Excellencies, ladies and gentlemen,

Speaking on behalf of the ifo Institute for Economic Research and the University of Munich, I also welcome all of you, hoping that we will have a stimulating conference on a topic that is of great importance for Europe. I thank the BMW Stiftung Hebert Quandt and its head Kai Schellhorn as well as all our sponsors for their help and fruitful cooperation.

This year’s Munich Economic Summit parallels the meeting of the European Council in Brussels where the new EU constitution is to be signed by the representatives of 25 EU countries. We will have to see whether all parliaments will ratify the constitution and, in particular, which result the British referendum will yield.

Having a constitution is a matter of urgent necessity for Europe. I very much hope it will help to speed up European integration and to move us closer to my childhood dream of a United States of Europe. Even today, I am deeply convinced that this is where Europe should go, but I now also hope that a United States of Europe will be a liberal Europe. Unfortunately, I see more and more signs that my dreams will not come true. There may neither be a United States of Europe, nor may the limited Europe that will come be similar to the one of which I have dreamt.

The new constitution does not define the United States of Europe. There is still a long way to such a union. But the constitution does give direction. Some people say that the constitution does not imply anything new in addition to what has already been laid down in previous EU treaties, including the Treaty of Maastricht. I do not share this view. If it were right, we would not need a constitution. Even though there are no radical changes, the Constitution has the important function of ennobling some of the European rules and regulations, making them superior to others. The constitution narrows the scope of interpretation in cases where the existing rules are vague, and it ranks the rules that are potentially conflicting.

Important examples of what I mean are articles I-4, I-8 and II 34 that define basic rights for EU citizens. I cite from these articles:

• …any discrimination on grounds of nationality shall be prohibited …
• … every national of a Member State shall be a citizen of the Union …
• … Citizens of the Union shall have the right to move and reside freely within the territory of the Member States …
• … the Union recognizes and respects the entitlement to social security benefits and social services
• …Everyone residing and moving legally within the European Union is entitled to social security benefits and social advantages …
• … the Union recognises and respects the right to social and housing assistance so as to ensure a decent existence for all those who lack sufficient resources …

These articles will greatly affect the future of Europe. The non-discrimination clause together with the explicit social inclusion rights and the right of free residence will reinforce the development towards a Social Union of Europe that, according experts in EU law, has already started in the past due to various EU directives and decisions of the European Court of Justice.

For many, Social Union is the next logical step after Economic Union and Monetary Union. From a German perspective, however, I hesitate to follow this logic, as the social union of Germany has not been a success. The social union has meant that the German welfare state created excessively high replacement incomes in east Germany like social assistance, unemployment benefits and early retirement benefits that have pushed up the wage scale. The welfare state’s replacement incomes are minimum wages. If these minimum wages exceed labour productivity, the result is unemployment. East Germany has been suffering from mass unemployment which is intensifying year by year, and there has been no convergence of the two parts of the country since 1997. In fact, the gap between east and west Germany has been widening. I attribute the economic failure of German unification primarily to the social union which has made the welfare state into a competitor of private business in the labour market. Private business is losing the contest. Since this competitor has to be paid for with west German taxes, even the west German economy has been suffering from this development.

If Europe establishes a social union of the German kind with harmonised replacement incomes throughout the continent, there will be twenty regions like east Germany in Europe. No one can afford that.

Thus, the social union for which the Constitution paves the way, can only be one with non-harmonized welfare benefits whose size is determined by each individual country. However, as the theory of fiscal competition has demonstrated very clearly, it is not possible to maintain the European welfare state when there is free migration, full social inclusion as defined by the Constitution and separate policy decisions of individual states. The reason is that welfare states are magnets that attract poor people who receive more resources from the state than they pay in terms of taxes and social security contributions. By attracting the needy, the welfare state will not be able to keep its expenses under control. Thus there will be a kind of competition of deterrence among the welfare states where each state scales down its benefits so as not become the target of poverty migration. With all countries behaving in a similar way, the welfare state will erode and shrink far below its efficient size, whatever that is.

Europe will become like the United States of America in this respect. Remember New York City. John Lindsay, the mayor of the city of New York had implemented a generous welfare program in the sixties so as to get the poor off the streets and help calm down social unrest. However, as a result of his policy, New York attracted the needy from all over the United States and the city was driven close to bankruptcy. In 1975, the program had to be abandoned because the banks were no longer willing to extend credit to the city. The Washington D.C. welfare program suffered a similar fate.

I do not want to be misunderstood if I point to these problems. I am not arguing that migration is a danger and that we should impose constraints on migration flows. Migration as such is a good thing for Europe. To the extent migration is driven by wage differences, it improves the allocation of labour in Europe, because wage differences reflect productivity differences. It is good that people migrate from low productivity to high productivity countries, because this will generate additional GDP growth for Europe. In particular, mass migration from eastern Europe to western Europe is necessary to efficiently allocate the available labour force to the various countries during the transition phase until the eastern countries will have caught up with the west. There is nothing wrong with migration as such.

Neither am I saying that the forces of systems competition will necessarily imply large migration flows. In a symmetrical world of similarly advanced countries with perfect labour mobility, there would be no visible migration, but nevertheless the forces of systems competition would be eroding the welfare states.

What I am saying, however, is that from the point of view of the theory of fiscal competition it is hardly possible to construct Europe along the lines the draft constitution prescribes. Free migration, full social inclusion and the maintenance of the European welfare state are three goals that simply cannot coexist. One of these goals has to be sacrificed.

EU politicians do not follow this logic. They tend to downplay the problems, arguing that we are far away from the inclusion rights that would trigger off the erosion of the welfare state. The truth of the matter is, however, that we are already in the middle of welfare state erosion in Europe. For me, Agenda 2010 is only one step among many that are coming. Competitive forces take decades to take effect, but they are strong and persistent.

It is true that to some extent such erosion should be welcomed. Maybe eastern enlargement and the migration flows resulting from it will be the Trojan Horse for Europe through which the fighters against an exaggerated welfare state will enter, as Michael Burda once argued. However, I would rather prefer a planned reform of the welfare state, as the forces through which the erosion is to work are not overly convincing.

There are three kinds of forces that have to be distinguished.

First, there is the direct migration of employed people into the welfare state. This migration is one of the fundamental rights of the EU, and in fact the EU has experienced massive labour migration of this kind over the last thirty years. Migration of workers has been a direct migration into the welfare state because the migrants have less than average productivity, earn less than average wages and are therefore beneficiaries of the redistributive activities of the welfare state. They pay taxes and contributions but receive more public resources from the state than they paid for. According to a study of the Ifo Institute, in 1997 the average migrant who had been here for less than ten years received a gift of about 2,400 euros per year. This average includes the people in the workforce, their non-working relatives and just everybody who happened to live in Germany. The sum is enormous. For a family of five it amounts to 118,000 euros over ten years. People who stay longer, receive less from the state because their productivity and wage is higher, but only those who stay in Germany for more than 25 years are net contributors to the government budget. Unfortunately, however, there are not so many of them, since 80 % of the immigrants had died or left the country 25 years after entry.
The second erosive force is the indirect migration into the welfare state by crowding out nationals from their jobs. Such a kind of migration has been the reality in Germany for three decades at least. From 1970 to 2002 there has been a net immigration to Germany of seven and a half million people. Of these about 3.1 million found official employment. The increase in unemployment among nationals over that same period of time happened to be nearly the same, namely 3.2 million.

Germany has been unable to provide the immigrants with additional jobs. Because of the rigidity of wages at the lower end of the income scale, which itself has been caused by the replacement incomes the welfare state has been paying, immigration was unable to stimulate the creation of additional jobs. There would have been more jobs only if politics had accepted declining wages, because only declining wages induce employers to create more jobs. Because of the wage rigidity, there was an indirect migration into unemployment. The immigrants took the jobs, and instead of entering a low wage competition that could have resulted in declining wages and additional jobs, the nationals preferred sit down in the easy chair that the welfare state was offering them.

Indirect immigration into unemployment has also been indirect immigration into the welfare state. The benefits of the welfare state have kept wages high. That attracted excessive migration. And the increasing unemployment among the domestic population incurred substantial budgetary costs for the state.

The third kind of welfare migration has been the least important, but things may change. It is the migration of non-employed (inactive) people including students, pensioners and others. This type of welfare migration has not been quantitatively important in the past since non-working foreigners who applied for welfare could be denied the right of residence. Under current German law, they can be sent back to their home countries.

Things have indeed changed insofar as on 1 May of this year the new Directive on Free Movement has become European law. That directive has to be implemented into national law before 1 May 2006. It gives an immigrant the right of residence of up to five years if he or she can show sufficient resources so as to make it unnecessary to apply for social aid for the planned period of residence and if the immigrant has health insurance coverage.

There are two points where the directive differs from current German law and where German law and the law of a number of other countries will therefore have to be changed.

First, the immigrant will have the permanent right of residence after five years, even if he has no resources to live on. He will then be fully entitled to all the social benefits that are granted to nationals. An immigrant family with two children planning to stay in Germany for fifteen years will therefore be entitled to ten years of social benefits, which under current conditions would amount to more than 180.000 euros, non-discounted.

Second, it is impossible for the host state to shorten the time of residence below the period granted upon entry if the immigrant becomes needy and claims social aid unless the claim is unreasonable. However, it is up to the government to prove that it is unreasonable.

These two changes are substantial, and they have passed without any notice being taken in the German public debate. They imply that the door of the welfare state has been opened further. There is not only the direct migration of working people into the welfare state and the indirect immigration of working people insofar as they push domestic residents into unemployment. There is now also the possibility of a direct migration of non-working people into the welfare state.

All in all, this means that Europe will be subjected to the destructive forces of deterrence competition among its welfare states that I described above. I therefore expect gradual erosion over the next few decades. And I also expect tendencies to harmonise minimum standards for social benefits in Europe with the consequences for wage equalisation and increasing unemployment that I described.

Neither of these expectations is pleasant. Both raise doubts about the wisdom behind the new draft constitution and the paragraphs I cited. The fathers and mothers of the Constitution certainly wanted to preserve the social framework of European society, but I am afraid that they might contribute to its destruction instead.

As I said, the welfare state, social inclusion and free migration are three goals that do not fit together. One has to be sacrificed.

If we do nothing, the European welfare state is likely to erode. If we want to preserve the welfare state, we will have to sacrifice either free migration or the inclusion principle. As a ban on free migration of the type Germany has enacted for the countries of the east is detrimental to European growth, I would opt for a limitation of the inclusion principle.

The principle of selectively delayed immigration suggested by the Council of Advisors to the German Ministry of Finance and the ifo Institute is one useful kind of limitation. The principle says that immigrants pay taxes and social security contributions and that they receive all contribution-financed benefits and have free access to the public infrastructure. However, certain tax-financed social benefits such as social aid and subsidized housing will not be granted for a transition period. Actually Ireland and Great Britain have recently adopted a variant of this principle.

I would apply the principle of delayed integration to employed people, and in addition I would apply a home country principle to non-employed people. Everyone can freely migrate, but if he does not work in the host country, the home country remains responsible for welfare benefits. With these provisions, Europe would be liberal and social at the same time, as the erosive forces of systems competition would effectively be banned.

This is my personal view on the matter, and I am sure that not all of you will share it. There is ample time during this conference to discuss the issues and exchange diverging views.
We have three main sessions that will touch upon this and other topics.

The first session deals with the problem of deterrence competition among the welfare states as such. The second will address the question of whether migration constraints could be the right means to prevent the erosion from taking place. The third will address the problem of migration into unemployment as described above, and thus the problem of indirect migration into the welfare state.

We have competent academic speakers to clarify the issues, and we have first-rate politicians and business leaders to comment from their perspectives. And then we have you, dear guests. We expect all of you to participate actively in the debates, and I am confident that there will plenty of time for plenary discussions.

Thank you very much for your attention.