Society and the marketplace
Why European economies lag behind the U.S.
BY EDMUND S. PHELPS
Monday, February 12, 2007 12:01 a.m. EST
The nations of Continental Western Europe, in the reforms they make to try to raise their economic performance, may prove to be a testing ground for the view that culture matters for a society's economic results.
As is increasingly admitted, the economic performance in nearly every Continental country is generally poor compared to the U.S. and a few other countries that share the U.S.'s characteristics. Productivity in the Continental Big Three--Germany, France and Italy--stopped gaining ground on the U.S. in the early 1990s, then lost ground as a result of recent slowdowns and the U.S. speed-up. Unemployment rates are generally far higher than those in the U.S., U.K., Canada and Ireland. And labor force participation rates have been lower for decades. Relatedly, the employee engagement and job satisfaction reported in surveys are mostly lower, too.
It is reasonable to infer that the economic systems on the Continent are not well structured for high performance. In my view, the Continental economies began to be underperformers in the interwar period, and have remained so--with corrective steps here and further missteps there--from the postwar decades onward. There was no sense of a structural deficiency during the "glorious years" from the mid-'50s through the '70s when the low-hanging fruit of unexploited technologies overseas and Europeans' drive to regain the wealth they had lost in the war powered rapid growth and high employment. Today, there is the sense that a problem exists.
What could be the origins of such underperformance? It may be that the relatively poor job satisfaction and employee engagement on the Continent are a proximate cause--though not the underlying cause --of the poorer participation and unemployment rates. And high unemployment could lead to a mismatch of worker to job, causing job dissatisfaction and employee disengagement. The task is to find the underlying cause, or causes, of the entire syndrome of poorer employment, productivity, employee engagement and job satisfaction.
Many economists attribute the Continent's higher unemployment and lower participation, if not also its lower productivity, to the Continent's social model--in particular, the plethora of social insurance entitlements and the taxes to pay for them. The standard argument is fallacious, though. The consequent reduction of after-tax wage rates is unlikely to be an enduring disincentive to work, for reduced earnings will bring reduced saving; and once private wealth has fallen to its former ratio to after-tax wages, people will be as motivated to work as before.
An indictment of entitlements has to focus on the huge "social wealth" that the welfare state creates at the stroke of the pen. Yet statistical tests of the effects of welfare spending on employment yield erratic results. In any case, it is hard to see that scaling down entitlements would be transformative for economic performance. (Indeed, some economists see increased wealth, social plus private, as raising the population's willingness to weather market shocks and helping entrepreneurs to finance innovation. I am skeptical.)
In my thesis, the Continental economies' root problem is a dearth of economic dynamism--loosely, the rate of commercially successful innovation. A country's dynamism, being slow to change, is not measured by the growth rate over any short- or medium-length span. The level of dynamism is a matter of how fertile the country is in coming up with innovative ideas having prospects of profitability, how adept it is at identifying and nourishing the ideas with the best prospects, and how prepared it is in evaluating and trying out the new products and methods that are launched onto the market.
There is evidence of such a dearth. Germany, Italy and France appear to possess less dynamism than do the U.S. and the others. Far fewer firms break into the top ranks in the former, and fewer employees are reported to have jobs with extensive freedom in decision-making--which is essential at companies engaged in novel, and thus creative, activity.
Further, I argue that the cause of that dearth of dynamism lies in the sort of "economic model" found in most, if not all, of the Continental countries. A country's economic model determines its economic dynamism. The dynamism that the economic model possesses is in turn a crucial determinant of the country's economic performance: Where there is more entrepreneurial activity--and thus more innovation, as well as all the financial and managerial activity it leads to-- there are more jobs to fill, and those added jobs are relatively engaging and fulfilling. Participation rises accordingly and productivity climbs to a higher path. Thus I see the sort of economic model operating in the Continental countries to be a major cause-- perhaps the largest cause--of their lackluster performance characteristics.
There are two dimensions to a country's economic model. One part consists of its economic institutions. These institutions on the Continent do not look to be good for dynamism. They typically exhibit a Balkanized/segmented financial sector favoring insiders, myriad impediments and penalties placed before outsider entrepreneurs, a consumer sector not venturesome about new products or short of the needed education, union voting (not just advice) in management decisions, and state interventionism. Some studies of mine on what attributes determine which of the advanced economies are the least vibrant--or the least responsive to the stimulus of a technological revolution--pointed to the strength in the less vibrant economies of inhibiting institutions such as employment protection legislation and red tape, and to the weakness of enabling institutions, such as a well-functioning stock market and ample liberal-arts education.