It’s ok over here!

European economies appear on the mend. French business confidence has reached its highest levels since spring 2001 whilst German business confidence is rising quickly, with GDP growth in Q2 a (for Germany) spirited 2%. Looking over the longer-term there is increasing evidence that Europe?s economic inferiority complex with the US is misplaced.

Of particular interest is a new paper from American economist Robert Gordon, reviewed by Sam Brittan in the FT (subscribers only, I?m afraid), that examines the growth experience of the US and Europe, in particular North-West Europe, over the last 200 or so years.

America has been ahead since the 1870s, an advance Gordon attributes to political unity which fostered large-scale manufacturing and marketing, plus various other factors (such as immigration) that would have meant Europe would have been at a disadvantage even if it had achieved political union. This lead expanded in the first half of the 20th century as the crucial inventions of electricity and the internal combustion engine were deployed widely in the US, while Europe tore itself apart in wars. Only in the Golden Age of 1950-1975 did Europe implement these technologies, the period in which it enjoyed its greatest ?catch-up?.

The 1990s saw the US surge ahead again, partly again due to earlier technological adoption (namely IT) but also due to productive advances in retailing, which Europe due to its constrained space and thus tight planning laws was unable to follow.

Thus today European GDP per capita is only 77% of US GDP per capita.

But to what extent does this matter in terms of living standards?

European output per capita is partly lower because Europeans work less hard. When Europeans do work they are nearly as productive as Americans? with output per hour worked a much higher 93% of the US level.

Insofar as Europeans choose to work less hard then, as Brittan says ?there is nothing to complain about?. You can?t take both leisure and work (at the same time) thus, assuming rationality, if one trades off work for leisure it is welfare-enhancing. But to the extent European?s shorter hours are due to restrictive labour markets it is not welfare enhancing. Gordon estimates that one-third of the difference is due to voluntary decisions, and two-thirds due to bad labour market laws.

Thus advantage still with the US. But Gordon believes other factors may be in Europe?s favour. Brittan notes:

?When Prof Gordon turns from crude GDP to welfare, he is not so sure. He suggests that not all the higher US GDP is welfare-enhancing. Some of it involves fighting the environment: for instance, heating and air conditioning to combat a more extreme climate. Some of it, too, goes on a higher level of home and business security to protect against crime or to maintain 2m people in prison. He speculates that the Europe/US economic gap might well be reversed by a broader welfare measure?

Brittan concludes, interestingly, that:

?My own assessment is that the US and at least north-west Europe have now reached a stage of development where there is little to choose between them in economic performance and where growth is no longer the most sensible policy objective. If the “European social model” is to be criticised, it is because it restricts freedom of choice.?

28 thoughts on “It’s ok over here!

  1. I’ve had this argument before with an economist friend of mine. If I have a problem with the analysis, it’s that I find the guesses at how much of the European “working hours” gap is voluntary, how much of U.S. product is spent “fighting the environment”, etc, etc, to be just that, mere guesses. You can lay on arguments in both directions at length, but I have yet to see any solid numbers.

    An additional objection has to do not with the GDP gap per se, but rather with its implications. One thing the U.S. most certainly _does_ spend a larger proportion of its larger product on is the generation of military strength. This cannot be directly added to personal utility, I think, but I will note that objections to Europe’s inability to project power regularly crop up on this blog. A Europe that works fewer hours than the U.S. but attempts to maintain the same physical standard of living as the U.S. must, perforce, be a Europe that cannot have a similar capability for power projection as the U.S. Something always has to give, ladies and gentlemen.

    Bernard Guerrero

  2. There is, as I see it, a very big problem with this sort of analysis. The easiest way to point it out is with the example of health care. Health care costs are rising fairly rapidly (and bringing with it increased health, vitality, and longevity). While Europe might choose to have 7/10ths the economy of the US, I doubt it will long suffer 7/10ths of the health care of the US.

    Some costs are fixed. If an economy produces less per capita than another country, those fixed costs will appear far more expensive.

    For a time Europe can hide these cost increases in enforced price-fixing of such things as pharmacueticals or in hidden rationing of care, but as time goes by, the disparity in health spending will begin to cut into that same health, vitality and longevity that Europeans expect.

    They may find that in a few years their economy is not strong enough to keep them as healthy as Americans.

  3. Bernard Guerrero,

    “One thing the U.S. most certainly _does_ spend a larger proportion of its larger product on is the generation of military strength.”

    That depends on the country – this statement isn’t true of either the UK or France.

    “…but I will note that objections to Europe’s inability to project power regularly crop up on this blog.”

    Again, this depends on the country. France can and does project power overseas all the time – which is why it can send a few thousand troops half way around the world on rather short notice. The same is true of the U.K.

    Ann,

    The problem with all the doom and gloom scenarios for Europe is that they assume that Europe will remain static, which is unlikely.

  4. You also have to take into account the fact that a lot of the per capita gap is due one factor – energy consumption.

  5. Gary,

    If Europe grows at a rate of 2% a year *more* than the US every year, it will take about 17 years before it catches up to the US.

    That means if the GDP growth one year in the US is 3%, the EU would have to grow by 5% that year to stay on track to catch up in 17 years.

    It is hard to see Europe doing that if it continues, as the piece here suggests, to opt for less work and a lower GDP. I would agree, though, that they may be able to keep up with increases in health care costs.

    Explanation of my math: http://www.annsbox.com/logger/archive/archi.cgi?read=2309

  6. Ann,

    Well, that assumes that health care costs will continue to increase; with advances in genetic technologies in the next ten-twenty years costs may decrease since in expensive gene therapy may be fixing our woes.

    Anyway, I don’t see Europe keeping the more inelastic features of its labor market for too much longer; there is already a revolt against it brewing, and these nations will re-adjust.

  7. Gary,

    For my part I hope you’re right. I’d rather have an economically strong Europe than the alternative. But so far, I don’t see any great movement in that direction. While I do see lots of attempts to forestall any such movement. The FT article which started this thread seems to suggest that Europe plans on settling into a slower pattern than the US. That is a valid choice, but that choice will have repercussions over the long term. If Europe chooses to grow more slowly, it won’t be long before the disparities between the US and the EU begin to become stark. The hope lies in reforms within Europe, but I don’t share your optimism that these are coming within the near term.

    I know there is growing resistance in some parts of France to the shortened work week, but other parts of France love the greater amounts of free time. It will come down to a question of who has more political clout: the white collar folks living on a salary who love to get out of work early, or the hourly workers who have taken a pay cut because they can’t work as hard as before? My guess is that the former will prove to be politically stronger.

    The agricultural sector will continue to be propped up by heavy subsidies. That will mean the allocation of money that would be better spent elsewhere, and at the same time the propagation of inefficient farming techniques. (More importantly, from a global perspective, this will continue to shut out poorer countries from many international markets. For many poor countries, agriculture is the first rung on the ladder to prosperity. Without free trade in agricultural products, the poor get screwed. My personal view is that developed-world farm subsidies are deeply immoral because they keep the poor of the world poor.)

    I do see some loosening of labor laws, but I also see some backlash from even modest changes. Schroeder is getting hammered because he tinkered on the margins with labor laws. I don’t see Schroeder or any successor trying reforms again for a while.

    Then there is the issue of ‘tax harmonization’. If it goes through, you’ll see rising taxes reducing economic activity in those countries which currently enjoy lower taxes. The benefits that have made countries like Ireland grow so quickly in the last decade will evaporate, and with it the economic dynamism that has propelled those countries will weaken. If the fast-moving economies are pulled back in by the slow ones, the result will be an overall slowing of Europe’s economy.

    There is also the difference in immigration. The US is blessed with having excellent immigrants. Living in Los Angeles, it is impossible to go through a single day without marveling at the hard working, creative, entrepreneurial immigrants we get here. I may be wrong, but I don’t get the impression of the same incredibly strong work-ethic from immigrants to Europe. Don’t get me wrong, both countries have hard-working immigrants, but I think fewer of the ones in the US are looking for handouts, and more are working hard. I can’t find the statistic on line at the moment, but I believe I read within the last week that half of France’s prison population was born outside France. There is a problem there which will be very hard, painful, and possibly expensive to address.

    There is also the problem of pension reform. I have long thought that the first country to solve the basic underlying problem of a growing retirement population will get a major competitive advantage over any rivals. Right now, I can’t really say which side of the Atlantic will do better at that, because right now, neither side seems to be taking it very seriously. The only thing helping the US is the demographics, which gives us more young people on average than Europe. Europe can import more people, but that might lead to even more problems with immigrants.

    These problems are real, many are deep-seated and worsening.

    I would like to share your optimism that these things will be fixed soon, but I do not see the political class displaying the willpower to do it, nor do I see a clamor from the population to address these issues. I want it to happen, I just don’t see any movement.

  8. …objections to Europe’s inability to project power regularly crop up on this blog.
    “When you have a big hammer, all problems begin to look like nails.” (Old management consultancy saying.) Personally, I’d prefer to err on the side of a smaller military.

    There is also the difference in immigration…
    Unfortunately, Ann, I must partially agree with you. However, I’m unconvinced that the US gets a better class of immigrant, so to speak. Rather, I think the fault is the treatment of the immigration question by European governments. Instead of people who want to come to Europe being welcomed positively, both economically as tax payers and as part of a solution to the pensions problem you mention, we outlaw them. We refuse to allow them to work, force them to survive on handouts and disenfranchise them to the extent that many, particularly bored young adults, turn to crime.

  9. Ann, the problem with the health care argument is that currently and for the recent past the average European has enjoyed better health than the average US-American (judged by statistical indicators from infant mortality to life expectancy).

    One reason is that the best health care is still preventative health care. If you lead a healthier lifestyle (including working less), then you are less likely to develop a variety of illnesses; if you can afford to see a doctor early whenever you are ill, you’ll get all the benefits of early treatment.

    Another reason is that the higher GDP of the USA does not automatically translate into better treatment: a large part of the health care expenses in the USA cannot be attributed to superior treatment options, but to the higher bureaucratic overhead of health care and the fact that patients get overcharged. For example, prescription drugs cost twice as much on average in the USA compared to Europe. While it has been argued that US pharmaceutical companies invest considerably more in R&D (which is true), this difference in R&D investments accounts only for a fraction of the difference in drug prices.

    That is no to say that European helth care systems don’t have their own share of problems (there are plenty), but overall the argument that health care quality is directly proportional to GDP doesn’t wash.

  10. Reimer,

    ” For example, prescription drugs cost twice as much on average in the USA compared to Europe.”

    If Europe prices drugs below the cost of research and production of new ones, one of two things will happen: 1) New drugs will stop being developed, or 2) the drugs companies will shift the costs to those countries without price-fixing.

    We are already seeing fewer pharmacueticals coming to market.

    “Pharmaceutical manufacturers are projected to invest a record $26.4 billion on the research and development of new medicines in 2000. To date [October], the Food and Drug Administration (FDA) has approved 23 new drugs this year. In 1999, the FDA approved 40 new drugs. 1, 2 This compares to the 30 new drugs approved in 1998, 39 in 1997, and 53 in 1996. [ Link ]”

    And the high prices in the US are partly because we are essentially subsidizing countries like Canada and Europe. The money has to come from somewhere, if Europe and Canada don’t pay their fair share of research costs, those costs will fall to Americans to pay.

  11. Michael,

    You’re living in fairyland if you think that America treats immigrants all that well; indeed, we tend to treat immigrants like shit.

    Ann,

    Your little statistics might be artifacts of all sorts of confounding variables – for example, maybe most drugs are approved in November and December of any year.

    BTW, Europe is NOT a country, its a continent.

    As to the issue of subsidization, you tend to forget that European governments – particularly France and the UK – heavily subsidize their big pharma giants – so yes, drug prices may be cheaper to a consumer at the counter, but they still end up paying for through taxes. This really deflates the notion that the U.S. is pulling all the weight.

  12. Ann, the actual R&D expenditures for the US in 2000 were $21.4 billion. That still sounds like an impressive figure if you forget that the US health care market was in excess of $1 trillion (1e12). In other words, we are talking about roughly 2% of overall health care costs.

    Also, let’s take a closer look at my original argument here. In 2000, pharmaceuticals accounted for 12% of US health care expenditures, or roughly $120 billion. Compared to European standards, where prices are at less than half the US level, the US pharmaceutical companies thus earned some $60 billion extra, at the cost of an additional investment of perhaps $10 billion or so compared to a fictional country in Europe the size of the US (and that is not even counting patent licensing fees). In other words, R&D is a rather small part of the total cost of prescription drugs in the US.

    This is also reflected in the operating expenses of the large US pharmaceutical companies. R&D expenditures are dwarfed by the cost of production, marketing, and sales. Pfizer, for instance, had a total revenue of $32.3 billion in 2001, and R&D expenditures of $4.8 billion.

    So, why are drug prices twice as high as in Europe? Largely because through protectionism the industry does not have to worry much about competition. Which is also why they, through lobbying (which they spent $91 million on in 2002 alone), fight bills in Congress such as HR 2427, which would allow the import of drugs manufactured abroad.

  13. Gary: …indeed, we tend to treat immigrants like shit.

    At the risk of initiating a transatlantic depth-of-shit contest, I pulled this from today’s Daily Telegraph (Home News in Brief):

    ‘Demonstrations will continue today against the “indefinite detention” of asylum seekers following two apparent suicides at detention centres at Harmondsworth near Heathrow airport and Dungavel in Lanarkshire.’

    Immigrants in the US don’t create the same level of fear and distrust among ordinary people that they do in Europe. Therefore, there is less political pressure to use the sort of draconian measures in place here. Not only in the UK, visit any main railway station in Germany and watch the police “randomly” checking papers – they aren’t primarily looking for terrorists.

  14. About the cost of medicine. Marketing cost are much lower in most European countries because advertising medicine is much more restrictated so the profit margine in Europe may not even be that much lower.

  15. Reimer makes a good point about the cost of bureacracy in the US health care system. Some estimates put it at about 1/3rd of total expenditure, far higher than in many other systems.

    Indeed before the Labour government’s health care blitz US spending per capita on health care bureacracy was about the same as UK spending per capita on the National Health Service in total.

  16. I’ve read Pat Buchanan’s Death of the West. Can only agree with most of his pessimistic views on the USA. The problem is that EU is in even deeper problems than America. The level of complacency combined with economic illiteracy among European politics is incredible. With *****s like Schr?der, Chirac, Verhofstadt, ?pidla, etc, we can only drag behind the US economy. None of them seem to possess proper understanding of how market economy works. Very sad.

  17. “One thing the U.S. most certainly _does_ spend a larger proportion of its larger product on is the generation of military strength.”

    That depends on the country – this statement isn’t true of either the UK or France.

    Really? I wasn’t aware that any European spent more of its GDP on the military than the US did. Is this true? What is France spending money on?

    In 2000, pharmaceuticals accounted for 12% of US health care expenditures, or roughly $120 billion. Compared to European standards, where prices are at less than half the US level, the US pharmaceutical companies thus earned some $60 billion extra, at the cost of an additional investment of perhaps $10 billion or so compared to a fictional country in Europe the size of the US (and that is not even counting patent licensing fees). In other words, R&D is a rather small part of the total cost of prescription drugs in the US.

    As ususal on the research question, you are ignoring the enormous failure rate of the small pharma research companies that do a huge amount of the most innovative work. Many of them exist for a few years and die, while only a very few exist long enough to get something useful and get bought up by the Pfizer’s and Merck’s of the world. These costs are reflected in the high cost of acquisitions of the sucessful small start-ups. (You have to pay people a lot for success to get them to take the huge and expensive risk of failure). This is not reflected in the ‘research costs’ on the accounting books of the big companies, yet it is absolutely a function of research costs in any rational look at pharma research.

    But you shouldn’t have needed that analysis to realize that drugs at a forced price near the marginal cost of physical production could not possibly pay for the rather huge development costs. (See especially Canada.) Someone is paying those costs. Who do you think it is?

  18. Ann,
    Since you live in L.A. and not in Cannes or Cologne, I’d be less worried about France/Germany’s pension reform than I would about United Airlines imminent pension failure bringing down airline pensions in turn bringing down the quasi-governmental Pension Benefit Guarantee Corp.

    If the Federal Government can’t keep PBGC from going down, who’s going to prop up over-extended Fannie Mae and Freddie Mac ?

  19. A Europe that works fewer hours than the U.S. but attempts to maintain the same physical standard of living as the U.S. must, perforce, be a Europe that cannot have a similar capability for power projection as the U.S. Something always has to give, ladies and gentlemen.

    I wonder – and I’ve asked this before whenever the military comparison between the US and Europe came up – if anyone ever attempted to analyse the true nature of US defense spending.

    I believe the economics of military spending are more complicated. In many areas I think there must be a decreasing marginal rate of power projection capability increase as the defense budget increases. I doubt anyone has ever been able to dtermine to which extent defense spending – or subcategories thereof – much of the US defense budget could also be seen as some kind of hierarchical redistrtibution effort giving opportunities to people who otherwise would not get any – is increasing safety or said power projection prowess, even assuming that the latter was a concept that did not actually defy a generally agreed upon definition.

  20. Interesting proposition, Tobias. Yet we can also take a look at the armed forces of many social democratic western European states, where lots of money is spent on a conscript army consisting of young men listlessly performing their legally-ordained tour of mandatory duty. Contrast that to the all-volunteer armies of the US and UK, which can project power more readily (and get more efficacy for the investment) simply because they’re volunteers (whether through idealism or enticement).

    Countries like France and Germany, on the other hand, will always be hampered by the political difficulty of sending a conscript army of non-volunteers into conflict. Yet even such an army will have to be paid for, whether there’s a conflict or not. So who is really getting their monies worth, if we are to measure power projection in terms of “bang for the buck”?

    In the end, of course, France and Germany can always resort to another tactic: take a freeride after others have taken the risks and seen to the costs.

  21. Sebastian, I am not sure how you can say that “as usual, on the research question, [I am] ignoring […]”, given that to the best of my knowledge I have never discussed this issue publicly or in your presence before. I will cheerfully accept that I might be mistaken, but if you want me to revise my opinion, you’d be better advised to provide facts and figures, and not personal attacks. Right now, I am not willing to buy your argument without you providing further support for it.

    Let us also not distract from the main thrust of my argument, which was that higher GDP does not equal proportionately better health care (and definitely not always better health). As you may have noticed, even if we were to double the R&D expenditures of the US pharmaceutical industry, the overall effect on health care costs would be practically nil. Health care is a multi-faceted issue, and reduction to any single factor will likely overlook many others that are equally or more important.

    The underlying problem that I have been trying to address is an instance of the “more is better” fallacy, which usually manifests as a claim that if something is good, then more of it is even better. That argument fails in practice when we are dealing with non-monotonic functions or systems of interdependent variables, of which health care is a prime example; finding the right mix that delivers (near-)optimal results is a non-trivial problem of operations research.

    Note also that I did not claim that the pharmaceutical industry in Europe was operating either with wide or narrow profit margins; I simply did not express an opinion on that issue, and I am not doing it now.

  22. “European economies appear on the mend.”

    Since I don’t agree with this at all (sorry Mathew :)) I won’t get into the comments which seem to have drifted off into other issues.

    But I would just point out that the Gordon paper is available free online here:

    http://faculty-web.at.northwestern.edu/economics/gordon/2Cent-CEPR.pdf

    That being said I’m not that sure that there is too much we can extract from what he has to say about life over the last 200 years which may guide us much as to what is to come in the next five (economically speaking of course). Still, maybe that’s just me :).

    OTOH this other paper by Gordon, which I think I’ve posted about before , may add something to the picture:

    http://faculty-web.at.northwestern.edu/economics/gordon/P368-CEPR.pdf

  23. RSN, France has no longer a conscription army, since a couple of years. In Spain Aznar has suppressed it. Italy should go fully professional by 2006. German army is restricted in its activities. And Israel is more than enough proof that a conscript army is efficient when there is cause.

    DSW

  24. RSN,

    France no longer has a cnospript army (abandoned in 1997), and it won’t take long until Germany follows. Efficiency considerations aside, the power projection increase that allegedly follows a military professionlisation (Germany sends only professionals and volunteers abroad, for example) is also the downside. Personally, I think this is a part of a debate about renewed notions of citizenship and “the state”. For a long time, serving in the military was a question of social inclusion, today it is a paid service. Include Halliburton and the transactional structure of a “monopoly of power” becomes entirely blurred.

  25. I still owe Michael et al a response on this:
    fg: “…do you know a more appropriate site to discuss this topic than aFoE?”
    Michael: ?Not at all. But, we are off-topic, and its only polite to apologise before hi-jacking somebody else’s site & thread 🙂 ? from the comments on ?the trouble with referendums?
    and I think the comments here form a good context to provide it.

    At first I felt caught by the reaction. There is some truth in the allegation that apart from the involvement in the debates as such through comments elsewhere I try to get attention for my own thoughts (as mainly produced on my own blog) as well. After acknowledging that however, I can focus on other problems at hand.
    First there is this little dilemma concerning (for example) the size of your comments. While changing the categories on my own site I stumbled across this ?I wrote this post on “racism in the Netherlands” a few months ago for Bonoboland. It’s here now to support a reaction at A Fistful of Euros. (It’s to long to include it in someone else’s comments)? in a a post explaining The political landslide in the Netherlands in 2002. Well I think that was the right thing to do then but I think my point is clear.
    More important there is the problem of the responsibility for staying on topic.
    This post on ?It?s OK over here? elicits interesting debates on very different subjects: it?s about preventing health problems in the US vs Europe, about conscription, about working less hours voluntary or not, about patents on medicines, about immigration, about economic illiteracy among European politics etc etc. All highly interesting stuff but I do have problems when they all stay in the comments of one post. The chance that the discussion goes in all directions or remain to abstract grows.
    To some extend I think this problem is already rather big on every groupblog but when there is no strong policy on staying on topic it increases I am afraid. If a discussion develops on 2 or 3 interesting themes maybe it could be a solution to add posts to restart the then new topics.

    It is not a good sign when Edward Hugh is ?not getting into the comments while they have drifted off into other issues? while he does not agree on the core issue of the original post and we can definitely expect interesting comments from him on that original issue.

  26. Tobias: thank you for correcting me on the status of army conscription in France. I had a French friend who, in the early 90’s, was very vocal about his opposition to conscription; hence it stuck in my mind.

    But I can’t agree with your point. What matters not are notions of citizenship and state; what matters is how effective is the excercise of power. It is not the role of the armed forces to address questions of social inclusion. In fact, most armed forces were paid services until the French Revolution changed our notions of citizenship and national service; as a result, wars became increasingly total wars, with all the destructive havoc attendant.

    A paid service is much easier to control, – and much easier to dispatch to trouble spots – since it is based on a deal. And the notion you seem to suggest, – that because it is a transaction, the quality of the power projection is diminished – does not seem to hold, as the morale level of American forces in Iraq tends to be quite high (it’s the media that depresses them, not the notion of service).

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