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Friday, February 28, 2003

Query from John: ARE EU WORKERS MORE PRODUCTIVE THAN US WORKERS?

Our thanks to John, a close observer of the European scene, who has lived, studied, and worked there for years. The subject is the levels of (labor) productivity in the EU, and various countries there, as compared with the US.

Here is John's query:
Prof Buggy:

"I was wondering about your thoughts on certain economic statistics that The Economist has cited in recent issues comparing the US and EU, which purport to explain how EU workers produce more value in less time than Americans.

The first reference I saw was to a study by a US academic who sought to explain how the EU system (assuming you're lucky enough to have a job) is able to offer workers a superior quality of life at less cost to the overall economy because European leisure is cheaper than American leisure based on the fact the American can't produce as much value per hour as the European). Accordingly, Americans may be wealthier but they have to work so much harder than the Europeans to obtain that little bit of additional income (and I add it's a margin that gets whittled down by taxes anyhow). The statistics, apparently, support this 3 proposition assertion:

  1. US workers are more productive than EU workers, and GDP per US worker is greater than GDP per EU worker.


  2. If anything, these gaps are growing over time.


  3. By contrast, GDP per hour produced by an average EU worker is greater than the GDP per hour worked by the US worker.


This seems strange, and the only way it makes sense to me is as follows: productivity is measured as a ratio of the increase in real GDP and the hours worked on the other . . . in short, for any national economy, labor productivity for any year = the increase in GDP adjusted for inflation / hours worked by all the nation's worker, adjusted by labor costs. So the EU productivity lag appears to be explained by the fact that even though the output side of the ratio is greater for the European than for the American, the cost side of the ratio is just that much more expensive that it skews the ratio lower for the Europeans.

Based on this logic, even if the EU labor costs are brought down to raise productivity, they could still be sustained at a higher level than the US while maintaining an equal level of productivity. Accordingly, to the extent the American and European were to work the same hours, then the European would receive higher total compensation per head (ignoring the capital component). To what extent does this describe a latent strength of the European economies that just needs to be unleashed through labor market reforms-- and then watch out America about who is eating whose dust in (a view I've heard argued by friends). And to what extent does it suggest that Europeans' GDP per head would be much higher than the US if they just worked as hard as we do (recognizing this ignores diminishing returns)?"

 

John:

This is a good query, which raises some technical questions as well as practical ones. In answering both, I'll try to be as brief as possible and not wander off into technicalities, but some key matters need to be explained --- in five or six sets of observations --- before we deal directly with the question you raise about EU vs. US levels of labor productivity.

To anticipate though, note briefly that the EU productivity level on an average refers, usually, to output/worker. The US Bureau of Labor does the same. Both the EU Commission and the Bureau of Labor here can also define labor productivity as national output (real GDP) / per inhabitant. You mention a third definition, in which output/worker is then qualified in the denominator by hours worked. Though this is rare, it is done, and I'll cite a recent study by Robert Gordon of Northwestern that does exactly that. He shows that about a third of the big labor productivity gap between the EU and the more efficient US is reduced by about a third when qualified this way.

Note three things right off. First, the average US worker logs in about 20% more hours per year than the average EU worker. Second, the US labor force has grown from about 63% of the US population able to work (adults 18-65) to around 73% from 1975 to 2002, and the EU labor force has shrunk from 63% in the same period to around 59-60%, the US economy values creating jobs for more and more workers, including new entrants into the labor force, than does the EU countries' economies. Third, if you qualify labor productivity by hours worked as Robert Gordon does --- the assumption being that EU workers prefer leisure much more than Americans --- that makes sense only if in fact the much lower number of EU adults working reflects voluntary unemployment: they either don't want a job or prefer part-time or temporary jobs. Almost all studies doubt this.

The upshot is far higher structural unemployment in the EU countries: long-term, and especially hard-hitting on young people (more and more of whom stay in universities through government stipends until their late 20's or thirties) and immigrants. It also reflects far more rigid labor markets and more anti-competitive practices --- including protection against especially dynamic Asian manufacturing nations operating in the same industries as the Eropean populationsm as well as numerous subsidies to uncompetitive industries. And also reflects a third thing: high minimum wages that make low-skilled labor too expensive for firms to hire, compounded by the difficulties of laying off workers in a recession . . . which means that even in the expansionary phase of the business cycle, EU firms are reluctant to hire new workers if they can't lay them off when the next recession comes.

A second upshot: European firms, especially in manufacturing (a much larger sector of the EU big and mid-sized economies than in the US, save for Britain), have been able to sustain output with fewer and fewer workers over the last 25 years at the price of national unemployment. The same thing as happened the last year and half in the US economy, but cyclically . . . not structurally: firms as recession and fairly slow growth have occurred let go workers but sutained output --- the 3 quarter recession in 2001 was shallow and short-lived --- with fewer workers. That's the reason unemployment rose from 4.0% in mid-2000 to 5.9% last fall: this, despite a revised GDP real growth of around 3.0% for 2002. In the process, US labor productivity --- which had soared in the latter six years of the 1990s --- actually grew faster last year. Fortunately, the US economy enjoys flexible labor markets and matchless start-up firms, and will continue to create about 200,000 net new jobs each month over the long term of this decade . . . exactly as it has since the late 1970s. And though this might slow the growth in labor productivity --- not a certainty, mind you: there are other causes as we'll see --- it will be a fuller employed economy and still sustain a much higher per capita income than the EU.

And in the long-run, the best measure of an economy's efficiency (productivty) is its ability to sustain per capita income growth. Period. And the US has been the lead country here, believe it or not, since the 1880s.



 

FOUR BACKGROUND SETS OF OBSERVATIONS ABOUT PRODUCTIVITY, STANDARDS OF LIVING, AND SUSTAINED ECONOMIC GROWTH

1) Productivity

Any measure of productivity --- as we'll see soon there are three of them --- is a measure of a national economy's efficiency, how productive its workers and firms (small business, corporations, nationalized firms) are in generating increases from year to year in GDP. That's another way of saying any rise in real economic growth (and hence in the population's standards of living) depends on raising national efficiency or productivity. In introductory economics textbooks, this is illustrated by the production possibility function (frontier): rising productivity or efficiency is reflected in an upward/outward expansion of the PPF.

If the US, say, has a real per capita income 50% higher than the EU per capita income (the existing situation) --- adjusted for purchasing power --- this is another way of saying that the average labor productivity of the EU population is 64% of the US's.



  Two sidebar notes.

  • "Real" economic growth refers to the rise in GDP over a year adjusted for inflation. If GDP in dollar terms rises 5% this year in the US economy compared to 2002's final output, and average inflation turns out to be 1.0%, then real GDP in the US economy will have grown 4.0%.


  • Adjusted for purchasing power means that the only way to compare real GDP and real per capita income across countries is to find ways to make their price levels for goods and services comparable. In an era of floating exchange rates, the euro/$ value can change dramatically in a year or two. Thus the euro, when introduced in 1999, had an exchange ratio of 1 euro = 1.2 dollars ($1.18 to be exact). Within a few months, the euro had plunged in currency markets to around 90 cents: 1 euro = 0.90 dollars; and by early last year, it had dipped to $0.86. That was a loss of essentially 30% in dollar terms for the euro. Nonetheless, the standard of living in the eurozone of 12 EU countries --- measured in real per capita income --- didn't fall 30% in the same period; only the exchange rate of euros per dollar did. Similarly, since last summer, the euro has risen quickly against the dollar as international investors --- business firms, governments, individual investors, mutual funds and so on --- have adjusted their portfolios and switched hundreds of billions of dollars from US financial markets into EU markets: the stock market, the bond market, and government securities, as well as long-term investments in multinational acquisitions and real estate. The actual rise is about 20%, roughly one euro = $1.08; but the US standard of living (per capita income) didn't fall in the last few months by 20%, any more than the EU's rose 20%


      • To get around these problems of wide fluctuations in exchange rates, economists have developed measures that will bring US and EU price levels onto the same footing for comparative purposes. The technical term is purchasing power parity. In simplified terms, a PPP index will look at the total cost in the US of, say, 10,000 key consumer and intermediate goods and services (it could be 20,000 goods and services or 100,000). Suppose the total cost of producing the 10,000 goods and services turns out to be $1 trillion. The same analysis will then be done for the equivalent 10,000 goods and services in the EU. If the total cost of producing them turns out to be 1 trillion euros, then the actual euro/dollar exchange rate should be 1:1. If the euro at the end of 2003 rises to $1.20, that means it's 20% overvalued (and, incidentally, will hurt EU exporters).

      • If oppositely, multinational firms and mutual funds and governments and individual investors readjust their portfolios during the year --- seeing the US economy as more vigorous, and the stock and bond markets and US firms for sale more promising, selling off euros to buy dollars and invest here (hundreds of billions of $) --- then the euro could sink again to $.90 and be 10% undervalued. Real EU GDP and real US GDP measured in PPP terms remain unchanged. (I add only that various international agencies, including the World Bank, the IMF, the OECD, the European Commission, the US Commerce Department, the UN use slightly different PPP indexes, which in effect means a slightly different basket of 10,000 goods and services. As with any such estimates, their measurements of real GDP and economic growth and per capita income across countries will therefore vary . . . but, the key point, not by very much.)



     

    2) Three measures of Productivity (National Efficiency).

    So in the long-run any rise in real per capita income in any economy --- which is another way of saying real economic growth --- depends on raising the national economy's productivity or efficiency: labor, capital, and a more mysterious TFP (total factor productivity, essentially a measure of growing efficiency in the economy due to technological progress)

    Labor Productivity --- the standard term, used synonymously with productivity in general (a mistake, but understandable)

    In the long run, the standard of living of any country depends on the ability of its population to raise its productivity levels: more $ output per unit of input. If it's labor productivity, then if GDP for 2003 in the US rises 4% over 2002's GDP (after both are adjusted for inflation), and total hours worked remain the same this year as last year, then labor productivity has gone up exactly that 4%. In consequence, on an average, workers' incomes could be increased by 4% without any inflation. That's the same as saying the real standard of living of the US population rose 4% for the year.

    If labor productivity in the US turns out to be (as it is) about 50% higher than in Japan, that's also another way of saying it takes the average Japanese 50% longer to do the same thing as an average American worker. Note that this refers to a national average. Industry analyses show that in some industries --- mainly autos and consumer electronics --- Japanese labor productivity is slightly higher than in American industries. On the other hand, most Japanese industries --- including key consumer industries, steel, chemicals, food, financial services etc --- have unusually low productivity by US standards.

    Remember, as we noted at the outset, it's possible to qualify labor productivity by taking into account the hours worked by a labor force . . . say, in the US as compared to the EU average. From that angle, labor productivity = Real GDP Growth / hours worked for that year. Hours worked, I add, aren't that easy to determine: you have to ask enterprises how many hours their employees reported working --- including, you see, hours after work that are uncompensated for in white-collar industries --- or do direct surveys of workers using standard randon survey techniques. Neither is perfect. Workers may exaggerate, for instance . . . especially if they're compensated for the work on an hourly basis where no superviser is around.

    We'll try later on to adjust our comparisons of EU and US labor productivity with hours worked anyway . . . then see how realistic this is.


    Capital productivity. This refers to how efficiently a dollar (or euro) of investment in the market economy is in generating returns in the business sector. Just as labor in one country can be much more efficient in producing more output, so dollar investments can be more efficient in doing the same.

    Measuring capital productivity across countries isn't easy though. You have to take into account different national standards of capital depreciation, which can vary considerably, then adjust for these. You also have to decide what "investment" is: is it new gross investment, new net investment (after depreciation allowances are accounted for: that is, minus replacement costs of new machines and business plants), or some combination. Almost all measurements of investment stress "new net investment", which means subtracting from Dow Chemical companies' $500 million investments in new machines the fact that $300 million dollars of these investments went to replace old worn out machines. Oppositely, and more accurately, other economists point out rightly that the $300 new machines Dow purchased as replacements for the old machines might be much more efficient (this is blatantly the case of computers say), and hence $500 million should be the figure used. That then raises technical problems of measuring how much more efficient the new machines are.

    There are other technical problems here, which we won't go into. It's enough to note that studies across countries of capital productivity can be done, and they show that US capital productivity is about 50% more efficient than in Japan or Germany in the mid-1990s. British capital efficiency, in similar studies, was higher than in France or Germany at the same time (by about 20%), even though British labor productivity was about 20% lower in efficiency.




    Total Factor Productivity. This is a key measure, maybe the pivotal one, of how capable an economy is of sustaining real economic growth over the long run. Technically, it measures the residual --- what's left unexplained --- in GDP real growth each year that can't be accounted for by labor and capital inputs for that year. If the US economy were to grow 6% in 2003, and additional investments in US capital stock rise 2.0% for the year and labor inputs another 2% (due to either 2% more workers joining the labor force, or the number of workers stays the same but they work 2% more hours on an average), then labor and capital inputs account for only 4% of the 6% GDP. Hence 2% is the residual (technically, the error term in a multivariate statistical model of the US economy).

    What goes into the residual? Almost everyone now agrees this reflects technological progress --- broadly viewed: new knowledge embodied in better machines, but also smarter and more efficient ways of working with machines because of managerial improvements or better educated and trained workers, and maybe also better marketing, or some combination . . . in short, anything that enhances the efficiency of capital and labor, working together, to produce more and more output. To repeat, seeing this as just new and better machines is too simplified. A developing economy with low-levels of education might buy the most advanced production machines for making airplanes from Boeing, but neither the managers nor the work force in that country would be able to organize work and produce planes that anybody would buy,. The best way is to see technological progress, then, as advancing knowledge about producing old goods and services more efficienctly and with better quality, or whole new industries (eg, the Internet and consumer and business buying on line; or computers; or airplanes or cars earlier in the last century) . . . some of which knowledge is embodied in new or better machines, while other knowledge is reflected in smarter workers, better and more cooperative work procedures within a firm, and better management and marketing all together.

    It also refers to effective government policies to encourage new knowledge: either by producing it at home and employing it quickly in home country industries, or importing it from abroad (capital transfers) and diffusing it rapidly through your own economy, thanks to multinational investments in your country or licensing of foreign technologies. The US excels are producing and employing new knowledge, with rapid spillovers from one firm to another in the same industry, and then positive spillovers onto surrounding industries. Singapore excels at the latter.

     

    3) Two Kinds of Economic Growth, Only One of Which Is Sustainable in the Long Run: Creative Destruction

    To put it bluntly, economies can grow either quantitatively --- more and more increases in capital investment that raises cumulative capital stock, more and more workers entering the economy or working more hours --- or qualitatively.

    In the long run, only qualitative growth can be sustained. --- that is, through technological progress in the sense we've just defined, ever better machines, better worker skills, better management, and a continued use of what can be called "creative destruction". The latter means shifting skilled workers, managers, and investment capital from older, slow-growth industries to newer, more promising industries with better growth prospects and higher capital and labor productivity. And in turn that requires a flexible and mobile work force, good R&D, risk-taking entrepreneurs, and not least government policies that encourage both domestic and foreign competition in the national economy to hasten the shrinkage or disappearance of old industries whose goods and services are created more cheaply abroad, and the transfer of crucial skilled labor, managers, and capital to more promising, smarter industries. In short, a shift from a quantitative economy to an ever more qualitative economy.(which, to be sure, has to take into account environmental protection). And the underlying basis of a qualitative economy is advances in TFT --- in applied progress in knowledge, whether in machines or labor force skills or managerial efficiency.

    A quantitative-driven economy is doomed in the long run. Why?

    Think of the extreme cases here, the Communist countries --- especially the Soviet Union. For decades, the Soviet planners using coercive planning techniques mobilized huge quantities of capital investment into mfg. industry and huge quantities of labor. The result was rapid economy growth initially: more and more capital and labor inputs produced more and more GDP output. Sooner or later, however, the growth of the capital stock leads to DIMINISHING returns. When Soviet planners created a second steel plant, steel output might double the first year of its operation. A third or fourth plant might increase steel output noticeably too. By the time you create the 11th steel plant, it can't possibly double steel output for the Soviet economy; that would mean it would have to produce as much as the 10 previous steel plants. Essentially, it could produce only about 9% more. Yet the 11th steel plant costs as much to create and finance as the first. Now multiply this across the board. Even mobilizing 40% of GDP and more and more workers will soon lead, if everything else remains the same --- no technological progress, no increase in productivity --- to ever slower GDP growth. The only way the Soviet planners could get around this problem would be to shift from quantitative to qualitative growth: rapid increases in knowledge and better machinery, better motivated and better skilled workers, better managers, and more rapid and ambitious innovation.

    The Soviet economy, of course, couldn't do this. It couldn't produce high-quality autos like the Japanese or the Germans or the Americans or the French, let alone computers and passenger airplanes others would buy or the Internet or even good basic televisions and refrigerators. It remained stuck in an ever slower-growth economy wasting tremendous capital inputs, lacking incentives to change, and huge bureaucratic tape. On a different level, that's Japan's problem compared to the US. Aside from a half dozen impressive international-oriented firms like Toyota or Honda or Sony, the economy's ability to undergo "creative destruction" is handicapped by rigid labor markets, timid management, big protection around low productive industries (including banks, brokerage firms, insurance firms), bureaucratic red tape, and a risk-averse population. A qualitative economy like the US's means producing in the last 25 years 80% new Fortune 500 firms that didn't exist in 1978. It means Microsoft and Intel and Dell and Walmart and MacDonald's and MGM-Sony and CNN and Cox Cable.

     

    4) In the long run then, what explains why some countries are rich, most aren't?

    The answer is three-fold:

    1. A rich country is one in which the economy has invested high and steady levels of capital and labor inputs, and done this in efficient (productive) ways over long periods of time.

    2. Investing efficiently and creating efficient workers and managers depends, in turn, on having good economic and financial and political-administrative institutions and good government policies that encourages competition

      • Economic institutions refer to business firms --- corporations, small businesses, and how quickly new ones are created; good policies here mean honest accounting and transparency in behavior. Financial institutions refer to banks, capital and stock markets, brokerage firms, and insurance firms, and venture capital . . . all of which have the purpose in principle of bringing savers and investors together efficiently: technically, this means allocating capital productively to where it will bring the most market returns. Again, accounting honesty and transparency --- as we know in the US economy the last two years --- are crucial if savers are to have confidence that their invested money won't be mishandled. More widely, a legal system with institutions like the courts and the SEC and regulatory bodies like the FCC and FIC are needed to protect property rights, intellectual property rights, and others, while limiting and punishing quickly corruption and other business and political fraud. Efficient administrative institutions --- especially IRS and regulatory bodies (including those like the Environmental Protection Agency) --- need to work with limited red-tape and be cost-efficient: always a challenge in any economy. They also need to be manned by honest administrators, another rarity in the world, but varying considerably with honest administrators and politicians found more in advanced industrial countries than developing countries, more in Northern Europe than Southern Europe, and widespread in the advanced English-speaking countries like Britain, Canada, the US, and New Zealand. There are, I add, good cross-country estimates of these (such as the size of the underground economy or surveying business managers to find out how many bribes they have to pay to stay in business).


      • Good policies mean encouraging a sound investment climate at home for domestic and foreign investors, and encouraging competition in the home market by means of anti-monopoly practices and opening up the economy to foreign firms, either through trade or implanting themselves as multinationals


      • And somewhere in this equation a cultural factor --- risk-taking vs. risk-aversion, along with raw entrepreneurial animal energies --- comes into play. The more risk-taking leads to new and better products or whole industries, the better. The more start-up firms, the better. The less failure is punished --- as it is almost everywhere in the EU and Japan compared to the US (not just in the business world, but in education and the professions and getting credit even as a homeowner) --- the better. The more willing workers are to get retrained or move to another region of the country for a higher paying or more satisfying job, the better. Creative destruction will then work more rapidly in the economy.


    3. And finally, if a country invests large quantities of capital and labor over long periods of time efficiently, and it is has good private and public institutions pursuing policies that reward risk-taking and encourage competition and innovation, then in the long run what will drive an economy's growth will be advances in technology: new knowledge, created either at home or imported, that is quickly applied, produces spillovers, and hastens the operation of creative destruction.



      EU VS. US PRODUCTIVITY

    Against this background now, we can directly and quickly answer John's questions:

    1) The best measure of a country's overall productivity --- capital inputs, the efficiency of capital inputs; labor force growth, the quality and level of labor skills (including managers, engineers, scientists, technicians etc); technological progress; and better ways to organize and motivate an enterprise's work force --- is reflected in real per capita income, adjusted in purchasing power parity terms.

    On this composite score --- all sources of economic growth and productivity --- the US is about 50% richer and hence more productive than the EU average. Essentially, the much faster growth in productivity of all kinds in the 1990s in the US reversed the earlier four decade tendency of the EU countries to close the per capita income level, thanks to standard convergence catch-up growth: this predicts that poorer countries, once they are launched onto a path of sustained GDP growth will, all things being equal, grow faster than the lead economy. By the late 1980s, Italy and Germany had closed the gap to around 85-90%, with France around 82%, and Britain about 75%. By the end of 2001, the EU average had fallen back to where it was in 1965 --- about 65% of the US per capita level. The four big EU economies were each slightly higher than the EU average, around 67-68%.

    2) Some of the smaller EU countries --- especially Ireland, Finland, Denmark (each 4 million in population), and Holland (15 million) --- did much better than the EU average, and were around 75-80% of the US per capita income level. With, astonishingly --- a total reversal of centuries of economic backwardness, usually of a dire sort --- Ireland now the richest EU country!

    3) In labor productivity --- which the EU Commission's studies all measure in terms of GDP per WORKER employed (no adjustment for hours worked) --- the US lead is not quite so marked. The EU average is around 77% (vs. 65% for all kinds of productivity that go into a standard of living), and five small EU countries are close to 90% of the US level: Holland, Belgium, Ireland, and Austria. France and Italy are around 83% of the level, Denmark at the EU average of 77%. Germany and Britain are below the EU average slightly, and Finland and Sweden a little below them, and then Greece, with Portugal the low man on the totem pole by far. This is all brought out in the following chart from the EU Commission's Economic Competitiveness Report 2002

    EUProd (33k image)

    4) Note that this is for labor productivity/ worker across the board --- in mfg. and services, agriculture, and mining. To repeat: US labor productivity is about 30% higher than the EU average at 77%, with a big divergence among the EU countries.

    What explains then the much greater gap in per capita income, roughly 50% higher? The answer: capital productivity, which is much more efficient in the US, and faster technological progress, plus letting market competition in the home market --- due to both regulation and more and more international trade and investment --- shift labor, capital, and management from declining or stagnant industries into faster growing, more advanced ones in international competitiveness at a much speedier clip than in the EU?

    5) In manufacturing industry --- which in the US and UK accounts for about 13% of the labor force (but about 22% of US GDP), and anywhere from double to 2.5 times that percentage of workers in the big EU countries --- labor productivity in the EU is much closer to the US level, with productivity in Italian and French manufacturing slightly higher now, and the German level about the same as that of the US.

    I add right away that the figures here are contested in some studies, which show US manufacturing industry on an average enjoying higher productivity than Italian and French manufacturing industry, and all studies that I know do agree on two other things: US mfg. productivity grew faster than that of the EU average in the 1990s (considerably so), and almost all the productivity advances in EU mfg. in the big countries were due to shedding surplus labor, rather than to technological progress and more competitively run firms . . . though that's not the case in Holland, Ireland, Denmark, and a couple of other small EU countries.

    6) The tendency to shed labor in EU mfg. industry --- which, to repeat, has been the main source of productivity advance (fewer workers, same output or slightly more output) --- is a big problem for the EU economies, reflected in growing unemployment of a long-term structural sort. That's because all the advanced economies have tended to reduce their mfg sectors over the last half century, as earlier in the late 19th and early 20th century they reduced their large agricultural sectors (over 50% of the work force in much of Continental Europe) to around 3-5% today. The US, for instance, had about 40% of its labor force in mfg. in the early 1950s. These days, to repeat, it's down to 12% and declining too.

    The difference is that the service sector in the US --- especially in knowledge-based industries (education, the media, finance, health, business consulting, information and communications generally (ICT) like the Internet and computing and telecommunications, pharmaceuticals and biotech, aviation, defense) --- has expanded far more rapidly than in the EU, creating almost all our new jobs . . . some 55 million since the mid-1970s even though manufacturing industry itself, in the 1990s, actually increased its share of GDP. The result? Whereas the private sector has created those 55 million new jobs since the mid-1970s, the EU's private sector created only about a quarter that number.

    This is reflected in unemployment levels that are anywhere from two to three times the US average over the last 20 years, with most of the EU unemployment, especially among the young, long-term . . . a big problem. It also bears down heavily on the immigrant communities in the EU, especially the large Arab and other Muslim ones, with unemployed and poorly educated youths more and more alienated from mainstream EU life: economic, social, educational. And prone more and more to crime, Islamist fundamentalism, and support for terrorism in some quarters.

    7) As we noted at the outset, in principle labor productivity could be measured as real output / workers adjusted for hours worked in the year. A few studies do this, a good one recently by Robert Gordon of Northwestern University: He finds that about a third of the labor productivity gap between the EU and the US can be explained by EU workers putting in a shorter work year. Two Centuries of Economic Growth: Europe Chasing the American Frontier. The following chart is taken from The Economist, which adapted it from Gordon. It is in the March 1st issue of this year:

    EUHours (5k image)

    Three points prompt themselves here.

    First, if the unemployed in the EU have not in fact chosen leisure over work, but can't find work --- or would prefer full-time jobs as opposed to the faster growing part-time and temporary jobs --- then the EU's performance here is not to enhance leisure: it reflects rigid labor markets and insufficient competitive pressures to change and advance through creative destruction.

    Second, overall productivity would still be greater in the US even if adjusted for hours worked. Remember, it's 50% higher (the EU average is 65%, reflected in per capita real income). Adjusting for hours worked on this score would still leave the US with a 30% lead.

    Third, long-term unemployment among especially youths and immigrants --- reflected in a growing decline of the % of the adult population (18-65) actually employed in the EU since 1975, whereas it's much higher in the US --- is a serious social problem, which shows up in growing violent crime, disaffection and alienation, and a variety of other social pathologies. Keeping university students on for years and years, or creating makeshift training jobs that lead nowhere after six months or a year , only back to the unemployment line, are hardly good substitutes. And the problem of a shrinking work force will manifest itself in another burdensome way in a decade or so: more and more retirees whose pensions are state-pensions and have to be funded by taxes on the existing, declining work force.

    8. As for costs of labor, you're right: they are generally higher in a fair number of EU countries, not just in mfg. but across the board . . . depending on existing exchange rate between the dollar and euro (which is what counts in comparing labor costs and final product costs in international trade). Other countries aren't so bad off compared to the US here. Note though: these stats are from the Bureau of Labor here, and are for 2001: the high costs would have climbed about 20% since then in dollar terms, what with the rise of the euro from around $0.89 in those days to around $1.08 now. Germany is especially disadvantaged.

    1">
    2000 2001
    US 100 100
    Austria 99 96
    Belgium 110 104
    Denmark 109 108
    France 79 78
    Ireland 63 65
    Italy 71 68
    W. Germany 122 117
    Germany 117 113
    Sweden 102 90
    UK 82 79


    9. Finally, the two countries that were once touted to overtake the US in overall productivity levels and hence real per capita income --- Germany and Japan --- have in fact racked up the worst economic performance in the industrial world. Japan's economy has stagnated for over a decade; it has been in recession, essentially, for four years now; its GDP annual advance has been less than 1.0% a year; and industrial production has fallen off more since 1991 than in the US during the Great Depression. Germany, while doing better, has been the worst performing economy in the EU the last five years, and has grown around 1.7% since 1991, half the US rate. It is likely to remain one of the worst performers in the EU for a few years too.

    Why the poor performance of both? Both are heavily corporatist economies, with a big governmental direction to labor markets, investment, subsidies, and other forms of anti-market activity. Both countries too are rapidly aging, full of risk-averse people; and both therefore are about the worst in the industrial world in entrepreneurial energies and creating new start-up firms. And in both, finally, governments have been reluctant to undertake the necessary changes in policies that --- however painful in the short-run --- would help to make the national economy more competitive and productive and increase long-term economic growth.

    Their problems, if reforms are delayed much longer, will shoot up in a decade or so when more and more retirees have to live on the work and taxes of a rapidly shrinking labor force.

    Replies: 1 Comment

    Thanks for your reponse to my inquiry. I'd seen some discussion of these points in various sources, but the statistics were presented in summary without any clear explanation of their derivation, leaving the reader to parse through the possibilities. I think that the issue of Old Euope's economic prospects-- which as you point out is what we're really talking about here-- is essential to understanding what is driving anti-Americanism there. The widening gap in the economic growth potential of the US as compared to Europe's biggest economies is far more troubling to Europe than what America does as the sole superpower at the end of the Cold War.

    In the case of Germany, for example, Schroeder tapped into a huge reservoir of emotional insecurity when he began bashing America in the last election. Germans are often reluctant to express their national pride, but when they do, they usually will point to the country's wealth following a half century of rapid economic growth from the ruins of war and the social welfare system that developed as a reflection of Germans' belief in their inexhaustible capacity to flourish. Substantive reform of that system is emotionally charged not only because it is viewed as reneging on a social compact Germans have come to rely on; it also represents in Germans' minds a turning away from a belief in their capacity to flourish. Germans have long believed that they were inexorably on the path to a utopia of high living standards and economic security for all. The widening gap between the US and Germany after almost a half century of national pride being tied up in closing it appears to rub Germans' noses in the awful truth that their system is broken. The country's anemic growth and high structural unemployment are particularly German problems; they aren't problems plauging all advanced economies because America doesn't have them. If change must come it's preferred that it come slowly, but the rate of American growth over the last ten years puts even more pressure on the timing and magnitude of reform because decline is relative.

    I can't help but wonder if part of what's driving Germany's reluctance to back a US led war or to participate in any Iraq action regardless of a UN resolution is mainly a means to reserve the right to say no if they are ever asked to share the expenses of fighting it (as was done during Desert Storm).

    Posted by John @ 03/02/2003 04:16 AM PST