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Monday, December 31, 2007

2nd Exchanges about the Performance of the US and EU Economies


At the admirable web site, Marginal Revolution, prof bug continued his exchanges with some Scandinavians about the relative performance of the US's relatively free-market economy compared to that of the advanced welfare-state economies of Denmark, Finland, and Sweden, all members of the EU, but with Denmark and Sweden not in the eurozone. (Britain is the other West European country that doesn't use the euro, and Norway is not an EU member.)

It will help if you remember that the three small Scandinavian countries --- Denmark, Norway, and Finland --- have 4 million people each, while Sweden's population is 9 million. Traditionally, these are ethnically homogeneous countries that industrialized in the mid- and late-19th centuries, and all four are wealthy countries: Denmark has a per capita income of around $38,000, making it the second richest country in the EU after tiny Ireland (also four million: about $44,000 per capita income). Sweden and Finland each have about $33,000 per capita income. The US, by comparison, has about 300 million people, is very heterogeneous in its ethnic/racial composition, has no socialist traditions, equally it has no strong statist conservatism as the West Europeans all do rooted in pre-democratic, pre-industrial values, and --- unlike the Continental EU countries --- diffuses state power by means of a strong federalism, divided powers in Washington D.C. between the two houses of Congress, the Executive, and the Judiciary. It also subjects all legislation and much executive behavior to judicial review.

The US, too, was a pioneer in political equality, ahead of all other industrial countries on this score: an early establishment of a mass-voting system --- in the 1840s, about 2/3 of the white population voted for the presidency and Congress, as opposed to Britain that was just entering an era of expanding voting powers . . . about 10-11% of Britons eligible to vote in that decade. It also pioneered the open primary, the popular referendum, and the recall-referendum in the early 20th century. As for the judiciary, the US is unique: Americans vote directly for all judges and district attorneys at local and state levels, and indirectly through Congress for all federal judges, the Supreme Court, and federal prosecutors. One result of these "populist" measures shows up in the differences over the death penalty. When Britain first abolished the death penalty in 1971 --- followed in the next decade or so by all the current members of the EU --- there was not any majority in any country favoring such abolition. In the US, by contrast, legislators, district attorneys, and judges on the state and local level are far more sensitive to majority opinion --- for good or bad. Some states, about a dozen now, have nonetheless either formally abolished the death penalty or suspended its use, with Texas alone accounting for about 2/3 of all executions yearly in the US --- about 45-50 in the current year.

Oppositely, all the EU Continental countries were early pioneers in developing a larger state role in economic growth and welfare measures. The latter grew slowly but steadily throughout the late 19th and early 20th centuries. At the start of the 1930s, as fascism and Nazism were destroying one Continental democracy after another, the Swedes instituted an historic compromise between socialism and capitalism by instituting an advanced welfare state. The upshot? Today, the state in these West European countries normally controls about 40-50% of GDP through a combination of taxing power, transfer benefits, medical systems, old-age pensions (virtually confined to state social security), infra-strucure development, education, and wide-ranging regulatory controls. Britain falls between the US free market traditions and the statist systems on the Continent. Its government controls about 45% of GDP, despite successful efforts to limit welfare spending in the Thatcher era of the 1980s, and reduce unemployment benefits to increase labor market flexibility. By contrast, governments at all levels in the US spend about 31% of GDP: the federal government responsible for about 2/3 of that percentage, the rest by state and local governments. Keep in mind, too, that the US spends about 4.0 - 4.5% of GDP on defense, double what France spends in that regard, the French the second largest spender in NATO.


For an effective depiction of these differences across industrial countries, consider the following figure that shows GDP per capita in PPP terms on the vertical axis, with Canada the base comparison of 100, and along the horizontal afxis shows the percentage of overall social spending. (Source): 


Note that Norway is an outlier, slightly richer than the US in per capita income but with about 70% higher social spending as a percentage of its total GDP. There's another reason it's an outlier: it has huge oil and gas reserves in the North Sea that is largely responsible for its uncommonly high per capita income, and though it's certainly a credit to the intelligent management of these resources by the Norwegian government, its relatively non-industrialized economy would look more like Finland's probably without the oil/gas revenues.  As things stand, with oil priced at around $90-100 a barrel, petroleum exports --- Norway's the third largest exporter in the world, behind Saudi Arabia and Russia --- account for well over 50% of all its exports and, by extension, somewhere between 25-30% of Norway's total GDP

Otherwise, note that the two richest countries --- the USA and Ireland (in the EU, with a population of 4 million) --- spend relatively little as a percentage of GDP compared to France, Germany, Denmark, Sweden, Italy, Austria, and Belgium in the EU. Note finally that Canada, Australia, Ireland, and to an extent the UK (60 million, like France and Italy, with Germany at 80 million in population) tend to limit social spending as a group compared to the EU Continental countries. This reflects a long history of Anglo-American efforts to limit the size of the state, a preference historically for free markets (which changed only in Britain, Australia, and New Zealand after 1945 for three or four decades), the use of common law as opposed to continental Roman law (which underpins state authority), and strong entrepreneurial traditions.

The US, of course, goes further in these directions, with its federal system, divided central government, judicial review, and a strong heritage of cultural individualism and individual responsibility for a person's life.

Japan, despite a much stronger statist tradition than the Anglo-American countries --- at any rate after the Meiji modernizing revolution of the 1870s and 1880s that culminated in a powerful militarist, fascist-like state in the 1930s and down to the end of WWII --- has also limited social spending and isn't much different on that score than the US and most of the countries following an Anglo-American form of free-market economics . . . always understood, of course, in comparative terms. Laissez-faire never really existed anywhere except in much of the 19th century in Britain --- and certainly not in the US, where government from the outset did play a large role in fostering infra-structure development and protected much of our industry until the start of the 20th century.


JSK (A Scandinavian poster):

1) Thank you for your comments, which are food for thought. Yes, it is quite possible for two countries to have equivalent per capita incomes --- always adjusted by a PPP index --- but different disposable incomes on the average. How so? For one thing, as in the EU, high taxes can clearly reduce household income; and even if government transfers are then considered, the household's disposable income in an EU country would be lower than a hypothetical country of a similar per capita income but different tax rates (average and marginal) and transfers.

2) The EU countries have very high indirect taxes compared to the US. That would further reduce the buying power of, say, Irish, Swedes, Britons, French, and so on.

3) In addition to higher income taxes and indirect taxes --- and transfer benefits (lots of US benefits are in-kind, not money) --- certain key goods can be more expensive in the EU than the US. That's notoriously the case with gasoline, taxed extremely high in the EU (for good or bad, mind you). Food prices are notoriously higher in the EU too, thanks to the economic absurdities of the Common Agricultural Policy that subsidizes even more blatantly a dwindling number of small farmers for the benefit of much bigger, increasingly corporate-like farm businesses (less so in dairy products).

4) Housing prices can also vary noticeably across countries, and hence rents too. It all depends on land restrictions and, possibly, population densities. The latter do matter, but not as much as the restrictions on housing developments. Thus Holland, the most densely populated country in the world, has less restrictions on suburban developments than Germany, and the price of housing is generally lower there. One clear sign: lots of Germans who work in Germany near the Dutch border have moved their chief residences to Holland.

As a result of such differences, Germans, say, pay more for housing and rents than the Dutch, and so the amount of disposable household income left after taking into account such housing costs would be lower in Germany than Holland. The same would hold for the US compared to EU countries.

5) If, then, you add up high income taxes, different transfer benefits from the government --- US in-kind transfers reduce generally income poverty in this country from about 12-13% by about a third --- add in too high indirect taxes, high food prices, and excessive land restrictions that raise the price of housing, then clearly a typical if prosperous country like Ireland can leave its citizens feeling much poorer in income than American citizens with a per capita income (PPP adjusted) of similar value.

6) Incidentally, Norway --- 4 million people outside the EU --- has a per capita income slightly higher than the US in PPP terms, but Norwegians who move to the US (and the few Americans who work in Norway for Norwegian wages) find that their incomes in Norway are far below American buying power at similar PPP-adjusted "real" exchange rates.

The Buggy Professor AKA Michael Gordon

A Couple of Follow-Up Comments in Response to JSK and Other Scandinavian Posters:

  • It just dawned on me. Those posters here talking about emigration from the US to Denmark or Sweden need, I believe, to see if these are permanent residents in those countries or there temporarily, say studying or working for US multinationals. I suspect that Danes and other EU immigrants to the US are much more inclined to be seeking permanent residency here. Mind you, that's only a conjecture, nothing else; but when 52% of German university students say that they would like to live outside Germany, Germans --- to take one example --- who move to the US are likely seeking to stay here permanently.

  • Another postscript comment: Tersely put, as violent crime continues to increase all over the EU --- even as US cities have just been found to have a near all-time low in homicides for the last 40 years --- I suspect that more EU middle class families will seek refuge in North America or elsewhere to start a new life. And that's likely to be doubly the case as native EU populations with very low birth rates --- in effect, all the EU countries --- tends to experience ever higher numbers of aggrieved and alienated Muslim minority communities.

Here's a concrete and startling example. When a Swedish Minister, apropos of all this, openly said a year ago that "If we are nice to the Muslims today, perhaps they'll be nice to us when they're the majority in the future", that kind of semi-defeatist, semi-fawning attitude is further food for thought. (The words in quotes are from my memory and may not be exactly those uttered by the Swedish Minister.)


A sudden thought or two are worth adding to the comments about why real disposal household income can be less --- maybe even much less -- in a EU country with an equivalent per capita income in PPP terms as the US has.

I mentioned higher income taxes, higher indirect taxes, higher food and fuel prices, and higher housing prices --- not compensated for by different kinds of government transfers (or, in the US, not considered income if they are in-kind like food stamps) --- as the reasons for this gap. Remember, though PPP indexing should cover such differences in costs to firms and end-user consumers, such indexing covers only a certain basket of goods and services --- maybe several hundred or even a few thousand --- compared to tens of thousands of such services and goods that probably exist in rich industrial countries like those in Japan, West Europe, and North America.

1) Another reason, which might not be fully accounted for in PPP indexing --- itself much better than using nominal (existing) exchange rates across countries, but still at best an approximation --- is different kinds of wholesale and retail businesses. US businesses in these areas, generally more efficient than their EU counterparts anyway owing to government regulations in Europe, experienced the biggest gains in labor productivity of all industries in the US during the 1990s. Even in the EU, it was reckoned in a French study in the 1970s (or 1980s) that more efficient retailing in Germany reduced prices to households by about 20% there compared to France. In principle, you'd think these differences --- a separate French franc and German Mark --- might have been captured by PPP indexing, but probably weren't fully.

2. Household incomes in the US are likely to be increased on a yearly basis compared to the EU if, as seems to be the case, credit facilities are much more generous here. In the EU, a household that loses its credit card rating will generally find it hard to even obtain credit of any kind. In the US, indebtedness, bankruptcy, or failed businesses for that matter are far more easily forgiven.

3) You could generalize further on this score. From what I found studying and teaching in EU universities --- in Britain, France, Switzerland, and Germany --- failures of any sort, even a decision to drop out of the usual structured schedule of schooling, travel the world, and return to university, are or were severely punished. The same is true of failed businesses. Credit ratings are unforgiving. All this may explain, at least in part, why entrepreneurial-ship is so circumscribed in EU countries.

4) None of this is to deny that it may be cultural too, this risk-aversion. Europeans were markedly willing to emigrate to the New World for religious, political, and economic reasons from the 16th through the early 20th centuries. Tens of millions moved out of the British Isles alone after 1815 for a good century. Did all the risk-takers in Europe leave by the start of WWII? Well, those who stayed might have mainly been killed off by the Nazis and their European collaborators. The entrenchment of an advanced welfare state --- which continued to transfer and redistribute income (not necessarily across income quintiles as between age groups, health or sickness-groups, and ethnic groups) for decades --- was then followed after 1975 by ever greater transfers that made no sense economically, they weren't dealing with hardships, but reflected rather huge differences in political power. France is notorious here. Though trade-union membership as a percentage of the population is no higher there than in the US --- it may even be lower --- it is concentrated in all the communication, transportation, medical, media, educational, and civil service areas, and hence an aggrieved group in these areas can practically bring the economy to a standstill.

What goes on in France or Italy may be more blatantly visible than elsewhere, but powerful unions and associations in the state sectors are found throughout the EU (with Britain something of an exception now), and they are deft at transferring privilege and benefits from their fellow citizens by virtue of their market and political power.

The Buggy Professor AKA Michael Gordon

To be continued in the next buggy article in this series.