Europe v USA: whose economy wins?

Interior of Boeing Factory, Seattle (picture Meutia Chaerani / Indradi Soemardjan)

By George Irvin

Many Europeans are deeply ambivalent about the economic performance of the European Union. “The EU was meant to bring us a golden future, but instead it has brought us stagnation, unemployment and social discontent” has become a familiar refrain. What is worse, lest we abandon our relentless pessimism, our eternally optimistic American friends excel at reminding us that they are richer, enjoy faster growth with lower unemployment and are generally better off in every way. Lots of sensible folk buy into this story; but is it borne out by the facts? The right answer is not a simple yes or no, so let me explain.

In what sense is the US richer?

Average gross domestic product (GDP) in the US is about 40 per cent higher than average GDP of the EU-15 when measured at purchasing power parity (PPP). The gap is slightly greater if we consider either the twelve Eurozone members (EU-12) or add the accession states (EU-25). Although GDP is a poor indicator of measure of welfare or happiness, let’s agree to use it for the sake of comparison.

The main reason the US is richer is because, first, a higher proportion of Americans are in employment and, secondly, they work about 20 per cent more hours per year than Europeans. When we look at GDP in 2005 per person per hour worked, there is virtually no difference between Germany, France and the US.

Economists often speak of this as revealing different American and European social preferences for work and leisure. In truth, both the employment rate and how long the average person works are explained mainly by political history. Until the late 1970s total hours worked were falling both in Europe and in the USA; since then, total hours worked have continued to fall in the EU-15 but have risen again in the US. Equally, if we look at employment data by age group, Americans join the work force earlier and leave it far later than Europeans. The key to understanding why this has happened is the change in US income distribution over the past 30 years. Since 1979, the bottom 40 per cent of income earners in the US has been treading water while the bottom 20 per cent has become poorer. US workers have needed to put in more years and longer hours simply to maintain their real income position.

Who has faster growth?

Does the US grow faster than the EU? Again, the answer depends on what we measure. When we compare the growth rate of GDP of the US and the EU-15, the US rate averaged over the past decade is about 1.2 percentage points higher than that of the EU-15 (oddly, the difference is slightly smaller if we use the EU-25). But the usual measure of growing prosperity is GDP per head; i.e. if GDP grows at 2 per cent but population grows as 3 per cent, then GDP per head is falling! US population growth is a full percentage point higher that that of the EU-15, mainly because US immigration in the past decade has been higher. Expressed on a per capita basis, GDP growth rates in the US and the EU are virtually the same over the past decade. The same is true of labour productivity growth.

What is also true is that since the 2001 recession, the US has bounced back faster than the EU. At present, both GDP growth per head and labour productivity are growing faster in the US. But recent US productivity gains are concentrated in distribution rather than manufacturing, and US growth continues to pull in more imports than it produces exports, resulting in a growing external deficit – funded in part by the EU current account surplus.

On the EU-15 side, lower growth is reflected in a high and prolonged average rate of unemployment, which has remained about three points above that of the US for some time. Equally, looking at the disaggregated data, some EU-15 countries have done better than others over the past decade in terms of prosperity and unemployment; e.g. the UK, Ireland and the Nordic countries. But these differences exist for quite different reasons and, equally important, we do not normally disaggregate US data to compare growth in (say) North Dakota and California.

Employment and unemployment

Perhaps the most common argument is that contrasting the job-creating virtues of the US ‘flexible’ labour market with the sclerotic state of the EU where unemployment is persistently high. Economics students attending US university (and increasingly those in the EU as well) learn that because EU labour is supplied at an artificially high wage rate, equilibrium employment in the EU is lower and unemployment higher.

Now while it is true that the US has a better employment and unemployment record, the key to understanding the difference between the EU and the US lies in disaggregating employment by age group. If we compare employment rates in 2005 of the 25-55 age group, there is virtually no difference; e.g. the employment rates are 86 and 88 per cent for the EU-15 and the US respectively (ignoring differences in how the data are recorded). The US data show a higher employment rate for youth (15-24) and a much higher rate for pre-retirement (55-64) and post retirement (65 and over) groups. What the average employment and unemployment figures hide is the age-specific nature of the ‘European problem’. The picture remains much the same when comparing the US and the EU-25.

source: Terry Ward, Alphametrics, Cambridge and Brussels, 2006

Once again, the crucial element in understanding these differences is income distribution. At the youth end of the scale, young workers in the US get less education and those who go to university are more likely to work part-time than their European counterparts. At the older end of the scale, pension provision in the US is neither as broad nor as generous as in the EU so people – particularly the poor who cannot afford to save for retirement – carry on working.

Making labour markets ‘more flexible’ (ie, cutting wages) does not cure these problems; if anything it makes the problem worse. By contrast, putting resources into active labour market policies such as improved education, retraining and high benefit provision contingent on job searching helps workers to find and retain high productivity jobs. This is the strategy pursued by the Nordic countries, one which has paid and will continue to pay handsome rewards in terms of prosperity and job security.

Who wins?

Comparing the economic performance of the European Union and the USA does not lead one to conclude that America has the more dynamic economy, or that it has performed better in the past or will do so in future. The most crucial feature of the comparison’ is neither the growth nor the unemployment record of the US and the EU. It is, rather, that US growth, unlike that in the EU, is funded by a dangerously high mountain of foreign debt. US external indebtedness in turn is driven by the US house price bubble, enabling US consumers to spend more than they earn. Ironically, it is the EU which, together with China and Japan, continues to lend the money to the US which keeps their households spending and their economy growing.

The truth is that neither side ‘wins’ in this beauty contest. Europe merely does less badly than the USA in some crucial respects. Yes, while it is true that the core Eurozone countries could perform far better, Germany, France and Italy have quite different problems – in comparison both to the US and to each other – which require quite different solutions. Anybody who claims that the US provides a model which the EU should copy needs to consider the basic economic facts of the case.

George Irvin is a retired academic economist who is currently Professorial Research Fellow at SOAS, London. His new book, “‘Regaining Europe”, was published in April by Federal Trust. The opinions expressed are those of the author and not necessary those of Federal Union. June 2006.

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