Is Europe Falling Behind?

After three years of near stagnation, the mood in Europe is definitely gloomy.

The two economic books on the bestseller list in France in 2003 are called “La France qui Tombe” (“The Fall of France”) and "Le Desarroi Français” (“The French Disarray”).

Both books offer a pessimistic vision of France and its economic future, a future in which — unless dramatic reforms are implemented – France will steadily lose ground against its competitors.

France is not alone. All over Europe, governments are trying to put on a good face. But their boasts — such as the goal adopted at the EU Lisbon conference in March 2000 to make the European Union “the world’s most dynamic and competitive economy within ten years” — are seen largely as empty rhetoric, if not pathetic.

The most articulate diagnoses of where Europe stands today argue that — like Stalinist growth in another time and place — the European model worked well for post-war Europe, but is no longer fit for these times.

For much of the post-war period, the argument goes, European growth was based on the notion of “catch-up growth,” based primarily on imitation rather than innovation. For such growth, large European firms — protected in both goods and financial markets — could do a good job.

They could do much of the R&D in-house. They could develop comfortable long-term relations with suppliers of funds. Best of all, they could offer long-term relationships and job security to their workers.

The ample rents generated in the European goods markets could be shared between firms and workers, and could always be counted on to help finance the welfare state.

Now that European growth must increasingly be based on innovation, now that firms cannot be insulated from foreign competition, the European model has become dysfunctional, this argument concludes.

As a result, relations between firms and suppliers of funds, between firms and their workers, must all be redefined. This requires nothing short of a complete transformation of Europe’s pattern of economic and social relations.

So far, the argument concludes, Europe has not risen to the challenge. Instead, it seems increasingly petrified, unable to engage in fundamental reforms. This is why the future is bleak.

I have a more optimistic assessment.

Two facts are often cited by euro-pessimists: GDP per person in the European Union, measured at purchasing power parity (PPP) prices, stands at 70% of the U.S. level of GDP per person. Not only that, but this ratio is the same as it was 30 years ago.

These facts are correct. They suggest a Europe stuck at a substantially lower standard of living than the United States — and unable to catch up. However, this interpretation would be misleading.

Things are not so bad. Over the last 30 years, productivity growth has been much higher in Europe than in the United States. And productivity levels are roughly similar today in the EU and in the United States.

The main difference is that Europe has used some of the increase in productivity to increase leisure rather than income — while the United States has done the opposite.

The stability of the U.S.-EU gap in relative income on a per capita basis comes from the decline in hours worked. To be specific, in the United States, over the period 1970 to 2000, GDP per hour increased by 38%. Hours worked per person also increased, by 26%. Thus, GDP per person increased by 64%.

In France, over the same period, GDP per hour increased by 83%. But hours worked per person decreased by 23% — so GDP per capita only increased by 60%.

Viewed in that light, the performance of France — and of the European Union in general — does not look so bad. The EU had a much higher productivity growth rate than the United States. And the EU countries chose to allocate part of those gains to increased income — and part to increased leisure.

True, unemployment has increased and is too high. But most of the decrease in hours worked per capita reflects a decrease in hours worked per worker — rather than higher unemployment or lower participation.

This choice, however, does not suggest that a deep and wide-ranging reform process is not taking place in Europe. As a matter of fact, this process is driven by reforms in financial and product markets. Reforms in those markets are, in turn, increasing pressure for reform in the European labor market as well.

Significant reform in the European labor market will eventually take place, but it could not happen overnight — and not without political tensions. These tensions have dominated and will continue to dominate the news. But they are a symptom of change — not a reflection of immobility.