Mirror mirror on the wall Europe v America Special Report June 19 2004 America is widely admired as the beauty queen of the economic world But the euro area s figures are more shapely than its reputation suggests economic statistics for the 11 countries that make up the other two thirds look surprisingly like America s see chart 1 Were Britain part of the euro area this effect would be even more striking As America s economy has bounced back the economies of the euro area still seem to be crawling along This perception has reinforced pervasive gloom about continental Europe s economic future A great deal has been written about America s superior performance relative to the euro area But wait a minute the widely held belief that the euro area economies have persistently lagged America s is simply not supported by the facts America s GDP surged by 5 in the year to the first quarter while the euro area grew by only 1 3 Europe s GDP growth has consistently fallen behind America s over the past decade in the ten years to 2003 America s annual growth averaged 3 3 compared with 2 1 in the euro area Yet GDP figures exaggerate America s relative performance because its population is growing much faster GDP per person the single best measure of economic performance grew at an average annual rate of 2 1 in America against 1 8 in the euro area a far more modest gap Furthermore all of that underperformance can be explained by a single country Germany whose economy has struggled since German reunification in 1990 Strip out Germany and the euro area s annual growth in GDP per person rises to 2 1 exactly the same as America s Germany does represent around one third of euro area GDP but still the fact is that The most popular myth is that America s labourproductivity growth has outstripped that in the euro area by a wide margin America s productivity has indeed quickened in recent years but the difference between productivity growth in America and the euro area is exaggerated by misleading incomparable figures In America the most commonly used measure of productivity is output per hour in the non farm business sector This grew by an annual average of 2 6 over the ten years to 2003 For the euro area the European Central Bank publishes figures for GDP per worker for the whole economy This shows a growth rate for the period of only 1 5 But unlike the American numbers this figure includes the public sector where productivity growth is always slower and it does not adjust for the decline in average hours worked Using instead GDP per hour worked across the whole economy American productivity has risen by an annual average of 2 0 since 1994 a bit faster than the euro area s 1 7 growth rate However a study by Kevin Daly an economist at Goldman Sachs finds that after adjusting for differences in their economic cycles trend productivity growth in the euro area has been slightly faster than that in America over the past ten years 1 Since 1996 productivity growth in the euro area has been slower than America s But it seems fairer to take a full ten years But has not America combined rapid productivity growth with strong jobs growth whereas continental Europe s productivity growth has been at the expense of jobs This may have been true once but no longer is Over the past decade total employment has expanded by 1 3 a year in America against 1 in the euro area Again excluding Germany jobs in the rest of the euro area grew at exactly the same pace as in America And since 1997 more jobs have been created in the euro area as a whole total employment has risen by 8 compared with 6 in America It is true that during the past decade productivity growth has accelerated in America but slowed in the euro area Alan Greenspan chairman of America s Federal Reserve blames Europe s rigid labour and product markets Structural barriers to laying off workers or to new methods of work may have prevented firms from making the best use of IT equipment However there is another less worrying reason why productivity growth has slowed in continental Europe Reforms to make labour markets more flexible have deliberately made GDP growth more jobintensive Firms now have more incentive to hire new workers thanks to lower labour taxes for lowpaid workers and a loosening of rules on hiring part time and temporary workers which allow firms to get around strict job protection laws The flipside is slower productivity growth for a period as more unskilled and inexperienced workers enter the workforce This is exactly what happened in America in the 1980s In the longer term more flexible labour markets should help to boost growth Another popular misconception is that the return on capital is much lower in the euro area than in America because European business is inefficient and hobbled by high wage costs and red tape This argument is often given in defence of America s large current account deficit America s higher return on capital it is argued attracts a net inflow of foreign money so it has to run a current account deficit But according to calculations by Goldman Sachs the return on capital in the euro area has actually been roughly the same as in America in recent years The total return on equities over the past decade has also been broadly the same which is what you would expect given their similar pace of productivity growth Nonsense in nonsense out So far we have established that based on official statistics productivity growth over the past decade has been virtually the same in the euro area as in America and although GDP per person has grown a bit slower the gap is modest However using official statistics can be like comparing apples with pears because of differences in the way that GDP is measured in different countries For example American statisticians count firms spending on computer software as investment so it contributes to GDP In Europe it is generally counted as a current expense and so is excluded from final output As a result the surge in software spending has inflated America s growth relative to Europe s A second important difference is the price deflator used to convert growth in nominal spending on information technology equipment into real terms In America if a computer costs the same as two years ago but is twice as powerful then this is counted as a 50 fall in price Though logical this is nevertheless a contentious issue among economists Most euro area countries do not allow fully for improvements in computer quality
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