What Europe’s Mistakes Teach Asia; Nations that sacrifice too much economic freedom for social security end up with neither

April 9, 2013, 3:55 p.m. ET

What Europe’s Mistakes Teach Asia

Nations that sacrifice too much economic freedom for social security end up with neither.

By SRI MULYANI INDRAWATI

A Chinese proverb tells us that it is wise to learn from your own mistakes but wiser to learn from the mistakes of others. Asian leaders should take this advice to heart as they juggle between policies for social welfare and economic dynamism. By keeping a keen eye on Europe’s fiscal crises, they can avoid the worst of the Continent’s productivity-reducing excess.

At the same time, it would be a mistake for Asia to look to Europe solely for lessons on which policies to avoid. Europe could not have attained the highest quality of life in human history without doing some things right—namely, trade and openness.In the decades since World War II, Europe has become the world’s center of trade. In 2008, half of the world’s trade in goods and services involved the Continent. Two-thirds of this trade was within Europe, helping small developing countries access big markets.

People in Asia worry about a “middle-income trap.” Countries seem to easily grow to levels of per-capita income of more than $1,000, but find it difficult to reach and stay above high-income levels of more than $10,000. In Europe, powered by vibrant trade and open financial flows, a dozen emerging economies have attained high incomes since 1985, such as Portugal in the 1990s and Poland in the 2000s.

European enterprise is also a success story. Between 1995 and 2009, Western Europe’s entrepreneurs created jobs faster than the U.S. did, and European economies exported more than the BRIC countries of Brazil, Russia, India and China. Eastern Europe’s productivity increased more rapidly than East Asia’s.

The main reason for this success is a freer business climate. European nations figure at the top of most rankings of entrepreneurial freedom and competitiveness. This is the result of reforms such as those in Sweden in the 1990s and Germany a decade later that modernized labor markets and welfare systems, and made it easier to start and shut down companies. (Greece and Italy show what happens when structural reforms are postponed).

Asia can learn much from Europe. Trade could be made easier in Asia, and the conditions for doing business could be improved by reducing red tape. In this regard, Hong Kong, Singapore and South Korea have done better than the best in Europe. Now China, India and Indonesia stand to gain from doing the same.

The prosperity created by Europe’s economic freedoms has allowed its citizens to lead longer, healthier lives. But the way Europeans have responded to growing wealth and longevity should serve as a cautionary tale for Asia.

Over time, Europeans have come to rely on governments to protect them from the rougher facets of private enterprise and to look after them in old age. According to the World Bank’s Golden Growth report on the European economic model, Europe today spends more on social protection than the rest of the world combined—amounting to 60% of global public outlays on welfare.

The result has been a precipitous decline in work. In the 1950s, Western Europeans worked one month a year more than Americans. Now the situation is reversed: Today Americans work one month a year more than the French and Swedes, and noticeably more than the Greeks and Spaniards. Men in France now retire nine years earlier than in 1965 and live six years longer—meaning that the average Frenchmen can expect to draw pensions for 15 more years than they did almost five decades ago.

The costs of such largesse are obvious. Both payroll taxes and fiscal deficits have increased. Europe could lose about 50 million workers over the next five decades if it fails to loosen labor laws and reform welfare programs.

As dynamic as Asia is today, it is not immune to these same predicaments. The most aged country in the world right now is Japan, and China and South Korea are the quickest-aging nations. In 2010, the average South Korean was 37 years old. By 2050, the median age there will be 57.

While prosperity and longevity arrive together, they cannot be treated the same. With greater wealth, people in Asia may not have to work as many hours as they do now. But living longer means they will have to work more years, not fewer. Just as Northern European countries such as Iceland and Norway have raised the age of retirement, so must every prospering economy. To do otherwise would unjustly burden future generations.

Europe’s economic malaise grew out of numerous mistakes. Some, to be sure, are tied to the peculiarities of the Continent’s currency union. But Europe holds plenty of wider lessons for Asian states. They should see how nations that sacrifice too much economic freedom for social security end up with neither, impairing both private enterprise and public finance.

Ms. Sri Mulyani is managing director at the World Bank. She was Indonesia’s minister of finance from 2005-10.