Since the mid 1980s, governments in western market economies and elsewhere followed the neoclassical prescription on how to deal with new economic and social problems. During the 1980s, in response to declining economic performance and mounting inflationary pressure, governments in the EEC/EU region withdrew from the direct management of economic activities through privatization and deregulation policies and adopted more restrictive macroeconomic policies. Fighting inflation was given priority over maintaining full employment through tightening the control of monetary aggregates and establishing monetary stability. The reduction in aggregate demand resulted in a loss of output and contributed to unemployment.
More recently, the deregulation of labour markets, combined with selective protection of the most affected social groups and more education and training, has been gaining ground in western Europe as a reaction of government to unemployment and recession. The USA seems to be moving in the opposite direction, trying to diminish the most drastic inequalities in society with recent proposals for health care reform and the introduction of social security.
Similar policy schemes to improve economic efficiency have been applied on an unprecedented scale in eastern and central Europe after 1989 in order to "fix" the centrally planned system. Most governments in these countries followed the traditional mix of monetary and fiscal policies. Privatization-cum-stabilization programmes accompanied by extensive liberalization and deregulation of economic activities have proceeded, but have come under increasing pressure from society that wishes to maintain the level of social benefits. The policies are now being reassessed both in transition economies and in western market economies against the background of unemployment, the slow recovery from recession and other stretched institutional capabilities to deal with new problems.
The need to modernize the welfare state and update the social contract has been illustrated in a series of recommendations by some international organizations including OECD (1994) and the Commission of the European Communities (1994). These are searching for a new "geometry" between the state, the private sector, the community and individual households in the development process. Change is needed at several levels simultaneously: how formal institutions are organized, how policies are formulated and how people interact with each other. This includes questions of attitudes and social norms which exert an informal control over many aspects of the formal institutions.