Macroeconomic Performance Since 1997: United

Macroeconomic Performance since 1997: United States vs. The European Union

The Transatlantic Economy)

Unemployment

Retirement Age and Associated Pension Costs

Labor Freedom of Movement

Resisting New Labor Entrants

Counter to the Trend: Healthcare Expenditure Differences

In Health Care, Europe also Has a Problem

Education: Europe better in Lower Grades, U.S. better in Colleges and Universities

Forecasting the Future: Europe and the United States

Productivity

Education

Pensions and Government Burden

Taxation

Health Care

This paper discusses the changing nature of macroeconomic performance between Europe and the United States since 1997. Although the U.S. has long exceeded Western Europe in economic and employment growth, recent trends have suggested that, at least in some European countries, unemployment is approaching low U.S. levels. Economic growth is closely related to population growth and productivity. This paper will discuss how productivity advances in both economic areas has affected growth, and how population discrepancies will exacerbate the already significant differences in economic growth between the U.S. And Europe.

Europe's changes in the past 10 years will be discussed as they pertain to the overall growth picture. There has been a great deal of discussion about a "two-speed" Europe, in which some older members of the EU may be experiencing slower growth, while some of the newer members are growing faster. Are these differences in growth due to differences in fiscal, monetary and employment policies, or to other factors, such as relative size of the economy or advantageous terms of trade?

Record of Economic Growth

The United States' real GDP growth from 1995 to 2006 has been 3.4%. This has outpaced the major European nations, in which the following growth has been seen over the past 10 years:

Country

Growth Rate (real GDP % per year)

Germany

France

Italy

United Kingdom

Euro Area

The relatively anemic growth in Germany and Italy lags the European growth rate, which has been dominated by smaller countries with better performance, including Denmark, the Netherlands and Spain.

This lower growth rate than the United States has continued since 1980. At that time, the relative difference in income between major European countries and the U.S. was relatively minor. Since then, the U.S. has pulled ahead of all European countries save several small ones, such as Norway ($64,000 per capita) and Ireland ($48,000). The U.S.' current GDP per capita compares favorably to major European countries:

Country

GDP/Head ($) 2006 (Economist)

Germany

France

Italy

United Kingdom

United States

The figures for Germany are somewhat skewed due to their assumption of Eastern Germany in 1990, which lowered overall per capita income; with the exclusion of this region, total German per capita income is roughly equal to that of France or the United Kingdom.

The comparison of income per head is even more dramatic if one takes into account how much each citizen can purchase for his/her income. This index, called PPP (purchasing power parity) estimates what is the relative purchasing power of the same equivalent currency in each country. PPP is a useful measure for living standards, as it takes into account the relative prices in different countries, including sales or VAT (value-added tax), living costs and other costs, such as gasoline and transportation.

As compared to the United States, the major countries of Europe are significantly more expensive. By adjusting the GDP per head, one arrives at a calculation of the PPP equivalent of the average GDP/person in each of the countries, as illustrated below:

Country

GDP/Head ($) 2006

PPP %*

PPP equivalent GDP/Head

Germany

France

Italy

United Kingdom

United States

Thus, in PPP terms, the U.S. income per capita is 30% higher than the next-highest European country, the UK, and 43% higher than its largest European trading partner, Germany. Put a different way, an employee in a German company needs to work 43% harder, or longer, or a combination of both in order to enjoy the same lifestyle and purchasing power as his or her U.S. counterpart.

Over time, this relative difference has increased. The following graph shows per capita GDP in four major European countries vs. The United States since 1970 (note that the previous figures are lower, due to the low incomes of Italy and Spain in the period):

Differences in income vs. U.S. (U.S.=100) (Alesina)

Causes of Income Differences between Europe and the U.S.

Unemployment

Why is there such a difference in income between the two economic areas? Some of the difference is due to unemployment differences between the two areas. Most major western European nations have dealt with high levels of chronic unemployment for the past 25 years. Although current rates are declining, only the UK has demonstrated a consistent unemployment level below seven percent (Economist). Since 1996, the average unemployment rate in Germany has averaged 9.1%, while France has averaged 10.7% and Italy 10.3%. These figures tend to underestimate the actual level of unemployment, as those who are in job-creation and -training schemes, such as Germany's ABM (Arbeitsbeschaffungsmassnahme) are not counted in official unemployment statistics. Counting those programs, the actual unemployment rate may be closer to 15% for these countries (BLS).

Added to this is the relatively low number of people of working age in the workforce. Unemployment is a measure of how many people are actively looking for a position. Western European countries have a generally low employment level, which may partially be due to the lack of employment opportunity. Schooling is generally longer in Europe, but relatively fewer European students attend or graduate from college as compared to the United States. In Germany, for example, the average college (undergraduate) student leaves the university at age 27. Only 46% of German students attend any portion of tertiary education, as compared to the U.S., where 72% attend tertiary schools; the average U.S. graduate leaves college at age 22, which means that he/she has five additional productive years in the workforce than his/her German colleague.

Many books have been written about the causes for Europe's employment issues, but some elements can be singled out in any discussion of labour disequilibria. These include:

High barriers to dismissing employees, which results in a hesitancy to hire new workers

High social costs, which range from 35 to 42% amongst major Western European countries generous social welfare system which ensures that those without employment have a relatively comfortable standard of living

Lack of mobility on the part of workers, who are unwilling to move from a region of high unemployment to a region (even within the same country) where employment may be more plentiful (Nickell)

Those who are employed in these countries find themselves in an advantageous position: with relatively low chances of losing their position, generous social welfare coverage and pension benefits, those in employment form a powerful lobby for the status quo, even at the expense of supporting a large cohort of non-working fellow citizens.

Rates of Taxation are Higher in Europe second reason for the difference in income are the high rates of taxation in Europe as compared to the U.S. These tax differences can be seen on three levels: value-added tax (VAT) in Europe vs. sales taxes in the U.S., high benefits charges in Europe (between 35 and 42% of average salaries in Europe vs. The United States' 22%, including healthcare costs), and higher income taxes. The result, in economic terms, is that the average European worker receives less of his Euro than the U.S. worker his dollar for every incremental addition of hours and/or productivity.

Microeconomic theory indicates that as income per unit of production increases, individuals will work harder, but each incremental unit of income is worth less than the previous increment. Put another way, the value of leisure time increases. Taxes have the effect of depressing incremental income relative to those who have a lower incremental tax rate. That is, if one takes away a greater increment, one will work fewer additional hours. The relative hours worked between Europe and America has diverged since 1970. Per capita hours worked dropped in most OECD countries, and by over 20% in France. U.S. hours worked, however, increased by 20% from 1970 to 2002. The average hours worked per week has remained steady in the U.S. since 1980, while it has fallen in Europe during that period.

Edward Prescott attributes part of this difference in hours worked to higher tax rates:

In the early 1970s, Americans allocated less time to the market than did the French. In comparisons between Americans and Germans, the story is the same. Why are there such large differences in labor supply across these countries? Why did the relative labor supplies change so much over time? (King)

Prescott fails to mention that the top incremental tax rate in 1970 in the United States was still a high 70%. This fell to 35% in 1982 under Ronald Reagan, and has remained under 40% since then. This compares to French and German rates of greater than 50%. Also, unlike the United States, the highest tax bracket starts at a relatively low rate in most European countries.

Another way to look at the difference in hours worked is that Europeans place a higher value on their leisure time. Americans receive two to three weeks of paid vacation per year, while Europeans receive between 5 and 7 weeks. In addition, the U.S. has generally 8 paid holidays per year; the comparable figure for Europe is 12 to 18 days (holidays such as Easter and Christmas, plus national days and even the Queen's Birthday in the Netherlands). As a result, Americans average only 10.2 vacation days per year (Zuckerman). Americans work on average nearly 2,000 hours a year, while Germans work about 1,500 hours. This significant difference in hours worked may help to account for a significant portion of the 43% difference in per capita GDP for the two countries.

Retirement Age and Associated Pension Costs third reason are the retirement ages and associated pension costs. Europeans retire at an earlier age than Americans: generally between 57 and 62, while Americans tend to retire between 62 and 65. This difference in retirement age places a double burden on Europeans relative to Americans: with fewer years worked and more in the retirement class, each working European must support more retired workers than their American counterparts. This problem is exacerbated by the fact that Europeans are growing older faster than Americans. The birthrates in Germany, France and Italy are amongst the lowest in the world; with low death rates, the result is an aging population. The figures compare as follows:

Country

Fertility Rate

Germany

France

Italy

United Kingdom

United States

This age pattern will be exacerbated by population trends related to the above differences in primary birth rates between the two areas. The following comparative graph demonstrates that the U.S. is more youthful than Europe, and that this difference will widen, despite the expected continuing aging of the U.S. population:

Nations)

This looming problem of the demographic 'bulge' forces countries of Western Europe to look for alternatives to their current pension and retirement plans. While it is clear in the U.S. that social security and retirement plans must also be addressed, the problem is more urgent in Europe. It is estimated that in Germany, for example, by 2025, each working adult will need to support two retirees on their "pay as you go" system.

Another way to combine income and aging is in the following analysis, which demonstrates that Europe is growing older while income is flattening -- a combination which will make it hard for Europe to maintain, much less advance, its standard of living:

Percentage of the Population aged 65+ versus GDP per Capita (Eberstadt)

Labor Freedom of Movement

There is a significant cultural difference between Europeans and Americans in their willingness to move in order to find better employment. In short, Americans are willing to move, and move much more often than Europeans. Part of the U.S.' advantage is cultural: all Americans speak the same primary language, and a move from, say, the East Coast to the West Coast is much less of a culture shock than moving from Berlin to Madrid.

Another key difference is cultural: Europeans tend to be wedded to a particular region in their country. Generous social welfare programs for 'disadvantaged' areas, such as Wallonia in Belgium or Northern France, tend to provide incentives to underemployed people to remain. This lack of will to move was put in particularly stark contrast in recent years by the reunion of Western with Eastern Germany. Although 2,000,000 East Germans moved to West Germany, 15,000,000 stayed behind, despite considerably higher unemployment and lower levels of income.

European countries are not only split by nationality, but also by regional identity. Spain is a combination of Basques, Catalans and Castilians. France is a combination of Bretons, Alsatians, Normans, Basques, Corsicans and many other regional variations, each of which is more varied than their counterparts in the United States. The Catalans, Basques, Corsicans and Bretons each have their own history, culture, and a distinctively different language (not just a regional dialet) which differentiate them from their putative fellow-citizens.

If anything, the political union of the EU has made these regional differences more stark. An Alsatian's dialect, for example, is closer to Baseler Switzerdeutsch or Luxemburgisch than it is to German or French. A French Basque speaks the same language as a Spanish Basque, even though they belong to linguistically-different countries.

While the dismantling of inner-European borders came with the Schengen accords of 1992, the cultural and linguistic differences make it more difficult for a European to consider a job in another region.

Resisting New Labor Entrants

Despite the above trends, which demonstrate a decrease in the number of workers in Western Europe, politicians are loathe to allow new members of the EU to send their citizens into their job markets. Germany, for example, has 3.8 million unemployed (2006). Franz Muenterfering, the head of the Socialist Democratic partner of the current coalition government, opposes any easing of Germany's tough immigration policies, even for new entrants to the EU, such as Poland, Bulgaria and Hungary. He and others in his party are calling for "foreigner quotas," which should limit immigration (Expatica). In France, where over 23% of youths under 25 are unemployed, immigrants are particularly frowned-upon. The current level of strikes and violence is primarily targeted against immigrants who, in the minds of many French citizens, take jobs away from natives. Jean-Marie le Pen's support of 15-20% of the voters is due primarily to this wish to prevent immigrants from entering France.

The low birth rate in Germany is leading to the need to increase immigration simply to replace the number of workers it is losing to retirement. It is estimated that Germany needs 300,000 new workers per year in order to maintain a constant workforce. While this is lower than the comparable figure for Japan, at 800,000 per year, the concern is that Germany's politicians will not allow such an inflammatory number of immigrants while unemployment remains so high.

Eastern Europe: France and Germany's NAFTA and Mexico

The European Union has grown in recent years from 15 to 27 members. Nearly all these members have come from Eastern Europe. Many of these nations have average wage and income levels that are significantly below those of Western Europe. The comparison with NAFTA (1992) and Europe (2000) is interesting. The average Mexican per capita income today is $7,180, as compared to $41,000 for the United States. The average Pole today earns $7,880, versus the average German, who earns $33,800. The ratio of income is as follows:

Relative GDP per Person

US - Mexico $7,180/$41,640 15%

Germany-Poland $7,880/$33,800 23%

Population Comparison

US -- Mexico 297M/103M 35%

Germany -- Poland 82M/40M 40%

The U.S. And Mexico have formed a close relationship, with Maquiladoras and joint ventures enriching citizens on both sides of the border. Although there are strict immigration laws between the U.S. And Mexico, the border is nevertheless porous: it is estimated that there are 12 million illegal aliens in the United States, many of them from Mexico.

With this American perspective, one could take a look at Germany and Poland and pose the question: since Germany is short of qualified employees and Poland has a ready supply of workers who would benefit from the higher incomes that they could earn in Germany. As with the U.S. And Mexico, Germany and Poland would also benefit from a European version of the Maquiladora. The rules of the European Union, negotiated at the time of Poland's accession to the Union, preclude many of these free-trade benefits. German and French farmers, concerned about the lower-cost factors of production, pushed to keep out Polish imports of everything from agricultural products to labor-intensive auto parts. Despite the fact that both countries are in the same European Union, tariffs, non-tariff barriers and restrictions on immigration prevent the two countries from coming closer together for mutual economic benefit (Nulle).

This problem has grown worse as poorer and poorer countries have been added to the mix. At the beginning of 2007, Bulgaria and Rumania joined the European Union. While the EU was willing to send considerable "solidarity payments" to those two countries to help them increase their industrial, cultural and legal standing, they proved less willing to allow free movement of goods and workers from those countries to other parts of Europe.

Differences in Budgeting and Monetary Policy

Prior to the introduction of the Euro in 2001, each country could, in theory, change its monetary policy to be able to respond to specific needs in their economy. Those countries which were growing fairly quickly, like Spain, Portugal and Ireland, for example, could run higher deficits and a fairly 'loose' monetary policy, recognizing the need to attract foreign capital (and due to the higher return on capital provided in a faster-growing economy). Those countries which grew more slowly, and/or were concerned about inflation, could run a tighter monetary policy. Germany, for example, was famous for the fiscal austerity of the Bundesbank, perhaps due to the memories of hyperinflation during the Weimar Republic in the early 1920's.

In the run-up to the monetary union, each of the potential participants agreed to maintain their money (M1) growth in a narrow band, and to adhere to a fixed exchange rate. This monetary 'lock-step' was in place for three years, and served as a guarantee to those countries most concerned about the dilatory effects of monetary looseness that Italy, Belgium and other 'profligate' (i.e. high national debt as compared to GDP -- in both cases over 100%) would be able to observe these targets.

The effect of combining currencies has led to benefits; in particular, the European participants have reduced non-tariff barriers to trade and the 'frictional' losses of money exchange between themselves. This has also removed an element of risk -- currency changes -- among major trading partners.

But there has also been a downside. Those countries with lower growth rates, such as Germany and Italy, have dominated the monetary policy of the Euro Zone countries. As a result, their slow money growth policy has kept interest rates relatively high, and squelched growth. For those countries which desire a faster growth rate, this tight money policy has been even more restrictive. It has resulted in double disadvantages: higher interest rates and therefore less availability of capital, and high exchange rates relative to other currencies of major trading partners, which depresses exports and encourages imports.

Economists credit Milton Friedman and the Chicago School for suggesting the steady monetary policy of the Fed since 1980 in calming inflation and helping to fuel a tremendous increase in economic growth in the United States. Friedman and others argued that Europe's artificially-restrictive monetary policy helped neither the large, slower-growing countries, nor the smaller, faster-growing ones.

Part of the reason that monetary policy was not as well-used in Europe as in the United States may pertain to the Europeans' support of demand-side government 'pump priming' in order to grow the economy. The neo-Keynesians argued that all demand is roughly equivalent, and if consumer or industrial growth is not sufficient, government spending can fill in the gaps. Although even Keynes admitted that such a policy was unsustainable over the long-term, it has been preferable for European politicians to 'square the circle' by supporting government spending in order to 'create jobs' and 'stimulate growth.'

Counter to the Trend: Healthcare Expenditure Differences

In one key area, the Europeans are in better condition than in the United States: Healthcare expenditures. There are a number of reasons for the U.S. having higher costs, but the differences are dramatic. The U.S. spends 15.4% of its GDP on healthcare, as compared to around 10% for France and Germany, the second- and third-highest countries in the world in terms of percent of GDP spent on healthcare. Given the PPP and GDP/head differences, as seen in the above figures, the difference in spending per person in the United States is nearly double of that in Europe.

Americans are proud of calling our healthcare system "the best in the world," but the ultimate statistics -- average life span -- do not support that claim. The average life span in the U.S. is 75.6 years for men and 80. 8 years for women. Comparable figures for women in Europe include France at 84.1 years, Germany at 82.1 years, and the UK at 81.6 years. Thus the average number of years of life delivered for each dollar spent demonstrates that the U.S. has a significant cost disadvantage vs. key European countries.

Another way to regard the drag imposed by healthcare expenditures is that each American pays an additional "tax" of 5% of his or her income for healthcare. This goes some of the way to ameliorate Europeans' cost disadvantages as compared to Americans.

Europeans can point to several elements which make their healthcare systems more efficient. Regardless of the system, be it single-payer in the UK or hybrid public-private in Germany, each country has a form of universal health care which reduces overall "risk aversion" in the healthcare system. Unlike the U.S., there is not a substantial sub-cohort of individuals who must be supported by the rest when admitted to the hospital.

Europeans place a higher degree of government control on expenditure, as compared to the United States. English and French pharmaceuticals are significantly less expensive than in the U.S. German pharmaceutical expenditures, still the highest in Europe per capita, are also lower than the U.S. Governments use their negotiating power and purchasing responsibility to negotiate lower prices. The quality of healthcare delivered, as measured by citizen satisfaction, differs significantly from country to country. Of the major countries, France is the most interventionalist in promoting preventative care, but all major European countries engage in more preventative healthcare than the U.S., with the exception of U.S. capitated systems (such as Kaiser, the Mayo Clinic and the Cleveland Clinic health plans).

In Health Care, Europe also Has a Problem

Health care expenditures increase with age. As Europe's average age is higher than the U.S., and the gap is growing wider, even a more efficient healthcare system will start to close the gap. That means that Europe's relative cost advantage vis-a-vis the United States will diminish over the next decades.

It is not certain that the United States will undertake a policy to improve healthcare efficiency. If one looks at the current Democratic and Republican presidential candidates, only John McCain is focusing on the cost of healthcare. Other Republicans and their fellow Democrats are focusing much more on benefits and exceptions (Economist). As with Social Security, perhaps the healthcare entitlements already appreciated by many Americans will continue to be a difficult political problem to solve.

Education: Europe better in Lower Grades, U.S. better in Colleges and Universities

The conventional wisdom is that Europeans do a much better job than Americans in educating their primary and secondary school students, while the U.S. does a better job with college and continuing adult education. While that is still true, for the most part, the gap is narrowing in primary and secondary education. The No Child Left Behind Act is forcing elementary and high schools to improve their performance; while there has been modest progress, the major effects of testing and ending 'age promotion' have not been fully felt.

On the other hand, the PISA school results in Europe, comparing 22 different countries, has shocked major European countries at the problems that they are encountering in early and middle education. Germany and France found that their children badly trailed those in Hungary, Finland and Estonia, other EU members. Germany and France, once known for their vaunted apprenticeship and vocational programs, is also losing on those fronts.