GAPING:

US/EU economy: The US-European economic gap: how serious is it? (THE ECONOMIST INTELLIGENCE UNIT, 2/21/05)

There is very little evidence that the stark contrast between EU and European performance—and in particular the striking divergence since 1995 in productivity growth—is a statistical artefact. Several factors impair cross-country comparability of productivity, but these tend to offset each other or be of little overall significance. On the one hand, compared with the US, European productivity statistics are flattered by the fact that the lowest-productivity workers are unemployed and hence not included in labour productivity measures. On the other hand, the treatment of information and communications technology (ICT) in the US and most European national accounts tends to inflate the US advantage in levels and possibly also in growth of productivity. In the US computer software spending is treated as investment, so it contributes to GDP. In Europe it is generally counted as a current expense and so is excluded from final output. The surge in software spending thus increases US growth relative to Europe's. Unlike in the US, most euro-area countries may not make sufficient adjustments for improvements in computer "quality", understating Europe's growth relative to the US. However, alternative productivity estimates for the US and Europe that are built up from adjusted, disaggregated industries data, and that use a uniform methodology, do not yield a significantly different picture from that based on official national accounts data.

Is euro zone underperformance purely a German and Italian phenomenon? Even if it is, stripping these two out of the euro total is arbitrary. If there is a big problem that affects almost half the region, that surely means that there is a euro-zone problem. Even without Germany and Italy, the euro zone growth in GDP per head only matches that of the US, whereas theory tells us that it should in fact be considerably higher given the 30% gap in GDP per head levels. In terms of GDP per head, the US-euro area differential is not just persistent (allegedly in the main the result of a choice of leisure over work); it is increasing. Pointing to the successes of several small European states—especially Ireland and some Nordic countries—says little about the European model, since these states account for a very small share of the euro area's population and output.

In terms of GDP growth, the US has continuously led Europe since 1973, and the period since 1995 is not a special case from this perspective. However, whereas in the earlier periods differences in labour input explained higher US growth, in the latest period all sources of growth show a higher contribution in the US than in the EU. Particularly worrisome for the euro zone countries is the trend in all-important total factor productivity growth (TFPG, growth that is not accounted for by increases in labour and capital inputs). The data in table 2 show that that TFPG has been steadily declining in the euro area since the 1970s, with TFPR growth halved in 1995-2003 compared with the 1980s and early 1990s. In the US, by contrast, TFPG has actually accelerated since 1995 to nearly double the euro area rate.

Despite the increase in employment rates and higher labour input contribution to growth in recent years in the euro area, European unemployment rates remain higher and labour force participation rates lower than in the US. About 30% of the working-age population in the euro area is neither employed nor seeking work, compared with less than 25% in the US. Even with recent improved European employment growth and several years of "jobless growth" in the US, average employment growth in the euro zone and the US since 1995 has been equal. The average unemployment rate in the euro zone of about 9% is far higher than in the US.

Over the past decade the US has managed both to maintain employment growth and achieve stronger productivity growth. The latter has not come at the expense of the former. In contrast, following earlier declines in Europe, a recovery in employment growth since 1995 (which has, however, not even surpassed that in the US) has been associated with declining productivity growth.

On the income-leisure trade-off, it is often said that if the situation is the product of individuals choosing more leisure but less income, then there is nothing further to be said. It is individual welfare that matters, not the maximisation of national wealth. However, that may in fact not be the end of the matter. First, the extent to which the leisure/income balance is a product of choice as opposed to a consequence of market distortions is a subject of disputed empirical assessments. Even if it is assumed that most of the fall in hours worked in Europe has been the product of choice, even revisionists would acknowledge that a part is the result of involuntary unemployment and/or market imperfections that distort individuals' calculus of the income/leisure balance. Second, the impact of demographics suggests that this choice in Europe will be unsustainable. Growth still does and will matter; Europe's demographic reality will enforce an increase in average working hours and changes in the income-leisure balance. And finally stepping outside the bounds of liberal economics, questions can be asked about the long-term future and vitality of societies in which leisure-oriented values predominate so heavily and the work ethic is downgraded.

Thus, two facts stand out. The US embarked on a productivity spurt in the mid-1990s while Europe did not. Second, Europe's earlier productivity spurts have been at the expense of employment growth, while periods of higher employment growth have been associated with declining productivity growth. The US has shown more success in combining productivity growth with employment growth.

The funniest revisionist argument is that the numerical comparisons on growth aren't fair because our population is growing so much faster than theirs and there's nothing they can do about that.

Posted by Orrin Judd at March 1, 2005 9:27 AM