<B>Can Europe grow at the same pace as the USA?</B>

Rafael Pampillón

24 April 2003

The U.S. economic machine continues to roll, while Europe continues to lose competitiveness. For the EMU nations to catch up, they must reform their labor markets and do away with the welfare state.

In the report for 2002 on World Competitiveness, published by The World Economic Forum, one can see how some European countries, such as Spain and Great Britain, are gaining in competitiveness with respect to 1994, while others (France, Germany and Italy) are dropping down the table. Gains made by Spain and Britain may be a consequence of their greater macroeconomic stability and market reforms (labor, electricity, land, telecommunications). Meanwhile, the U.S. holds on to its leadership in the competitiveness stakes and, what’s more, for 22 years (1981-2002) has been growing at a healthy rate (3 per cent a year on average), compared to the countries in the Economic and Monetary Union (EMU), who registered 2.2 per cent. The EMU’s three major economies (France, Germany, Italy) have been suffering low economic growth rates for years. Why does the North American economy outperform Europe’s? Why does it generate more employment than Europe? Why are France, Germany and Italy losing competitiveness? Why is Germany about to slash its welfare state? What are the real differences between Europe and the U.S.?

Competitiveness Ranking
1995 2002
USA 1 1
Germany 6 14
France 17 30
UK 18 11
Spain 28 22
Italy 30 39
Source: World Economic Forum
[*D The problems *]
First, firms within the EMU have greater costs – fiscal, social, administrative and financial (higher interest rates) – than the U.S. This causes them to lose competitiveness (for example, sales), and as a result, sacrifice economic growth and job creation. Thus, for example, while the tax burden in the U.S. is 30 percent, in the EMU it is 45 percent. Second, determining salary rates in the U.S. is decentralized (at an individual firm level), while wage negotiation in Europe is a centralized affair. This means salaries in the United States are guided by market forces, which permits a more efficient allocation of resources. Third, the U.S. has the greatest entrepreneurial spirit in the world. Every year, hundreds of thousands of new businesses are created there - many of which disappear within a year - yet around 100,000 survive.

This clearly defines America as a society with business initiative. Among other factors, this can be explained by Europe’s more costly, complex and time-consuming administrative formalities to create a business (in the U.S. it can take a month, while the EMU average is 15 months). The availability of risk capital and incentives for gaining access to risk capital are also far higher in America than in any European country.

Fourth, the EMU earmarks fewer funds for R&D – two percent of its GDP, while the U.S. sets aside 2.6 percent. This has allowed America to adapt better to new technologies and orient production and foreign investment towards the high technology sectors. In this sense, the U.S. economy has proved, and is still proving, capable of taking greater advantage of the IT revolution, based on reduction of costs for the transmission and storage of information. Moreover, at home and at work, its population makes greater use of PCs and the Internet than their European counterparts. In the software sector, where salary levels are well above average, the U.S. employs 50 percent more people per capita than France or Germany.
[*D The reforms *]
Is the American model applicable to European economies? Perhaps not as a whole or in the short term, basically due to deep-rooted concern for social differences. In addition, social differences are widening as the new information economy calls for increasingly highly qualified workers, who are going to earn ever greater salaries, while lower qualified workers will get reduced wages. Europe’s response to this problem should not consist in resisting market forces (establishing an elevated minimum salary, restricting layoffs from companies and opposing a more flexible system), but rather should aim at increasing investment in training and technology.

The welfare state, which we are not prepared to relinquish, has achieved a certain equality of opportunities, thanks to the availability of public benefits such as pensions, education and health. Now however, it seems increasingly necessary to redesign the welfare state. The government should no longer be a social services provider, but rather a guarantor for the provision of those services, in the interests of achieving greater efficiency. Pension systems have to be reformed, since in Europe (with one of the fastest-aging populations in the world – unlike the U.S.), the percentage of people who do not work is increasing, compared to those in work. To put it another way, the proportion of people in work is set to diminish progressively.

In the future therefore, either pension benefits will be lower or the tax burden will have to be stepped up, since fewer workers are going to have to support more pensioners. To make the pension system sustainable, it will be necessary to turn to foreign workers. But immigration, though it may help alleviate issues posed by the aging population, will not reverse the trend toward increased longevity, nor can it sufficiently raise the birth rate to ensure generational renewal.

For Europe to grow, it must drop ballast, as Germany is attempting to do. This entails reforming its welfare state (rationalizing an expensive and increasingly inefficient health system) and labor market (adding greater flexibility for layoffs), facilitating creation of new businesses (eliminating barriers stifling the entrepreneurial spirit), and spending more on R&D. This is the route that must be followed. Otherwise, our old and ailing Europe will continue to slide.

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