Macroeconomic performance of the United States and European Union since 1997

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.

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.

On the tertiary front, the U.S. is way ahead of major European countries (except the UK). The U.S. spends 5.9% of its GDP on education, as compared to 4.1% for the Euro area. Germany is a bit higher than the Euro average, at 4.7%, and France matches the U.S. The spending must be more effective in primary and secondary schools, however, as Germany and France only send about 50% of their students to tertiary education of any kind, as compared to the United States, which sends 72% to tertiary schools. This does not argue that the U.S. is problem-free in its education. The U.S. has other measuring sticks than Europe, concentrating on the academic excellence of East Asia and the more real threats of outsourcing than in protected Europe. As with goods, when people are protected from competition with others, they become lax and do not apply themselves.

A simple comparison of GDP spent on education may not tell the whole story. The U.S. has a much larger contingent of adult learners at all levels. Education is therefore not a discrete event, but a life-long task as the job force needs to adapt to new skills.

Forecasting the Future: Europe and the United States

If one were to forecast the relative positions of Europeans and Americans in 1980, one would have been hard-pressed to predict the relative spurt of America vs. The Old Continent. Part of the reason for these difficulties in prediction were the then-dire state of the U.S. economy. Hit by earlier attempts at price controls and two oil shocks in the 1970's, the U.S. In 1980 had a 12% prime rate and 22% mortgages. Unemployment hovered between 7 and 8%, high for America, and growth was at or near zero. Americans were concerned about their relative decline in living standards compared to other countries.

In addition, America during the Carter years experienced a leadership malaise which extended to monetary and economic policy. Despite the objections of many economists, Richard Nixon imposed price controls after the first oil shock, which resulted in an acceleration of inflation which continued for the next 8 years. U.S. fiscal policy in the 1970's resembled that of Europe today: high marginal tax rates, low growth in productivity, high deficits, and relatively high unemployment rates.

On the other hand, Europe was doing quite well. Based on a steadily appreciating market basket of currencies and low inflation relative to the U.S., Europe could count on growing income per capita. Europe also benefited from a population bulge which, while creating higher unemployment, also resulted in increasing talent in the workforce.

Fast-forward 27 years, and the situation is reversed. The U.S. has created 30 million jobs in the interim, not only forcing unemployment below 5%, but increasing employment to amongst the highest in the OECD. Real per capita income has raced ahead of our European counterparts (as demonstrated above), while inflation has been held in check due to increasing productivity and free trade.

The key question for future predictions is: what will happen to the relative costs of production between the two regions? In summarizing the above findings, one can make some predictions about what will unfold in the future. Following is a prediction by sector of the changes that might happen:

Population

The U.S. will continue its growth rate of about 2% per year, whereas the major developed countries of Western Europe will remain constant. This means that, due to population growth, the U.S. economy will grow 2% faster per annum than Europe (note that this does not affect per capita income, and assumes that continued increases in productivity and demand will absorb new U.S. employees). Part of the reason for growth in the U.S. is due to a higher birth rate, which may continue, but a part is also due to higher immigration, despite attempts by the governments to reduce immigration.

Productivity

The U.S. continues to outpace Europe in productivity growth. Part of this may be the rate of investment in PPE (plant, property and equipment), and part due to the more-rapid adoption of productivity-enhancing developments. Since the U.S. is more open to Schumpeter's notion of the 'creative destruction' of entrepreneurship, one can expect that U.S. voters and the economy will be more willing to tolerate the disruptive forces of innovation and accept the positive consequences. Europe, on the other hand, can be expected to coddle sunset industries, at least relative to the U.S.

Education

The European advantage vs. The U.S. is eroding, as its primary and secondary schools are not performing as well as they did; therefore, relative to the U.S., European schools will continue to decline. The U.S. advantage in tertiary and on-going adult education is expected to continue.

Pensions and Government Burden

Both the U.S. And Europe face a problem of pension support and an increasing number of retirees. Europe's 'population bulge' in those over 65 will nevertheless mean that Europe will have a greater drag on growth than in the U.S.

Taxation

Related to the above, entitlements will continue to take a larger share of government expenditures in both regions. The take will continue to be higher in Europe.

Health Care

Both regions will continue to experience increases in the percent of GDP devoted to health care. Due to the more-rapidly aging population of Europe, the relative advantage held over the U.S. will diminish.

Summary

Income does not equal happiness. Many Europeans would argue that their more relaxed lifestyle and greater free time give them the ideal balance between work and leisure. The task of the economist is not to place a value on this judgment, but to evaluate the outcomes. If Europeans are happy on considerably less income per head than the U.S., they will continue to have a high happiness quotient.