appeals to existing or newly imagined social rights to maintain or extend the state’s role in the economy.
Reform Failure
Any one of these factors constitutes a serious barrier to reform. Overcoming all three presently seems beyond the capacity of our present political arrangements. The looming risk is that the lumbering social democratic dinosaur, in its frantic search for more revenue and driven by the desire to appease large voting blocs, will cripple in its wake many of the freedoms, incentives, and institutions that generate the wealth that we need not simply to survive but also to flourish. Equally concerning is how the dysfunctionalities of present-day social programs are fueling a generational conflict between 1) those retirees who paid into social security systems and expect to continue to be paid; and 2) young people who suspect that they are presently subsidizing the incomes of comfortably off pensioners and who wonder if they will get anything at all when they enter old age.
Here and there, Western governments of left and right have implemented incremental changes to try and address these tensions. Yet far too many of these initiatives have come undone.
In 2023, for example, France implemented a pension reform that raised the retirement age from 62 to 64 (effective 2030) and increased the minimum pension contribution. Two years later, these minor adjustments were put on ice by President Emmanuel Macron’s government after a wave of protests. Likewise, the sturdiness of seemingly successful pension reforms, such as those passed by Sweden in the 1990s and 2010s, has been questioned on the grounds that they have put more financial pressure on retirees as well as increased temptations for governments to resort to ad hoc measures that will effectively undermine the reforms’ durability.
Even more seriously, few political leaders have been willing to face up to the fact that the enduring legitimacy of the underlying social democratic consensus creates expectations that sustain powerful stumbling blocks to meaningful change. The postwar social contract—markets overlaid and permeated by expansive and state-enforced social rights—has calcified into an interdependent system of metastasizing regulation, interventionism, bureaucratization, expanding entitlements, and political expectations which erodes the economic growth and fiscal solvency that are preconditions for free and prosperous societies.
Too many political leaders treat this situation as a problem to be patched over with either more intervention or marginal efforts at liberalization. They will not concede that the underlying social contract is now untenable. Nor will they admit that managing the competing demands of social rights and market disciplines is now beyond the powers of technocrats who appear impotent in the face of left- and right-populists selling political snake oil. We are only beginning, I fear, to see the economic and political whirlwind that we will all reap from this denial, absent a revolution in how we think about these questions.
Rewriting the Social Contract
Any such transformation that saves us from our perilous economic circumstances will require a thorough overhaul of our present social contract. Such a change must recognize that the “social” part of social democracy is damaging Western economies and facilitating unwholesome political trends which are contributing to deep fractures in many societies.
Fundamentally rewriting the social contract will require, at a minimum, the subordination of social rights to the demands of liberty and wealth creation. That will be deeply unpopular and provoke a harsh and likely violent backlash. But the alternative is that social democracy’s ongoing implosion could easily collapse the liberal framework of property rights, open markets, rule of law, and limited government that gives rise to commercial civilization and makes elevated levels of prosperity possible.
Our choice is thus no longer between greater or lesser versions of social democracy. It is between completely revising the social contract so that it conforms to the requirements of life in a robust commercial society or, alternatively, acquiescing to remorseless economic decline. The political consequences of the latter will not be pretty.
