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A Balanced View of the European Economy

by TGeraghty Thu May 18th, 2006 at 12:35:03 PM EST

In the recently-published collection The Global Economy in the 1990s: A Long-Run Perspective, Riccardo Faini of the Universita di Roma Tor Vergata takes issue with the irrationally pessimistic view of European economic performance than one usually gets from the mainstream business and financial press:

Europe: a Continent in Decline?

His conclusions:

  • Once corrected for demographic changes and accounting differences, the growth performance of the Euro nations since 1990 is no worse than that of the United States;

  • The income gap that still exists between Europe and the US is mostly accounted for by differences in hours worked, suggesting that higher American GDP results mainly from different preferences for leisure and not from European inefficiency;

  • There has been no systematic decline in the competitiveness of European economies; changes in world export share can be explained by changes in the nominal euro-dollar exchange rate;

  • The real problem with the European economy seems to be its inability to sustain rapid productivity growth and employment growth simultaneously.

(For those interested, more details below)

From the front page - whataboutbob


Euro-pessimism is back. . . .  between 1990 and 2000 GDP increased at an average annual rate of 3.2% and 2.1% in the US and in the EU respectively. . . .  

Adding to the concerns of the Euro-pessimists is the steady erosion of the EU exports share in world markets. Between 1990 and 2001 Germany's export share has fallen from 12.1% to 8.1%. Italy and France have not fared better, with their share declining respectively from 5.1% and 6.1% in 1990 to 3.9% and 4.8% in 2000. Again, the contrast with the US is striking: over the same period, the US share in world export markets rose from 13.1% to 14%.

Labor productivity is also mentioned as a further, and perhaps more fundamental, indicator of Europe's long term decline . . . between 1997 and 2002, the US has definitely over-performed the EU, with labor productivity growth rising to 2.2% in the former and falling to 1% in the latter.

. . . we take a closer look at the European performance. We take issues with the most of the indicators - GDP growth, world export share, productivity growth - that have been used to demonstrate the facts of Europe's decline:

His conclusions:

  • Once corrected for demographic changes and accounting differences, the growth performance of the Euro nations since 1990 is no worse than that of the United States;

  • The income gap that still exists between Europe and the US is mostly accounted for by differences in hours worked, suggesting that higher American GDP results mainly from different preferences for leisure and not from European inefficiency;

  • There has been no systematic decline in the competitiveness of European economies; changes in world export share can be explained by changes in the nominal euro-dollar exchange rate;

  • The real problem with the European economy seems to be its inability to sustain rapid productivity growth and employment growth simultaneously.

Economic Growth and Demographic Change

By and large . . . old Europe suffers first and foremost from a demographic decline. During the eighties population increased at an average annual rate of 1% in the US and only 0.3% in the Euro area. During the nineties, population growth in the US even accelerated to 1.15% and the gap with the euro area rose to more than 0.8%. Clearly, under these circumstances, comparing aggregate GDP growth is simply misleading. . . . When corrected for population growth, Europe's performance has been better than the US in the eighties, has worsened markedly during the first half of the nineties and, in the more recent years, has been at par with that of the US.

Average Annual Per Capita GDP Growth, US and Euro Area               
                    1981-90    1991-02    1991-96    1996-02
United States    1.9%         1.7%        1.4%      2.1%
Euro Area         2.1%         1.6%        1.2%       2.0%

Economic Growth and Accounting Conventions

The harmonization of national accounts definitions has been a decisive factor in allowing meaningful cross country analyses. Yet, substantial differences persist, even among industrial countries:

  • Military Equipment: In 1996 . . . when US national accounts were duly amended, the extension of coverage of investment was more extensive than recommended by international conventions, as it included also those assets that are used exclusively for military purposes. The effect on the level of GDP may not have been sizeable, 0.6% according to the OECD. Its impact on growth may be even smaller, 0.03% over the past decade. Both effects however are likely to grow larger given the recent military build up undertaken by the current US administration.

  • Financial intermediation services to households are a further item that is treated differently in the US, where it is included since the late eighties, and in Europe and Japan, where contrary to international conventions it is excluded mainly for measurement difficulties. The impact on GDP level is sizeable, 2.3%; that on GDP growth is not negligible, 0.1%.

  • Software Investment: Most European countries use a demand approach, relying on the way businesses record investment. An alternative approach, used in the US, is to measure the total supply of software services and then estimate the portion of such services with assets characteristics. The impact on the level of GDP is substantial. Given the disproportionate growth of software expenditure, differences in the measurement of software have also a sizeable impact on growth. According to the OECD, had the US used the European demand-based approach, growth in 1997-98 would have fallen by a substantial amount, up to 0.2%.

  • Hedonic Prices: Last but not least, Europe and the US differ in their use of hedonic prices. This is perhaps the most notorious correction. Perhaps surprisingly, its GDP effects are not particularly sizeable. Moreover, even the sign of such correction is not unambiguous. For instance, if hedonic prices are used for intermediate imported goods, the volume of imports will grow with a corresponding reduction, ceteris paribus, in the volume of net output. Overall, according to the OECD, the impact on US growth is relatively small, 0.1%. More crucially, it is offset by a parallel correction in US national accounts. Following international recommended practices, the US combines the use of hedonic prices with Laspeyres, instead of Fischer indices, the latter being used instead by European statistical offices. Laspeyres indices lead to a fall in measured growth rates of approximately the same order of magnitude as the increase associate with the reliance on hedonic prices.

Overall, allowing for different accounting definitions leads to a reduction in the US growth rate of around 0.2-0.3 %. As emphasized by the OECD (2003), this results only in a fractional reduction of the aggregate growth differential, 1% during the nineties, between the US and the Euro area.

However, the impact on the difference in per capita GDP growth is quite significant. Moreover, there is a further and quite crucial effect on the dynamics of the convergence process between Europe and the US. Recall that most of these accounting corrections have little or no impact on measured growth during the eighties, their main effect being to lower US growth during the nineties, particularly in the second half of that decade. This has a number of substantive implications:

  1. First, the decline during the nineties in the relative performance of the Euro area with respect to the US was less pronounced than previously thought, as it reflects to some significant extent different accounting procedures.

  2. Second, it is no longer true that the US economy grew at a faster rate than the Euro area during the first half of the nineties.

  3. Finally, and perhaps more crucially, in the second half of the decade US per capita growth would be again below that in the Euro area.

To sum up, if the convergence [catch-up of Euro per-capita GDP with that of the US] process ever came to a halt in the first half of the nineties - and even this conclusion is less than fully warranted - it was back on track during the second part of the decade. . . . once different accounting conventions are allowed for, per capita growth in the Euro area has not fallen behind the US and, most likely, has surpassed it in the most recent years.

Composition of Growth

To measure the proportional contribution of the different factors to the US - Euro area income gap:

  • Productivity differential were quite important at the beginning of the period, as they accounted for 57% of the gap.

  • Faster productivity growth in Europe meant however that this factor played a lesser role over time. Indeed, in 1997, productivity per hour was actually higher in the Euro area than in the US. More recent trends have however favored the US and, in 2001, productivity differential gave once again a positive contribution to the income gap between Euro and the US. At the same time, however, its role was much less reduced.

  • Indeed, in 2001, the key factor in explaining the income gap between the two areas was the number of hours worked per employed person. By and large, therefore, the preference for leisure . . . is the main factor behind Europe's short working time and, hence, its remaining income gap with respect to the US.

Competitiveness

[Although] the loss of market shares in world exports is often lamented as an unambiguous indication of the decline in Europe's competitiveness in the international arena. . . . there are no obvious indication of a structural loss in competitiveness for euro area countries. The evolution of their export share in world markets is well explained by the behavior of the nominal euro-dollar exchange rate. The recent recovery on world export share for Germany, France, and Italy also points to the paramount role of valuation effects.

The Real Problem with the European Economy

In a nutshell, while the US economy was able to combine fast employment growth with an extraordinary productivity performance, the Euro area economy appears to be facing a difficult trade-off between fast productivity growth, and hence sustained wage growth, and rapid employment growth but stagnant real wages.

Why might this be the case? Typically inefficient labor and product market regulations are cited, and Faini does not dispute this. Others have suggested a lag in the diffusion of information technology in Europe. But there may be another reason:

New entrants into employment were mostly young and quite inexperienced. The recorded fall in TFP growth may therefore be a statistical artifact, to the extent that no (or inadequate) allowance is made for experience. Over time, as the new entrants acquire more experience, Europe's productivity growth would rebound, softening the trade off between productivity and employment growth. . . . Whatever the answer, it remains true that the opening up of the productivity gap with respect to the US offers new prospects for Europe to catch up.

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"Once in awhile we get shown the light, in the strangest of places, if we look at it right" - Hunter/Garcia
by whataboutbob on Wed May 17th, 2006 at 03:55:13 AM EST
In a nutshell, while the US economy was able to combine fast employment growth with an extraordinary productivity performance, the Euro area economy appears to be facing a difficult trade-off between fast productivity growth, and hence sustained wage growth, and rapid employment growth but stagnant real wages.

Of course, given the questions over the median wage in the US, there remain questions about how much real wage growth there is.

The critics of this position cite investment income as making up for the stagnation of US wages, but of course that points to a very different economic model. (This is a point worthy of longer exposition than I have time for right now.)

One final question for the ET brains trust: How can increased productivity lead to increased wages? Or are they two basically separate issues?

by Metatone (metatone [a|t] gmail (dot) com) on Wed May 17th, 2006 at 04:51:54 AM EST
If you're more productive then you're producing more and your company is selling more so they pay you more. Assuming that there is competition for labour...
by Colman (colman at eurotrib.com) on Wed May 17th, 2006 at 06:50:26 AM EST
[ Parent ]
hm, that also implies demand.

One of the problems is that if I make widgets in competition with the Chinese, the productivity goes into price cuts, so I keep my job (good) but get no pay rise (bad).

by Metatone (metatone [a|t] gmail (dot) com) on Wed May 17th, 2006 at 08:05:52 AM EST
[ Parent ]
I'm curious about that too. Common discourse on productivity in Portugal (roughly 70% of EU average) always seems to imply we need to work more for less. Hardly a motivator for anybody, if you ask me.
by Torres on Wed May 17th, 2006 at 07:04:11 AM EST
[ Parent ]
Wikipedia to the rescue:
In economics, productivity is the amount of output created (in terms of goods produced or services rendered) per unit input used. For instance, labour productivity is typically measured as output per worker or output per labour-hour. With respect to land, the "yield" is equivalent to "land productivity". International intangible standards are used to calculate the productivity of human capital for all employees within an organization.

Some economists write of "capital productivity" (output per unit of capital goods employed), the inverse of the capital/output ratio. "Total factor productivity," sometimes called multifactor productivity, also includes both labor and capital goods in the denominator (weighted by their incomes).

Unlike labor productivity, the calculation of both capital productivity and total factor productivity is dependent on a number of doubtful assumptions and is subject to the Cambridge critique. Even measures of land and labor productivity should be used only when conscious of the role of the heterogeneity of these inputs to the production process.

"International Intangible Standards"? WTF, angels on pinheads!

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed May 17th, 2006 at 07:08:50 AM EST
[ Parent ]
If i understand correctly one way of increasing productivity is selling your product for more. You then get a better return for the work you put in. Thats why i always feel unconfortable when i hear of productivity.
We  keep hearing that our textiles and shoes  can't compete with the chinese, but then you learn that lots of textiles and shoes are made in Portugal but sold to, for example, Italy, rellabeled and sold at a premium.

So the productivity deficit must be blamed on the management who can't market their premium products properly, not the worker who can't possibly make more during his work hours. But you hardly ever hear that.

by Torres on Wed May 17th, 2006 at 09:38:43 AM EST
[ Parent ]
wow that paragraph wins the 'blatherspeak' contest of the year!

(still getting my head around 'fungible' meaning something else than 'mushroom-like', sigh...)

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

by melo (melometa4(at)gmail.com) on Fri May 19th, 2006 at 02:03:16 AM EST
[ Parent ]
Your point about lack of US wage growth is right on target.

The key is to have a balance between total supply (productivity) and total demand in the economy. If both are increasing then you can have rising productivity, employment, and wages.

To get that balance you need the right institutional set-up -- a strong labor movement, adequate welfare state, a corporate governance framework that involves workers and thus gives firms incentives to invest in the domestic economy while ensuring a fair distribution of enterprise returns, and public investment in R&D and infrastructure.

by TGeraghty on Wed May 17th, 2006 at 11:07:30 AM EST
[ Parent ]
There was an article somewhere recently that suggested that the big difference between US and EU productivity growth was in the retail sector: Wal-mart workers are very productive, much more so than workers in smaller stores and the EU doesn't have as many big stores... does this strike anyone else as a terribly preverse way of measuring performance?
by Colman (colman at eurotrib.com) on Wed May 17th, 2006 at 06:53:02 AM EST
What is the definition of productivity? In what units is it measured?

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed May 17th, 2006 at 06:58:38 AM EST
[ Parent ]
This PDF looks like it'll answer that question... i don't have time right now.
by Colman (colman at eurotrib.com) on Wed May 17th, 2006 at 07:08:29 AM EST
[ Parent ]
unicorn farts per pinhead.
by Metatone (metatone [a|t] gmail (dot) com) on Wed May 17th, 2006 at 07:54:09 AM EST
[ Parent ]
Productivity is simply output per unit of input.

Labor productivity = some measure of output (GDP, for instance, or some measure of revenues or value added for firms) per worker (or per hours worked, as in this paper).

Total factor productivity = output measure per a composite measure (usually a geometric mean) of all types of inputs (labor, capital, land, etc.).

by TGeraghty on Wed May 17th, 2006 at 11:30:27 AM EST
[ Parent ]
Sorry, I see you already posted an answer to this upstream.
by TGeraghty on Wed May 17th, 2006 at 01:38:39 PM EST
[ Parent ]
That sounds like the inverse of a leontieff matrix (input required for a unit of output).

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman
by Migeru (migeru at eurotrib dot com) on Wed May 17th, 2006 at 04:08:37 PM EST
[ Parent ]
A Leontief input-output matrix is a special case where the outputs are always a fixed multiple of the inputs; i.e. productivity is constant regardless of how much input you use.
by TGeraghty on Wed May 17th, 2006 at 06:36:02 PM EST
[ Parent ]
Yes, that's right -- retail and financial services, driven by investments in information technology and associated business reorganization. I wrote about it here.
by TGeraghty on Wed May 17th, 2006 at 01:14:28 PM EST
[ Parent ]
much as i loathe what walmart stands for, and bemoan the era passing of mom'n'pop stores, prejudices aside, i wonder if a walmart concept of megastore (but with alternative sustainable energy and ecodesign), is not the way forward, so as to unblock the snarl-up that inner cities have become in the auto age.

if you can't park near the store, you need a way to hump yer groceries, innit?

restoring historical centres of european towns to pedestrian use, means retailers there (still needing smelly trucks to deliver their supplies), need to purvey preferably high value-added services like restaurants, beauticians, hairdressers, jewellers and high fashion items, so that madame can carry her new gucci purchase, her hair and nails rebuffed, belly full, back to the parking zone to drive home.

unless she lives close by in the centre, and can hop on the pubtrans, bike or shank's-pony home.

ken livingstone's approach in london seems to be working, as far as i can see, though it penalises the poor, and until better, greener, cheaper, more reliable pubtrans comes along, is a palliative, not a real cure.

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty

by melo (melometa4(at)gmail.com) on Fri May 19th, 2006 at 02:19:03 AM EST
[ Parent ]
Or a return to delivery services for stuff.
by Colman (colman at eurotrib.com) on Fri May 19th, 2006 at 02:39:50 AM EST
[ Parent ]
i remember when harrod's in the 60's had electric delivery vans, and really cool pneumatic message delivery tubes from dept. to dept!

'The history of public debt is full of irony. It rarely follows our ideas of order and justice.' Thomas Piketty
by melo (melometa4(at)gmail.com) on Fri May 19th, 2006 at 02:07:45 PM EST
[ Parent ]
I don't understand. With mixed residential/commencial land use, and lots of small grocery businesses, one can walk or bus to the grocery store and buy in small quantities that are easy to carry. That's what we do anyway, and we get quality produce.

As Colman suggests, there are delivery services. I have tried buying online through Tesco and have it delivered (worked well, but Tesco is evil) and now we're getting organic produce delivered weekly to our door.

If we had a car we'd have to eat it.

A society committed to the notion that government is always bad will have bad government. And it doesn't have to be that way. — Paul Krugman

by Migeru (migeru at eurotrib dot com) on Fri May 19th, 2006 at 02:13:33 PM EST
[ Parent ]
We frequently fall into a trap, measuring the wrong the thing. Industry likes to measure by things like GDP, wages and import/exports.

People should use a human-scale measure. There have been many attempts to create one (like purchasing power parity), but they don't get much play in the press.

The real issue is how are people doing in their society? Do they have an adequate standard of living? Is their health care and retirement adequate? How about child care and education?

By even discussing "growth" we allow business to set the  terms of the debate. In the US over the past three decades the working class has gotten slightly poorer, the poor class has gotten larger, the middle class has stagnated and many services have gotten more expensive and, therefore, less available.

In addition the US has focused on militarism to such an extent that it has caused unprecedented levels of debt and a hollowing out of the non-military infrastructure. The response to Katrina is an example of what would be expected in a third world country.

I can't speak for Europe, but my impression is that (at least for western Europe) the poor are not quite as poor and that there are fewer of them as a percentage of the population. In addition social services are more widely available and more comprehensive.

So what's left to measure? Happiness and material possessions. The average US household certainly has more "stuff", but whether this is a useful indicator is not clear.

So how is Europe doing on the quality of life and happiness indexes?


Policies not Politics
---- Daily Landscape

by rdf (robert.feinman@gmail.com) on Thu May 18th, 2006 at 07:21:44 PM EST
we've been around this tree before, I think...

happiness is hard to measure but proven causes of unhappiness might be easier.

happiness-negative-metrics might include infant mortality (losing a baby usually makes people sad, provided that it was wanted in the first place);  rates of self-reported depression, call rates to suicide hotlines;  percentage of population in prison;  inequality factors (all the studies I know indicate that gross visible inequality creates anxiety and unhappiness);  number of hours worked per week (too high an average likely to lead to ill health);  sales of antidepressants and sleeping pills;  number of people in medical tutelage for chronic conditions...  violent crime rates... number of people suffering from food or housing insecurity...

some of these indicators are tracked and commented on but no one afaik has attempted to do a formal weighting and combination into a GNUI (Gross National Unhappiness Index) which could be a target for minimisation via policy.

ever-reliable wikipedia has an entry on alternative indices, which reads in part For example if X product is consumed in good quantity for high profit, classical liberal economists argue that societies know that this good, and all the factors used in the production of the good, generate a great deal of happiness for society.

to the average non-economist of course it seems to make a great deal of difference whether X is heroin or asparagus, handguns or garden trowels, gas masks or skipping ropes, SUVs or bicycles, etc.   or for that matter, whether producing tons of X today means that our grandchildren won't enjoy any X at all.  but then, we non-economists don't know any better than to think there are value systems outside the market :-)

The difference between theory and practise in practise ...

by DeAnander (de_at_daclarke_dot_org) on Thu May 18th, 2006 at 07:35:33 PM EST
[ Parent ]
This is a very, very good point. We did discuss some of these general issues in the Postmodern Values and Qualitative Growth, which provides some evidence suggesting exactly what you say -- for rich countries, simply piling up more things does not necessarily lead to more happiness.

I think GDP and productivity growth are still important in terms of providing resources to alleviate poverty and invest in social services and other kinds of quality output, but they are not everything.

In terms of broader indicators -- rich Europe is healthier than the US, with longer life expectancy, lower infant mortality rates, and better nutrition (since Europeans are now growing taller than Americans for the first time in 4 centuries).

Social mobility is also higher in the European countries with more generous welfare states. Inequality and poverty rates are lower.

Also, the EU-15 produce about the same output as does the US, but with half the CO2 emissions, so Europe is greener, too.

Putting everything together, you could make a strong case that the European standard of living is at least on par with that of the US. About the only thing you can't get in Europe is your suburban house on a big plot of land.

Here is some information on the human development index that combines some of these into a broader measure of well-being. The US is 10th, behind 7 small European countries as well as Australia and Canada.

by TGeraghty on Thu May 18th, 2006 at 10:33:12 PM EST
[ Parent ]


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