<B>What’s happening to Europe?</B>

Rafael Pampillón. Director. Economic Environment Area. Instituto de Empresa

18 June 2004

Why does the U.S. generate more employment than Europe? Why has competitiveness fallen in France, Germany and Italy? Why are the Germans trimming their welfare state? The author tackles these questions.

The latest report on world competition published by The World Economic Forum shows how, over the last 10 years, European countries like France, Germany and Italy have lost ground. The U.S. meanwhile, has held on to its second position (preceded by Finland) and has been growing steadily (3 percent annual average) for the last 22 years (1981–2002). Growth rate in European Union (EU) countries has been lower (2.2 percent). Why does North America’s economy grow more?

The problems

One: EU companies have greater tax, social, administrative and financial costs – including higher interest rates - than the U.S., which means they lose out in competitiveness. Their sales are lower, and as a result, so is economic growth and employment. The tax burden in the U.S. is 30 percent, whereas in the EU it reaches 45 percent.

Two: determination of salaries in the U.S. is decentralized (at the level of each company), while the salary negotiation process in Europe is centralized. This means pay in the United States depends on market forces, which allows for a more efficient allocation of resources.

Three: the U.S. boasts the greatest entrepreneurial spirit in the world. Hundreds of thousands of new companies are created each year, and though many disappear within 12 months, some 100,000 survive. This defines the U.S. as a society with business initiative. This is due, among other things, to the fact that the administrative procedures required for establishing a company are more expensive, complex and unhurried in Europe (in the U.S., procedures take one month; the EU average is 15 months). Furthermore, availability of venture capital and incentives for accessing such capital are higher in the U.S. than in any European country.

Four: the EU invests less in R&D - only 2 percent of its GDP – while the U.S. allocates 2.6 percent. This has made it possible for America to adapt better to new technologies, and has directed its production and foreign investment toward high-technology sectors. Consequently, the North American economy has known and continues to know how to make the most of the computer revolution by reducing the price of data transmission and storage. Furthermore, at home and at work, its population uses the Net and computers more than the overseas counterpart. In the computer software sector, where wages are somewhat higher than average, the U.S. employs 50 percent more people per capita than France or Germany. Europe has become aware of the benefits for growth and employment offered by new technologies, and has implemented economic policies to speed their integration. The European Council of Lisbon (June 2000) laid down an action plan with the aim of making the EU the most competitive and dynamic economy in the world this decade. This goal was later ratified by the Councils of Stockholm and Gothenburg. Unfortunately, the Lisbon strategy has harvested poor results thus far, which casts doubts on the possibility of achieving the results set for 2010.

The reforms

Is the American model applicable to European economies? Perhaps not entirely or in the short term. This is mainly due to the strong European awareness of social differences. The welfare state, which we Europeans are not prepared to relinquish, has achieved a certain level of equality of opportunities, thanks to availability of public assets like pensions, education and health. Now however, redesigning the welfare state has become a top priority. The state’s role must not be to supply social services, but rather to guarantee provision of them in the interests of greater efficiency. Pension systems need reform, since in Europe (with one of the longest life-expectancy populations in the world, unlike the U.S.) percentage of the unemployed to the employed is on the increase. In other words, the proportion of working people is gradually decreasing, while non-workers’ ranks are swelling. In the future therefore, either pensions will be lower or the tax burden will have to be augmented, since a smaller number of workers will be supporting a greater number of retirees. For the pensions system to be sustainable, foreign workers will have to be called in. Immigration may help relieve the burden of an ageing population, it will not be enough to invert the tendency to longer life expectancy, nor can it grow the birth rate to a level sufficient for generational replacement.

In short, for Europe to grow, it needs to release ballast - as Germany is trying to do by reforming its welfare state. This means rationalizing expensive and increasingly inefficient health systems, reforming labor markets, decentralizing collective negotiation, enabling market operation and creation of companies by removing barriers to entrepreneurship, and increasing the R&D spend. This is the road ahead. Otherwise, the old and ailing Europe will grow less and less competitive.


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