At the same time, a relatively low coverage of unemployment benefits means that the risk of poverty is comparably high. Rigid wage bargaining structures in the formal economy generate a highly compressed wage structure. Together with a large and inefficient public sector, the features of this model may render public finances increasingly unsustainable. The differences in the institutional features of the four models and the related growth and employment performance clearly show the relationship between values, institutions and economic outcomes. While, in the first place, there might be differences in the importance which the various European nations attach to fundamental values such as protection from poverty, safety of employment or income equality, the resulting domestic institutions and regulations make a crucial difference. For example, whether countries choose to protect workers from unemployment through restrictive employment protection legislation or through generous unemployment benefits has an impact on the overall level of employment: stricter employment protection legislation in the Continental and Mediterranean models appears to a have an adverse impact on employment creation, whereas generous unemployment benefits seem to play only a secondary role.5 Similarly, the probability of escaping poverty is greater in the Nordic and the Continental models, which is not only the result of a generous tax-benefit system, but also a consequence of higher human capital endowments (see Chart 8). 5  See Sapir (2005), as well as recent work at the OECD, e.g. van den Noord et al (2006).

In fact, the dispersion of growth and inflation rates within the euro area since the  4  6  See Blanchard (2004) and Alesina and Giavazzi (2006). BIS Review 43/2007  introduction of the euro is very similar to that observed across regions and states in the US. What is characteristic of Europe, however, is the persistence of the observed dispersion in growth rates. This persistence may be attributed to a number of factors, such as the stimulative effects of historically low interest rates, which sustained dynamic growth over recent years, especially in Spain, Ireland and Greece. Another important factor, which has received increasing attention, is the potential longerlasting influence of differences in economic institutions and social values, encapsulated in the socalled social models, of different European countries on their economic performance. As Sapir (2005) has observed, “the notion of a single “European Social Model” is largely misleading.” The prevailing social models in European countries can be meaningfully grouped into four types, as shown in Chart 8: First, there is what could be called the Nordic model, which applies to Scandinavia, Finland and also includes the Netherlands: in this model, social protection benefits, universal welfare provision and active labour market policies are highly developed. Public sector employment is significant by any standards. The associated fiscal expenditures are large, necessitating comparatively high tax rates. Powerful labour unions ensure that wage disparities remain limited. This model has contributed to generating high employment rates, in combination of with a low risk of poverty and relative income equality.