The European Union’s economic evolution for the last sixty years is specific to the long term stages of the economic cycle, of Kondratieff type. The economic expansion period has been characterized by a higher efficiency level (growth in productivity, in the labour occupation degree) which favoured the reducing of the inequalities related to incomes through the redistribution process. The economic recession stage showed that, under the terms of an increased unemployment, of a low aggregate demand and of a less flexible aggregate supply, the economic efficiency level is relatively lower. On these conditions, the providing of social equity (of the cohesion) will affect negatively the efficiency degree, fact which will extend the period of economic recession within The European Union.economic growth, labour productivity, economic recession, total factor productivity

Marinas Marius-Corneliu

Socol Aura Gabriela

Socol Cristian

English

Research Papers in Economics

  442 
THE ANALYSIS OF EQUITY-EFFICIENCY TRADE-OFF IN THE 
EUROPEAN UNION ECONOMY 
Socol Cristian  
Academy  of  Economic  Studies,  Department  of  Economics,  Bucharest,  Moxa  street,  nr.  11, 
socolcristian1@yahoo.com,  
Socol Aura-Gabriela  
Academy of Economic Studies, Department of Economics, Bucharest, Moxa street, nr. 11, 
auragabrielasocol@yahoo.com 
Marina￿ Marius-Corneliu  
Academy of Economic Studies, Department of Economics, Bucharest, Moxa street, nr. 11, 
mariusmarinas@gmail.com 
 
Abstract. The European Union’s economic evolution for the last sixty years is specific to the long term 
stages of the economic cycle, of Kondratieff type. The economic expansion period has been characterized 
by a higher efficiency level (growth in productivity, in the labour occupation degree) which favoured the 
reducing of the inequalities related to incomes through the redistribution process. The economic recession 
stage showed that, under the terms of an increased unemployment, of a low aggregate demand and of a 
less flexible aggregate supply, the economic efficiency level is relatively lower. On these conditions, the 
providing of social equity (of the cohesion) will affect negatively the efficiency degree, fact which will 
extend the period of economic recession within The European Union. 
 
Key words: economic growth; labour productivity; economic recession; total factor productivity 
 
The specific of the European model is to provide economic and social cohesion, meaning equity, 
by reducing the inequities in incomes both within the member countries and between the economies which 
are parts of The European Union. The social equity process represents the result of nationally incomes 
redistribution and of the conferring of structural funds within the communion. The providing of equity 
supposes, most of the times, a higher fiscal pressure on the employees and on the companies, and this will 
affect negatively the rate of economic growth. The result is a trade-off between equity and efficiency, 
which can be diminished only if the increasing of efficiency precedes the increasing of public expenses for 
equity.  
 
Why is there a trade-off between efficiency and equity? 
 
An  increased  rate  of  the  economic  growth  suggests  a  higher  degree  of  economic  efficiency, 
because it supposes both the increase of the labour productivity and the degree of occupation for the 
population (such as in the case of the decomposition below): 
L W GDP L
L
GDP
GDP L ∆ + ∆ = ∆ ￿ ⋅ = % % %  
The labour productivity growth (%￿WL) represents the result of the investments made by the 
companies, including those in new technologies, of improvement in the education level of the labour and of 
the continuous training programs. The most part of the occupation degree for the population represents the 
effect of the investments and of active policies on the labour market which favour a higher flexibility of the 
employees.  
The  providing  of  social  equity  influences  negatively  the  economic  efficiency  through  the 
following mechanisms:   443 
a)  the increase of the current social transfers determines the increase in the budget deficit and in the 
public debt, this affecting the living standard of the future generations; 
b)  the  loans  necessary  to  finance  the  budget  deficit  exerts  a  crowding-out  effect  on  the  private 
investments; 
c)  the increase of fiscality for the counterbalance of the supplementary public expenses involves the 
decrease of consumption, of the private economies and of the investments; 
d)  the  increase  of  fiscality  reduces  the  incentives  in  economy  and  discourages  the  business 
development.  
The relationship between efficiency and equity has to be expressed according to the stages of the 
economic cycle that a certain country passes through. Thus, during the expansion periods, higher rates of 
economic growth are recorded and this leads to improvement of efficiency at the macroeconomic level. As 
a result of the automatic stabilizers’ action, the budgetary incomes will increase, and this fact can support 
the social equity, without involving an increase in fiscality. In exchange, during the recession periods the 
budgetary incomes decrease because there is a decrease both in the labour productivity and in the degree of 
occupation of the labour. The maintaining of the same budgetary social expenses or even their increase will 
lead to the increase of the budget deficit and to the decrease of the economic efficiency to a greater extent. 
The  result  is  that  the  providing  of  the  social  equity  has  to  be  justified  by  the  improvement  of  the 
macroeconomic efficiency. 
 
The equity-efficiency trade-off in European Union 
 
The post-war economic evolution of the European Union is characterized by two distinct stages, 
which correspond to the long term stages of the economic cycle of Kondratieff type. Thus, until the ‘70s, 
there  was  a  recording  of  an  increase  in  the  labour  productivity  (assessed  as  GDP  per  employee),  an 
increase in the capital-labour endowment, as well as in the use of new technologies (of which impact is 
surprised by the evolution of the total factor productivity – PTF), and after 1973, their decrease (figure 1). 
 
 
            Source of data : The European Commission (2005) 
 
Figure 1. The European Union’s economic evolution 
 
The  rate  of  increase  of  labour  productivity  is  the  result  of  the  summarizing  the  percentage 
modifications of the total factor productivity and the capital stock per employee, as it results from the 
decomposition of the production function of the Cobb-Douglass type: 
0 
0,5 
1 
1,5 
2 
2,5 
3 
3,5 
4 
4,5 
5 
1950-60  1960-70  1970-80  1980-90  1990-2000 
% 
GDP/employee  Capital stock/employee  PTF   444 
L
K
PTF W
L
K
PTF
L
GDP
L K PTF GDP L ∆ ⋅ + ∆ = ∆ ￿ ￿
￿
￿
￿
￿
￿ ⋅ = ￿ ⋅ ⋅ =
− % % %
1 α
α
α α  
Until 1973, Europe knew a  period in  which there  was provided the sustainability of  the magic 
triangle,  made  up  of  economic  growth,  macroeconomic  stability  and  the  state  of  welfare,  thus 
diminishing the pressure of the compromise between equity and economic efficiency, through: 
￿  the increase of the GDP per inhabitant with 3.8% as a result of the increase of the investment rate 
and of the degree of occupation of labour; 
￿  the  decrease  of  costs  for  the  state  of  welfare,  under  the  terms  of  the  increase  in  the  labour 
participation rate and of a low unemployment (of about 2%). The public expenses weight in the 
GDP was almost 36% in 1970, out of which the transfers represented 12% of the GDP and the 
public investments and the subsidies 14% of the GDP; 
￿  the decrease of the rate of rise in prices to a 4% level.  
The European Union’s catching-up process  within these almost three decades (1946-1973) was 
mainly stimulated by the appearance of new industries within the EU countries, by the diminishing of the 
occupied population weight in agriculture and their migration towards the industrial sector and towards the 
commerce, as well as by the settling of unions-employers agreements concerning the salary rise.  
After the oil shocks there was a combination, with negative effects on the stability of the European 
social model, between a high rate of unemployment and the lowering of the rhythm of increasing the 
labour  productivity.  The  increase  of  unemployment  occurred  among  the  employees  less  adjusting  to 
changes – those with less qualifications -, under the terms of increasing the business relationships of the 
European companies with the lower salaries economies. As a consequence, the decrease in the occupation 
degree,  which  initially  appeared  to  be  a  cyclic  one,  proved  to  be  a  structural  one,  without  the  rapid 
productivity  growth  which  could  increase  the  Aggregate  Demand.  The  magic  triangle  broke  in  the 
recession stage of the Kondratieff cycle (figure 2), and this could affect the essence of the European model 
– providing social cohesion. Under these terms, the economies answered through policies of stimulating 
the  Aggregate  Demand, through an increase in the social transfers, supported, to some extent, by the 
increase of fiscality. The implementation of the Maastricht program for introducing the Euro currency has 
disciplined  the  EU  countries  from  a  macroeconomic  point  of  view,  but  the  decreases  in  the  rates  of 
unemployment  and  in  the  public  expenses,  as  well  as  the  GDP  increase  were  only  temporary.  The 
incentives (productive, but also for searching a job) have decreased, and this fact accentuated the equity-
efficiency compromise pressure. 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The state of welfare 
Economic growth  Macroeconomic stability 
Virtuous 
correlations until 
1973 
Vicious correlations after 1973 
 
-  a lower rate of labour productivity; increase in structural unemployment; 
-   the increase of transfers led to a decrease in labour offer (decrease of incentives) and a decrease in labour 
demand (by increasing fiscality). The unemployment increase to 8-10%, the economic growth rate decreased, 
but the budget deficit and the public debt increased (this tripled as weight in the GDP, reaching over 60% of the 
GDP); 
-  the policies of stimulating the Aggregate Demand were inefficient on conditions that the shocks which affected 
the states member to the European Union had a structural nature.   445 
Figure 2. Components of the magic triangle of EU 
 
Within the period after the oil shocks, the European Union was characterized by the decrease of 
the macroeconomic efficiency and by adopting a few measures able to support the social equity process. 
Their result was only the extent of the economic recession stage (figure 3). 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Figure 3. Emphasis of the equity-efficiency trade-off during the economic recession periods 
 
The rate of increase in the labour productivity decreased in the European Union during the last 
twenty  years,  from  2.2%  between  1987  and  1995  to  1.4%  between  1995  and  2007;  the  percentage 
modification of the productivity was even lower between 2000 and 2007; the percentage modification of 
the productivity in The European Union may affect negatively both the economic growth process on a long 
term and the social equity. This statement can be checked by performing a decomposition of the GDP in 
EU case, based on the values recorded by the labour productivity and by the PTF during the period 2000-
2007. 
α α − ⋅ ⋅ =
1 L K PTF GDP
α
α
α α α α α α − − − ⋅ = ￿ ⋅ = ￿ ⋅ ⋅ = ⋅ = 1 1
1
1 ) ( ) ( ) ( ) ( ) ( ) (
GDP
K
PTF
L
GDP
GDP
K
PTF
L
GDP
L
GDP
PIB
K
PTF
L
K
PTF
L
GDP
 
Because the ratio 
α
α
− 1
is subunitary (under the terms of approximating ￿ at the value of 1/3), 
then there are records of the decreasing marginal efficiency of the investments’ rate (which corresponds to 
the hypothesis of the Solow model). In stationary state, the ratio K/GDP is constant because the rates of 
increasing for the capital stock per employee and of labour productivity (depending on the capital) are zero. 
. 0 % % % = ∆ − ∆ = ∆ ￿ =
L
GDP
L
K
GDP
K
L
GDP
L
K
GDP
K
 
The European Union: 1975- present 
Decrease in the macroeconomic 
efficiency (low rates for productivity 
growth, high unemployment) 
Support for the social equity, which supposed the 
increase of the public debt and of fiscality 
Extension of the economic recession period   446 
It results that, in stationary state, which corresponds to the long term equilibrium of economy, the 
rate of increase in productivity is influenced by the evolution of the total factor productivity (PTF
1-￿ from  
the  above  equation).  Its  increase  is  obtained  through  logarithmation,  as  it  follows:  
PTF PTF ∆ ⋅
−
= − %
1
1
ln 1
1
α
α . On the conditions that the average increase of the PTF during the period 
2000-2007 was 0.4% and ￿ has the value of 1/3, then the annual rate of increase on a long term of the 
labour productivity is equal to: 
 
= ∆ ⋅
−
= ∆ PTF
L
GDP
%
1
1
%
α
% 6 , 0 006 , 0
66 . 0
004 , 0
= = .  
Between 2000 and 2007, the average increase of the occupied population within EU was 1.1%, so 
that the maintaining of the same evolution on a long term will generate an economic growth of only 1.7%: 
L W GDP L
L
GDP
GDP L ∆ + ∆ = ∆ ￿ ⋅ = % % % = 0,6% + 1,1% = 1,7%. 
 
Solutions for Diminishing the Trade-off between Efficiency and Equity. The Adopting of the Lisbon 
Strategy 
 
The inverse relationship between efficiency and equity can be described by a concave curve, 
according to which the opportunity cost for providing a more increased level of social equity is reflected by 
the bigger and bigger losses in the macroeconomic efficiency. 
In The European Union, under the terms of regulation of the markets and of the catching-up 
process after the World War II there was a more flattened form of the curve of the compromise between 
efficiency and social equity. At the present moment, the increase of the global competition on the factors  
and products markets as well as the trend to de-regulate them suppose a more abrupt form of the curve, this 
being explained through the necessity to increase the external competition (figures 4.1 and 4.2). 
 
 
 
              Efficiency                                                                  Efficiency 
 
 
  EU  EU 
                                             
       
 
 
                                          
                                                 Social equity                                                                   Social equity 
                     Figures 4.1.; 4.2. Trade-off equity-efficiency curves 
                               
The maintaining of the  same level  for the  social equity affects  negatively the current  rate of 
economic growth in the EU economy, and this determines a decreased external competition. A solution for 
its improvement is decreasing the social protection through the reforms in the social assistance systems, of 
which  implementation  is  nevertheless  pretty  slow.  As  the  EU  officials  have  asserted,  the  economic 
transformation of the model aims both the improvement of the economic growth and the social cohesion 
Until the ‘90s  At the present moment   447 
through intelligent reforms, which would determine the compromise curve’s movement towards the right 
(figures 5.1.; 5.2.).  
 
 
 
 
Efficiency                                                                               Efficiency      
 
 
     
                                                                                                  European Union 
                                European Union   
                                    
 
 
                                                 Social equity                                                                            Social equity 
 
Figures 5.1.; 5.2. Lisbon reforms finality 
 
In fact, the Lisbon Strategy, through the mentioned objectives, can provide intelligent solutions to 
the  problems  that  the  European  model  has  to  face.  Its  finality  is  predicted  by  the  Northern  states’ 
performances,  among  the  most  competitive  in  the  world,  although  there  are  super-developed 
welfare/providential states (if we take into consideration the public budget as a weight in the GDP, the 
amounts allotted for social assistance etc.).   
The Northern economies’ evolution is characterized by different mechanisms able to diminish the 
trade-off between equity and efficiency: 
￿  the increased productivity and the social cohesion may be in a direct correlation; 
￿  the  policies  active  on  the  labour  market  determine  the  diminishing  of  the  time  for  searching 
between jobs and the decrease of the rate of unemployment, on a long term; 
￿  the labour market flexibility and the social security are not contradictory objectives; 
￿  the continuous training, the developing of the employees’ competences represent conditions for 
increased adjustment to changes of the labour; 
￿  women’s integration into the labour market constitutes a central element of the prosperity raise;   
￿  the increase of the rate of participation on the labour market constitutes an efficient modality to 
diminish the pressure generated by the demographic evolutions; 
￿  the increase of the amounts allotted to research-development, as well as the innovations constitute 
sources  for  the  competitive  advantage,  which  determine  the  increase  in  the  macroeconomic 
efficiency. 
References: 
1.  Dew-Becker, I; Gordon, R (2006), “The Slowdown in European Productivity Growth: A Tale of 
Tigers,  Tortoises  and  Textbook  Labor  Economics,”  working  paper,  NBER  and  Northwestern 
University; 
2.  European Comission (2005), ”The economic costs of non-Lisbon. A survey of the literature on the 
economic impact of Lisbon-type reforms”, European Economy, Occasional papers, nr. 16; 
3.  European Comission (2006), “Globalisation: trends, issues and macro implications for the EU”, 
European Economy, nr. 254; 
4.  McQuinn, K; Whelan, K ￿i al￿ii (2006), “Conditional convergence revisited: taking Solow very 
seriously”, Ireland Central Bank, Research technical papers, nr. 6 
The reforms may suppose difficult choices  …but there is a potential for intelligent choices 
Lisbon Strategy finality   448 
5.  Pelkmans, J; Casey-Pierre, J (2004), “Can Europe deliver growth ?The Sapir report and beyond”, 
CEPS Policy brief, nr. 45; 
6.  Sapir, A (2003), “An agenda for a Growing Europe”, European Comission, Bruxelles; 
7.  Solow, R. (1956), “A Contribution to the Theory of Economic Growth”, Quarterly Journal of 
Economics, nr. 70; 
 
 
 
 
 
 

THE ANALYSIS OF EQUITY-EFFICIENCY TRADE-OFF IN THE EUROPEAN UNION ECONOMY

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THE ANALYSIS OF EQUITY-EFFICIENCY TRADE-OFF IN THE EUROPEAN UNION ECONOMY

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