The recent Organization for Economic Cooperation and Development report decrying economic performance in Europe was predictably received with gloating by the bulls of Wall Street and the George W. Bush administration. Yet they should not be so quick to gloat; the European economic model is stronger than it appears, and the U.S. model weaker.
The OECD’s principal gripes relate to European living standards, which over the past two decades “have fallen further behind the best performers.” However, the past two decades have seen the liberation of Eastern Europe, which was bound to be an expensive proposition for Western Europe, particularly Germany given the appallingly expensive way in which East and West Germany were united. That cost is now paid, and Europe is coming to benefit from a substantial pool of East European labor with high skills and relatively low wage levels. The OECD noted that European living standards were lower than in the United States, even taking into account the greater European level of leisure time, but that observers with a strong aversion to income inequality would find the gap between the two systems lessened.
The differences between the European and U.S. economic models are well known. The European model involves a higher level of public spending than the United States, greater income support at the lower income levels, socialization of the increasingly important healthcare sector, lower remuneration of top management and somewhat higher taxes on that remuneration, a greater level of unionization and a lower level of entrepreneurship (although the small business sectors as a whole are comparable in size.)
Europe’s model does not today involve markedly higher public ownership of the corporate sector than in the United States; privatization in Europe has greatly reduced public ownership in the power and telecom sectors while some assets such as airports are publicly owned in the United States and privately owned in some European countries.
Savings in continental Europe are more directed to bonds than in the United States; the continent avoided most of the late 1990s stock market bubble, and the core countries of the EU have avoided a housing bubble. On the other hand pension provision is largely through public sector schemes, which raises markedly the cost of low skill labor and provides a looming actuarial problem as populations age and move into retirement.
The standard U.S. conservative criticism of the European model notes the high level of unionization, higher social security contributions (for public sector pensions and healthcare), shorter working week, longer vacations and lower entrepreneurship and concludes that Europe is hopelessly uncompetitive against the emerging Asian economies, and doomed to become more so as European social security systems slip ever further into deficit.
There’s just one problem: it is the United States, not Europe that persistently runs balance of payments deficits with the rest of the world, and the United States, not Europe, whose public finances appear to be slipping ever further out of control. President George W. Bush’s request Friday for an additional $92 billion for the war on terror and Hurricane Katrina recovery, over and above the budget submitted only two weeks ago, demonstrates how feeble the controls over spending have become – typically, the request was submitted on a Friday before a holiday weekend, to minimize news coverage and market impact.
Looked at in reality, and not in rhetoric, the European economies appear sluggish but not uncompetitive, nor is there any real sign that their competitive position is in danger of erosion. The euro is expected by most commentators to strengthen, not weaken against the dollar in the near future. The comparison between Europe and the United States tilts even further towards Europe when you take into account that Europe does not use the “hedonic pricing” which has artificially suppressed U.S. inflation and boosted reported U.S. growth over the last decade, so that true European and U.S. economic growth rates, adjusted also to reflect higher U.S. population growth, are much closer than they appear.
This is not to say that Europe’s economic future is assured, far from it. The solution to Europe’s problems incessantly offered from across the Atlantic, to become more like the United States, is however unlikely to work. American industrial traditions are very different from those in Europe. You only have to look at the early history of the automobile industry, where U.S. manufacturers focused early on mass produced vehicles for the common man, while Europe concentrated on superbly engineered luxury cars for Grand Dukes and their chauffeurs. Austro-Daimler achieved a product placement coup for the ages by manufacturing the car in which the Archduke Franz Ferdinand was shot at Sarajevo, but it was Henry Ford who gained market dominance.
European attempts to imitate Ford were notably not carried out by the mainstream automobile manufacturers. In Germany’s case, the inventor of the Volkswagen, Ferdinand Porsche, saw his creation taken over by a megalomaniac state (though he later achieved success in the traditional European field of up-market sports cars.) In Britain’s case, the greatest success was achieved by a bicycle mechanic, William Morris Lord Nuffield, who even after becoming Britain’s largest manufacturer was so far outside the establishment that he was never consulted on what economic policies Britain’s postwar export drive, which he was to lead, might require.
To summarize a complex subject European business successes tend not to be based on supreme manufacturing efficiency, but on quality, branding and features. In such cases, there is a much greater role than in a more routinized business for highly experienced workers with a deep knowledge of the company’s operations, and for capable middle management with specialist knowledge, and European management and incentive structures reflect this. Operationally, this is a generalization with many exceptions, but it is a key to European corporate culture and prevents the simple adoption of an American economic model.
Rather than imitating the United States there are a number of policies which Europe could follow to assure its future. The continent is somewhat overcrowded, having a high population density and a low level of natural resources per capita. The current very low European fertility rates will remedy this, but they must be given time to do so. Accordingly, retirements must be delayed, and pensions trimmed, so that the burden of the retiree population does not fall too heavily on the younger generation.
Concurrent with this, immigration to Europe must be tightly restricted, in order for the benefits of declining population to be obtained. Fantasies that youthful immigrants will pay the pensions of elderly native-born must be avoided; in reality a tide of youthful immigrants will cause population to continue to increase, while at the same time changing its ethnic and religious mix, thus rendering the old age of the baby boomers both impoverished and troubled.
With the entry into the EU of ten new countries in 2004, and the potential entry of Romania, Bulgaria and Croatia in 2007-08, there is an ample supply of low cost labor for the foreseeable future, so the economic arguments for opening the borders further to non-Europeans are invalid. Indeed, absorption of nearly 100 million new relatively impoverished citizens will take a long time, probably a generation (East Germany, with a population of only 16 million, is still not fully integrated 16 years after unification.) Thus further expansion of the EU (other than to the small countries of former Yugoslavia) should be avoided until at least 2030, or more safely 2050. Both Ukraine and Turkey have large populations, and Turkey in addition brings cultural and ethnic questions that are difficult to solve, so the rapid entry of either country into the EU is only too likely to destabilize the economies and politics of existing members.
It may be desirable for the United States to subcontract its manufacturing to India and China, while focusing on services and the tech sector, but it is pretty clear that it is undesirable for Europe to do so to any great extent. Indeed, the yawning trade deficit faced by the United States, and the economic imbalances that have appeared the last decade, suggest that even for the United States and the world as a whole a full free trade policy may not be sustainable. The collapse of the Doha round of trade talks, caused largely by European intransigence, suggests that Europe has realized this, and that their living standards may more reliably be preserved by moderate protectionism.
Certainly one can argue about the balance; the Common Agricultural Policy, which hugely subsidizes wealthy European farmers at the expense of both consumers and the Third World, appears economically indefensible, but even here there is a strategic argument in favor of not becoming wholly dependent on imports for food which, given the high cost of European land and labor, might very well happen if full free trade were introduced. As European population declines, thus causing a sharp decline in land prices and a moderate decline in food demand, the protectionist policy can be relaxed, but even so the need to integrate large tracts of inefficiently farmed land in Eastern Europe would point to any relaxation being gradual.
European policymakers and the voting public appear to have grasped an important economic point here, which conventional analysis misses. Full free trade and rapid economic change impose costs on society, because of redundancies and the need to retrain, the majority of which are borne by the older and/or less skilled members of the workforce. It is of little consolation for a 50 year old steelworker who is made redundant to be told that Gross Domestic Product overall will benefit from the closure of the mill, and that the 25 year old tech sector employees who get the new jobs will be more skilled and better paid than he is – whatever the economic reality, he is likely to face a late middle age of impoverishment followed by a minimal state pension.
By inserting economic hysteresis into the system, and slowing Joseph Schumpeter’s “creative destruction” as far as possible, European policymakers are increasing the welfare of their older and less skilled citizens, and thereby quite possibly the welfare of society as a whole (particularly if they are preventing an increase in inequality, itself a reduction in welfare given convex welfare functions.) This is especially true if, as appears to be the case, there is no practical way to legislate against age discrimination, which forces redundant 50 year olds out of the workforce altogether.
Within the EU, on the other hand, protectionism and restrictions prevent full advantage being taken of the EU’s large market and sophisticated consumers. Hence the 1992 Single Market initiative, which is still only partially implemented in the services area, was very important. The EU can also benefit by harmonizing regulation, limiting the variation in business conditions between its 25 members, but only if restrictions are harmonized down and costs are removed rather than additional costs and regulations being imposed.
The Achilles’ heel of the European model is its government sector, which tends to grow uncontrollably until economic growth is stalled by its expansion. Here the Stability and Growth Pact, necessary for the creation of the Euro, has been very useful indeed, since it limited the growth of government, unless financed by always unpopular direct tax increases. Countries such as Italy and Greece, with a tendency to fiscal indiscipline, particularly benefited from its strictures. Germany too, which attempted to solve the problems of East German integration by a tsunami of government spending, has been brought back under control in the last few years and now appears likely to resume growth on a healthy basis. Fiscal discipline, not just in maintaining balanced budgets but in forcing the state sector to decline as a percentage of the total except in moments of acute crisis, is an important part of the policy mix.
Finally, one of Europe’s principal cost advantages over the emerging markets is its relatively high availability and low cost of capital. This advantage is minimized in periods of high world liquidity such as the present, when everybody has access to borrowed capital. It is maximized in periods such as the 1950s when real interest rates are high, money supply is tightly controlled and most investment is financed by well rewarded domestic savings. Tight money and restrictive lending practices have an additional advantage in preventing real estate bubbles. Thus Germany, with a restrictive housing finance sector and a low level of stock exchange speculation, will benefit enormously in the years to come from having missed out on the world real estate bubble of 2001-05. With population trending downwards, real estate costs can be expected to decline throughout the EU; this will become another significant competitive advantage.
This policy package, of restricting immigration, moderate protectionism, deregulation, opposition to rapid economic restructuring and tight control of state spending and the money supply is not that currently pursued by the EU policymakers, still less is it that favored by the United States. It is close to the policy followed by West German Chancellor Konrad Adenauer (1949-63) the father of modern Europe and the instigator of the wirtschaftswunder, the most impressive period of rapid economic growth any large European economy has ever enjoyed.
Finally, Britain under Tony Blair has enjoyed the best of European and U.S. policies – or has it? With a huge real estate bubble, a heavy trade deficit, resurging inflation and public spending that has shot up to European levels, rising by 5 percent of GDP in only a few years, Britain has the worst of both worlds. It is likely to suffer an asset-price-deflation slump similar to that impending in the United States, and then find its recovery blighted by an overgrown and unresponsive public sector, and accompanying fiscal strains.
Tony Blair and Gordon Brown may have a very different style to the pipe-smoking populist Harold Wilson (1964-70, 1974-76), but their policies are in the next few years likely to end in the same place – economic collapse.
-0-
(The Bear’s Lair is a weekly column that is intended to appear each Monday, an appropriately gloomy day of the week. Its rationale is that the proportion of “sell” recommendations put out by Wall Street houses remains far below that of “buy” recommendations. Accordingly, investors have an excess of positive information and very little negative information. The column thus takes the ursine view of life and the market, in the hope that it may be usefully different from what investors see elsewhere.)
This article originally appeared on United Press International.