Hamish McRae: Why Europe still struggles to catch up with the US growth story

What is to be done about the Lisbon Agenda? You may recall that at the special Lisbon EU summit held on 23-24 March 2000, the European leaders, worried that the US was streaking ahead in the hi-tech industries, committed themselves to catching up by 2010. The main theme was "Employment, economic reforms and social cohesion - for a Europe of innovation and knowledge".

What is to be done about the Lisbon Agenda? You may recall that at the special Lisbon EU summit held on 23-24 March 2000, the European leaders, worried that the US was streaking ahead in the hi-tech industries, committed themselves to catching up by 2010. The main theme was "Employment, economic reforms and social cohesion - for a Europe of innovation and knowledge".

Well, now it is four years on and the EU leaders are meeting later this month to review the progress. And, if they are frank, they will conclude that the progress, at least in the eurozone, has been somewhere between a serious disappointment and an utter catastrophe. The UK government can argue that it has done all right, and Sweden could make a similar case. But within the eurozone only Finland and Ireland have satisfactory records, and Ireland's excellent progress has been on the back of US investment and know-how.

If that sounds too dismal consider the charts here, taken from a study this week by Capital Economics. Start with that disturbing downward trend in the first graph. You would expect there to be peaks and troughs but the worrying thing surely is that the peaks have become ever lower through the 1990s. The deterioration vis-à-vis the US is even more disturbing (next graph). Whereas in the early 1990s the European performance compared favourably with the US, a consistent gap had opened up during the late 1990s. It was that gap that provoked the Lisbon initiative. But look what has happened since then: what was a modest gap has widened into a yawning chasm. American productivity has shot ahead while the eurozone's has stagnated.

If you look at absolute levels of productivity, rather than the growth, Europe's record does not look so bad. The most up-to-date figures I have on hand are for 2001, but then the output per employee in Germany was 70 per cent of the US level, the UK's 75 per cent and France's 90 per cent. Allow for the longer hours worked in the US (and to a lesser extent in the UK) than in France and Germany and the figures look better. Output per hour in France is higher than in the US, in Germany more than 90 per cent of the US level, and in the UK, 85 per cent.

Some people use this data to argue that the eurozone does not have a productivity problem as such, but rather a demand deficiency. But there are two points to be made against such a view. One is that the dynamic picture is serious: the problem is the trend, for relative European performance will have deteriorated further during the past two years. And the other is that the eurozone has much higher unemployment that the US. If you exclude the least productive 10 per cent of the workforce from having jobs, obviously the overall level of productivity of the overall workforce will be higher. (One of the reasons why US productivity has surged is because the recovery has been a relatively jobless one: it has not sucked those less-productive workers back yet.)

Looking ahead, the problem may well get worse before it gets better. The final set of figures show some Capital Economics forecasts for this year and next. There is an assumption that there will indeed be a recovery in growth this year and next, after the very disappointing performance last year. Let's assume that this does happen. But look at the implications for productivity and employment.

Productivity growth is forecast at about 1 per cent and employment is forecast to creep upwards too. But the labour force is still growing so there will be no improvement in unemployment. That is the average: since some of the smaller eurozone countries have been quite successful at getting people into jobs, that suggests German unemployment will remain above 10 per cent and French at about 9.5 per cent.

Indeed, you could argue that Germany and France must not have too rapid productivity growth because if they did, their unemployment rates would be even worse.

So what is to be done? Everyone is worried about this. The UK Treasury is of course worried about UK productivity, though some of us would feel that it is too worried about the private sector's record and not worried enough about that of the public sector. It has also conducted a couple of studies, one with France and Germany and the other with smaller EU countries. The OECD has devoted an enormous amount of attention to it.

But at the risk of over-simplification, I find most of the work too pernickety. Instead of over-analysing the possible reasons for the European shortfall, it might be more helpful to figure out why the US has done so well and try to imitate it - if indeed Europe is serious about catching up.

The really big differences are surely in education, labour market practice, and management attitudes.

European higher education is particularly worrying. There was a Shanghai study of world universities which ranked no continental European university in the world's top 50 - Cambridge and Oxford got into the top 10. The proportion of young people going through higher education in France and Germany is lower than the US, and now also lower than the UK. German 15-year-olds did particularly badly in the OECD global study of students' functional ability in literacy, numeracy and science. European countries that have put a lot of resources into education, such as Sweden and Finland, seem to do all right on the innovation stakes.

So much has been written about labour market practice that it not really very helpful to add more here. Most of continental Europe has made a political choice of trying to protect those in jobs, at the cost of excluding a larger proportion of the workforce from having jobs. I suppose the only further point to make is to use that economist's argument of revealed preference: you look at the choices people make by looking at what they actually do.

Here the evidence is that young continental Europeans want to study and work in the US and UK - witness the exodus of professionals that is taking place at the moment. Workers reveal by their choices of location which type of labour market they prefer. But of course if they move, that may actually reduce the political pressure for change back home.

And management? I feel much too little work has been done on this. We know that UK companies that are owned by US ones have higher productivity than those with a British parent. But I have not seen comparable data for US-owned companies in France and Germany. If these are indeed higher then it ought to be possible to identify the cultural and other differences of US management. We can then start to figure out which elements matter and which don't.

My guess is that Europe will continue to trail the US in productivity growth because that is the choice of a majority of its people. There is nothing wrong with that if that choice is being made rationally. Indeed, it is perfectly sensible for people to choose leisure over income. But if this is right, then governments should forget about the Lisbon Agenda and acknowledge that Europe will never catch up with the US. There will be no "Europe of innovation and knowledge" because most continental Europeans, at least, don't want it.