Europe is Winning on Productivity

Revision is in the air about America’s economic miracle. Not only did America’s bubble crash, but also it now appears that much of the US economic miracle of the 1990s never happened. When it comes to performance, Europe is king, not the US.

A study of the sources of economic growth by the OECD has brought together a formidable set of data and with it new views about who is doing well and who poorly. One new conclusion is that America’s economic performance is not as glittering as previously thought. The accompanying table captures the central fact: true, the US had high growth in the 1990s, more than Europe’s largest economies by a long shot. But the productivity part, the US as a productivity miracle, is wrong.

This is apparent at the conventional level of output per person employed. But it gets even worse when we recognize that in Europe many fewer hours are worked per person than in America. By the time we look at output per hour worked, Europe shows a full reversal. Suddenly a place thought dull if not worse, Germany, is the big winner. Germans do not work much, but when they do, it is with unmatched productivity, and the story gets better over time.

It might seem from these numbers that Europe has figured out a neat trick: work little but work well. In fact, not only was productivity growth better in Europe, but so also were productivity levels. West Germany or France produced absolutely more dollars worth of output per hour worked than the US. So too did Italy. By contrast, Japan, with its inefficient service sector, was way below the US or Europe, as was the UK.

How should we interpret these facts? One possibility is this: Europe’s labor market is a great problem. It is over-regulated and inflexible and, on top of these twin evils, is expensive even at the current low level of the Euro. Why be surprised, then, that European firms shy away from labor and operate in a capital-intensive fashion.

With high concentrations of capital per worker, other things being equal, labor is highly productive – that is the European model. Moreover, labor-intensive (i.e., low productivity) companies more readily outsource some tasks or go offshore altogether. This is partially because restructuring in Europe is hard, which can result in a whole business leaving Europe altogether. Consequently, by process of elimination, what firms remain are the ones showing gains in productivity.

That is a smart model, but is there a downside? The downside is this: Europe has high unemployment because firms shy away from hiring new workers. In the US by contrast, growth normally involves relatively less capital accumulation per worker and a small productivity gain per worker or per hour, but in exchange significantly more employment creation.

Revision is in the air about America’s economic miracle. Not only did America’s bubble crash, but also it now appears that much of the US economic miracle of the 1990s never happened. When it comes to performance, Europe is king, not the US.

A study of the sources of economic growth by the OECD has brought together a formidable set of data and with it new views about who is doing well and who poorly. One new conclusion is that America’s economic performance is not as glittering as previously thought. The accompanying table captures the central fact: true, the US had high growth in the 1990s, more than Europe’s largest economies by a long shot. But the productivity part, the US as a productivity miracle, is wrong.

This is apparent at the conventional level of output per person employed. But it gets even worse when we recognize that in Europe many fewer hours are worked per person than in America. By the time we look at output per hour worked, Europe shows a full reversal. Suddenly a place thought dull if not worse, Germany, is the big winner. Germans do not work much, but when they do, it is with unmatched productivity, and the story gets better over time.

It might seem from these numbers that Europe has figured out a neat trick: work little but work well. In fact, not only was productivity growth better in Europe, but so also were productivity levels. West Germany or France produced absolutely more dollars worth of output per hour worked than the US. So too did Italy. By contrast, Japan, with its inefficient service sector, was way below the US or Europe, as was the UK.

How should we interpret these facts? One possibility is this: Europe’s labor market is a great problem. It is over-regulated and inflexible and, on top of these twin evils, is expensive even at the current low level of the Euro. Why be surprised, then, that European firms shy away from labor and operate in a capital-intensive fashion.

With high concentrations of capital per worker, other things being equal, labor is highly productive – that is the European model. Moreover, labor-intensive (i.e., low productivity) companies more readily outsource some tasks or go offshore altogether. This is partially because restructuring in Europe is hard, which can result in a whole business leaving Europe altogether. Consequently, by process of elimination, what firms remain are the ones showing gains in productivity.

That is a smart model, but is there a downside? The downside is this: Europe has high unemployment because firms shy away from hiring new workers. In the US by contrast, growth normally involves relatively less capital accumulation per worker and a small productivity gain per worker or per hour, but in exchange significantly more employment creation.

In fact, much of America’s growth in the 1990s involved absorption of the unemployed and of welfare recipients into jobs. US growth thus involves lots of job creation; Europe’s growth, if high, keeps unemployment barely constant. Two different models, each with a downside. It would obviously be attractive for Europe to get the extra benefit of massive job creation and for the US to enjoy stronger productivity in addition to its mammoth jobs machine. Is there a chance of either happening?

Europe does not stand much of a chance to emerge from its unemployment trap either in the coming year of recession or any time soon. To change things, Europe would need to stoke up the economy with a lot of investment, cheap money, tax cuts for everyone, and perhaps public works spending as well. No prospect of that in these days of strict accounting. The story will remain one of good productivity – surprisingly good considering that Europe was not thought to be part of the “new economy” area.

In the US there is recession and hence rising unemployment. The likely modest recovery will not be strong enough to outpace productivity. Next year, accordingly, Europe and the US will look alike.

On the productivity side, the news may become somewhat better. This is the first time the US is showing productivity growth in a recession (during which productivity normally turns negative). If this holds up and strengthens with recovery, as Fed Chairman Greenspan seems to think it will, the US could soon face the European dilemma. It will be doing well on productivity, possibly better than Europe, but will not be able to get the unemployment rate down. Sadly, it is not at all clear which state of things is better.