Gavyn Davies: If there is anyone who can afford to gloat, it's the Americans

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The Independent Online

Peter Mandelson, the new European Union Trade Commissioner, has departed these shores warning his former colleagues in the UK government that they should resist the temptation to indulge in "exaggerated gloating" about the strong performance of the British economy relative to its neighbours in the eurozone.

Peter Mandelson, the new European Union Trade Commissioner, has departed these shores warning his former colleagues in the UK government that they should resist the temptation to indulge in "exaggerated gloating" about the strong performance of the British economy relative to its neighbours in the eurozone. Whether or not this remark was intended to thunder across the only relevant battleground remaining in British politics (that between the supporters of the Chancellor and Prime Minister respectively), it certainly did so. But I am more interested in the substance of the matter. Has Britain's economic performance really been so much better than that of continental Europe, and what can the two systems learn from each other?

In some crucial respects, it is irrefutable that Britain has achieved an impressive lead over the eurozone in recent years. GDP growth in the UK has been running at about 0.5 per cent a year higher than on the Continent for well over a decade now, and British unemployment has roughly halved relative to that in the eurozone over the same period. The growth rate, as opposed to the level, of productivity has also been stronger in Britain. Some of this may have been due to the fact that the UK was emerging from a much deeper recession in the early 1990s, but this does not explain the continuing growth discrepancy after both economies had fully recovered from their downturns by the mid-1990s.

After 1997, the role of economic policy must surely be given some of the credit - and the blame - for these developments. Fiscal policy in the UK has been more enlightened, and more flexible, than in the rest of Europe, even before the massive flaws in the EMU Stability Pact revealed themselves after 2001. Furthermore, the delegated independence of the Bank of England has worked much better than the rigid structure of the ECB, which was unfortunately designed to solve the economic problems of an inflationary era which ended 20 years ago. For those of us who would like to see the UK inside the euro one day, it is a severe worry that the coordination of fiscal and monetary policy within EMU has proven so deficient, not to mention the fact that the overall stance of macro-policy has developed an unhealthy contractionary bias in Germany and elsewhere.

But, important as these developments may be, they can and will be ironed out over time. Much more important for our long-term future is the behaviour of underlying productivity growth. Football coaches often say that form is temporary but class is permanent. In economics, cycles are temporary but underlying productivity trends are permanent. Over a decade or two, the latter will entirely dominate the effects of macroeconomic policy, however skilled, in virtually any developed economy.

And this is where comparisons between the UK and the eurozone become extremely interesting. In political debate, certainly on this side of the Channel, it is almost always taken for granted that the eurozone is a sclerotic mess, with much to learn from the productivity performances of the sprightly UK and US economies. In Britain, politicians find it irresistible to rub European noses in this, if only to get their own back for decades in which the opposite occurred. But the truth is very far from the caricature which is so firmly etched in Westminster.

Let us examine the current levels of living standards achieved in the UK, the US and the core of the eurozone (France and Germany together). In 2003, GDP per capita was roughly the same in the UK as it was on the Continent, so there was no room for exaggerated gloating in either direction. But both the UK and the eurozone lagged about 30 per cent behind the living standards achieved in the US, which therefore retained the huge lead which it has held for the whole of the post-war period.

Why are the British and Europeans still so far behind the Americans? In principle, this could occur either because they are less productive per hour worked, or because they work fewer hours per capita than the Americans. Here, there is a massive difference between the UK and the eurozone. In Britain, the utilisation of labour is only a little lower than the American standard, with the unemployment rate now better, and participation in the labour force almost as high. But UK productivity levels for those in work are a startling 20 per cent below the US standard. The productivity gap has started to improve in the past decade, but at the present rate of progress, it will take about 40 years for the gap to disappear completely. This is, in spades, the UK's biggest economic problem.

In Europe, we find precisely the opposite state of affairs. Remarkably, productivity per hour worked is almost exactly the same in the eurozone as it is in the supposedly superior US economy. Few people seem to be aware of this, or even to believe it when they are told, but it is true. However, much of the potential benefits of this extraordinarily strong productivity performance are thrown away by the fact that the European economy is unbelievably bad at generating high working hours from its population. Labour utilisation is about one-quarter lower than it is in the United States. Average hours per worker are 15 per cent lower in Europe; unemployment is 3 percentage points higher; and participation in the labour force is about 12 percentage points lower. The myth of the idle European is, it seems, not all myth.

So there we have it. In Britain, people work just as hard as they do in America, but much less efficiently. In Europe, efficiency levels are just as high as in America, but fewer people work at all, and those who do so, work for much shorter hours.

Faced with this evidence, who should be gloating at whom? It is tempting to say that the Europeans should be gloating at the British. After all, they need to work for much less time per capita in order to earn the same standard of living as the British. And if they are poorer, in GDP terms, than the Americans, then they can at least compensate for this by having the pleasure of longer holidays, more parents at home to tend the children, earlier retirement and longer periods in full-time education. The poor old British, by contrast, can achieve European living standards only by sweating away for much longer hours.

But this conclusion is only valid if the Europeans are working fewer hours as a conscious act of voluntary choice. If, instead, they would like to work longer hours for more money, but find that their ability to do so is constrained by the 35-hour week, by the absence of jobs in certain regions, and by enforced early retirement, then we cannot conclude that their system is such a success. Increasingly in the past two decades, extra European leisure has been enforced on its citizens by a malfunctioning labour market, and not by a collective exercise of free choice.

The direction for policy is clear. Britain needs European efficiency levels at the workplace. Europe needs British flexibility in the labour market. And heaven help us all if it happens the other way round!

Gavyn Davies is the chairman of Fulcrum Asset Management