Hamish McRae: If you can't beat them, be like them: must Europe learn to become more American?

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Washington DC - The macroeconomic US story catches the headlines but the microeconomic experience perhaps has more lessons for the rest of us. The state of the recovery or what the US does about interest rates matters, but the great challenge to the rest of us is American productivity. Why has the US managed to outpace Europe and indeed the rest of the world?

Washington DC - The macroeconomic US story catches the headlines but the microeconomic experience perhaps has more lessons for the rest of us. The state of the recovery or what the US does about interest rates matters, but the great challenge to the rest of us is American productivity. Why has the US managed to outpace Europe and indeed the rest of the world?

This is one of the subjects being discussed this weekend in The Hague by EU finance ministers. With Gordon Brown's criticism that slow European growth is holding up the world economy ring in their ears, they are meeting to consider why Europe's Lisbon Agenda has failed. At its summit in Portugal in March 2000, the European Council set out a 10-year strategy to make the EU the world's most dynamic economy. Hans Eichel, the German finance minister, admitted last week that Europe had failed. Indeed the EU, far from gaining ground vis-à-vis the US, seems to have fallen further behind.

Here in the US, you catch a feeling for the answer: the pressure to perform placed on employees. Americans work longer hours than Europeans and face other pressures to stay in jobs; often their access to healthcare depends on being employed. People are under greater discipline as a result - one of the less agreeable aspects of US life. If you adjust for hours worked, the productivity gap between the US and France and Germany is not significant.

Other explanations for higher US productivity,range from greater application of technology to higher business start-up rates. The problem is pinning down the differences.

But how far is Europe behind? A paper by Jean-Philippe Cotis, the chief economist of the OECD, a few weeks ago shows the differences in growth. As you can see from the bar chart (above left), the US has grown at the same rate as other English-speaking countries (the UK, Canada, Australia and New Zealand) over the past decade, an average 3.3 per cent a year. That compares with 2.1 per cent for the eurozone and only 1.7 per cent for the Continent's "big three": Germany, France and Italy. If you adjust for growth of population, the US performance is less impressive: it is still better than the eurozone but slower than the other English-speaking countries. But if you look at growth per employee or growth per hour worked, the US comes out top.

The graph on the right shows GDP per head relative to the US since 1970. Until the early Nineties, both Japan and Germany/France/Italy gained ground against America but since then, they have fallen back. The UK, by contrast, lost ground until the early Eighties but has since been pulling back America's lead.

So what should the eurozone do? The OECD has no magic wand, but its work suggests ideas that the EU finance ministers might consider. Mr Cotis listed seven policy areas, the first of which was the obvious need for good macroeconomic policies.

The next two were about labour markets. Most of the eurozone differs from the US (and the English-speaking world) in having much lower incentives to work. Hours are shorter and less-productive workers are priced out of jobs. In some countries (though not Scandinavia), relatively few women are in the workforce. So incentives to work should be strengthened.

The other labour idea was to check early retirement. In France, Luxembourg and the Netherlands, the effective tax rate on people aged 60 if they stay in work is over 50 per cent - so it makes more sense to retire.

Next, the OECD suggested that labour force skills should be improved. While that isn't controversial, the most interesting thing is the way the US achieves high productivity despite not having a particularly skilled workforce. What it does clearly have is an entrepreneurial climate. The issue here is whether this is an embedded part of US society, and so hard to replicate, or whether it can be encouraged or discouraged by the state. An OECD study of barriers to entrepreneurship said the UK had the fewest obstacles, fewer even than the US, yet we have a lower business start-up rate. But barriers among OECD members are highest in Italy and France, which have even lower start-up rates.

Next came the need to generate and deploy technical knowhow. In the case of the EU, the emphasis must surely be more on deployment, for given the state of European universities, it is unrealistic to expect them to make a serious challenge to the US in the foreseeable future. European companies, however, should be competitive with US ones and, in any case, the application of knowledge probably brings greater advantage than its generation. Indeed, too much emphasis on coming up with new ideas can be associated with a "not invented here" rejection of technologies developed elsewhere. The UK has suffered from this in the past, most particularly in its nuclear energy programme. The genius of the US is creating commercial applications for new technologies as much as creating them in the first place.

Finally, money. European financial institutions are, it is claimed, less willing to provide venture capital than their US competitors. France's government thinks so, having just last week pushed French institutions to increase their commitment to private equity. But since US (and UK) financiers now operate throughout Europe, it is hard to see quite why lack of capital is holding European entrepreneurs back. If there were serious money to be made in Europe backing new companies, global venture capitalists would be happy to have a shot. The problem at the moment is too much money chasing too few good projects, not the other way round.

A further influence is the willingness of US companies to push low-productivity activities offshore. A vast amount of consumer goods are made in China, and a rising proportion of services are moving to India. That is happening in the UK too, but less so in the rest of Europe. The faster you get out of these activities, the faster you increase the overall productivity of the economy. The important thing, then, is to find higher-productivity jobs, which the US is just about managing to do.

From a European perspective, this might seem dispiriting: catching up with America means adopting aspects of US society that it would find impossible or unpalatable to do. But that is to ignore the elements of excellence in Europe. For example, some parts of the EU, such as Scandinavia, are better at applying new technologies than the US. And employment rates in some EU countries are higher than in the US.

All is not lost, but a huge task remains in hand. At least now ministers can admit failure, and that itself is progress.

More grit and less glory: the challenge for the next Chancellor

Another reshuffle, another bout of speculation about the Blair/Brown relationship. For political observers, the questions are "what will Gordon do now?" and "who will be the next Chancellor?" But for people concerned about economics the most important question is surely "how might policy change after the next election?"

We don't know anything substantive, of course. But it is now almost certain there will be a new Chancellor next summer and that Tony Blair will seek to replace Gordon Brown with someone he feels will carry out his own vision of economic policy. It is also clear the next Chancellor will have to play from a rather less attractive hand of cards than that which was handed to the present one.

He or she will inherit a successful economy but one whose comparative advantage is narrower than it was eight years ago. The underlying balance of payments situation has deteriorated and, with declining oil production, will slip further. The fiscal position has also deteriorated, with the deficit now above 3 per cent of GDP. It cannot realistically be allowed to rise any further.

The cost of running public services has risen, and while arguably there are many areas where more resources are needed, it will be hard to fund even the present level of services without tax increases. And consumption, which has risen as a percentage of GDP, is likely to grow more slowly.

So being Chancellor will be a tougher job. It will be more like the sort of task facing finance ministers in Germany and France, where spending is constrained by weak tax revenues and the need to contain deficits.

That is not the end of the world. But it does mean the next Chancellor will be a less powerful figure, not so much because he or she will be a less powerful personality but because it will be harder to appear so successful. Policy will be more gritty. And that will happen whoever gets the job.