Less productive Europe now overdue for reform

Alberto Alesina and Francesco Giavazzi, Project Syndicate

War and its huge cost; the falling dollar; mounting trade and budget deficits; the chicanery that hollowed out companies like Enron and WorldCom; the bursting of the high-tech bubble: Capitalism American-style is both under strain and under a cloud. From left to right, many European intellectuals think that the capitalist game as played by the U.S. is passe. An active search is on for new models.

Strong on rhetoric and fueled by a wave of anti-Americanism, that search is nonetheless thin on facts. Stories of corporate malfeasance do, of course, abound in the U.S. But it is facile to jump from individual corporate scandals to broad conclusions about the supposed rottenness of the American economy.

A close look at productivity growth (output per hour worked) in the U.S. and Europe shows that U.S. capitalism remains as vital than ever. Having grown at an average annual rate of just 1.6 percent since the early 1970's, annual U.S. productivity growth in the non-farm business sector has accelerated to an average of 2.6 percent in the seven years since 1995, with no sign of a slowdown. In 2002, productivity grew by 4.8 percent -- an extraordinary result, because productivity normally falls during economic slowdowns.

Now look at Europe. Annual productivity growth actually slackened in the second half of the1990's, from 2.5 percent to just 1.3 percent today.

This productivity gap is often attributed to the "New Economy" that emerged in the late 1990's. True, many new technologies were developed and first applied in the U.S. But technology spreads rapidly: The same Windows or SAP programs are available in all countries, including Europe. So there must be other differences. Two candidates stand out: attitudes toward work and corporate governance.

Six OECD countries do better than America in terms of output per hour worked: Norway, Belgium, France, Ireland, the Netherlands, and Germany. But the rankings change if you make output per capita (a better measure of a country's economic well- being) the standard: Here the U.S. comes first, and France and Germany drop, respectively, to 16th and 11th place.

The reason for examining output per person rather than output per hour worked is simple: What determines a nation's wealth is how much each person works, and how many people work. This is where the U.S. overtakes Europe: Fewer people work in Europe than in the U.S., and those in Europe who do work don't work as much. Annual hours worked in the U.S. are about 1800, about 1500 in France, and 1400 in Germany.

One reason why Europeans work less is because they pay more taxes, and high taxes are necessary to support those who do not work -- an obvious vicious circle. But something deeper is at work. Perhaps the Europeans are perfectly happy to work less and enjoy more free time, both in terms of having more vacations during their working age, and spending less time in the active labor force.

This is a legitimate choice, but once made, Europeans should stop looking for scapegoats for slow growth. For the source of the problem is neither the European Central Bank, nor the Stability Pact. Europe grows less because it works less -- and it should not be surprised if a number of so-called "developing countries" soon catch up with Europe in terms of income per capita.

The availability of new technologies is a necessary, but by no means sufficient, condition to raise a country's standard of living, because there must also be companies that are able to make use of them. In the early 20th century, it took over twenty years for the electrical engine to transform the textile industry. New machines were available, but firms were not prepared to use them. To do so required a change in work practices and in the way firms were run. Unions opposed such change, but it also took time for bosses to understand that the way they ran their plants needed to change.

The new economy arrived after a decade of deep transformation within U.S. companies. During the 1980's, a wave of leveraged buyouts transformed U.S. corporate culture, evidently making bosses more receptive to technological innovation. Not so in Europe, where the interests of a company's employees and their unions often come before those of its shareholders. Indeed, at one European newspaper, articles that arrived via e-mail were re- typed by typographers: The technology for transferring them electronically was available, but not the work rules to allow the paper to apply it.

Unions are not the only culprits. Many European firms have complex ownership structures, with large shareholders whose interests often conflict with those of the company -- hardly the best way to take sound business decisions. This is particularly true in finance and banking. Whatever the corporate horror stories in U.S. banks, almost no European investment bank remains, and Germany is seriously considering a state-owned "bad bank" to bail out its all-powerful banking giants.

If Europe wants to work less, it must be extraordinarily productive when it does work if it is to keep up with the hard- working Americans. That is why Europeans should hope that the wave of corporate restructuring and reformation, which many thought would follow inevitably in the wake of the creation of the single market, begins to crest across the Continent and change the way businesses are run.

Alberto Alesina is Professor of economics at Harvard University; Francesco Giavazzi is Professor of economics at Bocconi University, Milan.