Hamish McRae: Right-wing spectre could spur reform of economies

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The string of victories of the right in successive Continental elections has shaken the European political establishment. But could these also revive the European economy?

The string of victories of the right in successive Continental elections has shaken the European political establishment. But could these also revive the European economy?

Up to now all the focus has been on the political fallout, the rejection by the voters of the old centre-left order, the implications for immigration policy and so on. But if the swing spreads to Germany, as seems likely in the autumn elections, a different ideology will be governing the European economy as well as European politics. One of the key priorities of these new leaders will be to lift Europe's economic performance.

The poor showing of the European economies vis-à-vis the US in particular became most evident towards the end of the 1990s – hence the theme of the EU's Lisbon summit two years ago, which set out a plan to try to catch up with the States. But since then the under-performance has continued, maybe even got worse.

You can catch some feeling for the scale of the problem, and indeed why European voters are so ratty, from the graphs. Take the core performance measure, labour productivity. As you might expect, productivity growth in the US was higher than European through the second half of the 1990s. That was, after all, a period when information technology was applied to commercial functions much more quickly in the US than in Europe. But what is really remarkable is that when demand in the US collapsed, the country still managed to carry on increasing productivity. The most recent figures suggest that productivity is rising even faster than it was in the late 1990s. By contrast, productivity in the eurozone is actually falling. (True, Merrill Lynch, which prepared these graphs, notes that US data excludes the public sector, whereas European data does not. But the distortion is not material: only 0.3-0.4 of a per cent.)

As a result of these large productivity gains, US companies have been able to increase wages much faster than their European counterparts. You can see that in the next graph. Wage growth has fallen sharply in the US as unemployment has climbed, but it is still running above the level of the eurozone. These figures are in money terms, not real ones, and they refer to the wage bill rather than actual individual earnings. Allow for inflation and taxation, and European employees have hardly been increasing their standard of living at all. No wonder they are upset.

So what is to be done? The new governments of Austria, Italy, Denmark, the Netherlands, soon France and probably in the autumn, Germany have to answer this question: how is Europe to become more prosperous?

Of course one huge difference is in unemployment levels. Despite the recent rise in the US, unemployment is only two-thirds the European level. That certainly makes people miserable – the German lady in the picture is protesting that she is unemployed. But different levels of unemployment do not explain the differences in the rate of growth of living standards of the people in work.

What else? There are significant differences in labour productivity in the US and Europe, with the US generally higher. There are economies of scale in the US market that, as yet, the supposed single market in Europe has yet to achieve. There is, of course, a different approach to welfare spending – though you should note that while US taxation is much lower than European, US citizens have to set aside a larger proportion of their income to cover health insurance and college education. But the biggest differences of all are in the hours worked – typically 30 per cent more in the US, and the proportion of the potential workforce who are actually in jobs.

Here in Britain some people fret that we work longer hours than people on the Continent. That is true. But we also work much shorter hours than Americans. We occupy the mid-Atlantic position, with something close to the US work-week but with European-style holidays. But the proportion of people of working age in jobs is an equally important reason why European living standards are so far behind the US. The bottom graph shows how the gap has widened over the last 30 years. That graph is for the eurozone and there are very big differences between countries. The further north the higher is the participation rate, with Scandinavia at the top, the UK just below, Germany then France in the middle and Italy at the bottom. So the scope for harmonising is enormous.

If the new European governments could manage to increase labour participation rates this would generate very large increases in living standards. Not only would there be fewer dependents; there would be increases in tax revenues.

Suddenly, Europe's fraught fiscal arithmetic would begin to look more manageable. Tax rates could come down without any cuts in spending, for the more people there are at work, the less each has to pay in taxation to fund the government. (That, by the way, is how Scandinavia manages to fund its enormously expensive welfare system: everybody works.)

There is a further obvious benefit. If tax rates on workers come down, more people are likely to be pulled into the labour market and more people would choose to take their compensation in the form of pay (which is taxed) instead of leisure (which is not). That further boosts tax revenues, and allows further cuts in tax rates or improvements in services.

There, in short, is the agenda that the new political leaders of Europe may choose to adopt: to establish a virtuous circle of growth. If they do, Europe will start to look much more competitive vis-à-vis the US and, I suspect, European workers will become more content.

Will this happen? I have two reasons for believing that it will. The first is that the need to increase labour force participation was already widely recognised by the centre-left elite. They just didn't know how to promote it: the numbers were creeping up but far too slowly. The second is that the new centre-right leaders have to do so something or they too will be ejected. Waiting for the euro to promote greater efficiency will take too long and in any case the "one-size-fits-all" interest rate is already causing serious difficulties in Germany, Europe's largest economy.

If fear of being outclassed by the US has not forced Europe's politicians to change policy, fear of being kicked out of office may do the trick.