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European Commission says no growth until 2014
Economic Growth in the European Union
Economic growth has been sluggish in many EU countries. Up to the 1990s, levels of GDP per capita in Western European countries were catching up with that of the US, but these tendencies were dramatically reversed in the 1990s.
In particular, France, Germany and Italy started to fall further behind the US. The European growth problems have led to major political discussions within the EU. The 2000 Lisbon strategy for growth and employment is an expression of political concerns about low growth.
We analyses the reasons behind the varying growth performance of Western EU countries. The first observation is that slow growth is not a universal phenomenon among the old EU countries. Some countries – notably Ireland, Finland, Greece, UK, Spain and Sweden – have performed well over the last decade. Furthermore, one is beginning to see “growth miracles” in several new EU member countries. Second, a process of convergence in per capita incomes in the EU is taking place.
This process is largely driven by the convergence between the EU-15 and the new member countries, that is, living standards in the new EU countries appear to be catching up with the old EU members in a long-term perspective.
Determinants of economic growth are analyzed by decomposing GDP growth into the contributions from growth of labour input, IT capital input, non-IT capital input and technological progress (total factor productivity).
Growth accounting reveals that the unsuccessful countries, France, Germany and Italy, have been growing mostly through traditional capital accumulation and to a much smaller extent through general technological progress. Labour input often played a substantial negative role, particularly in Germany.
In contrast, there have been different roads to prosperity in the successful countries. In one group, consisting of Ireland, Finland, the UK and Sweden, there has been a large increase in the contribution by IT capital growth, though all production factors have made a positive contribution in these countries, including labour input for most episodes. In addition, relatively rapid IT capital growth has been coupled with relatively high total factor productivity growth in these countries.
The best performer, Ireland, has had rapid growth in all factor inputs. Spain and Greece make up a second group of success cases, which have primarily grown through conventional capital accumulation and labour input growth.
There are large variations among countries in the determinants of growth in capital and labour inputs and in factors that influence technological progress. Finland, the UK and Sweden had higher shares of IT capital, relative to other capital, earlier, so the recent fast accumulation of IT capital has for this reason resulted in larger contributions to growth.
These countries are also at the top in terms of indicators of IT diffusion. Determinants of technological progress are likely to have been quite diverse, as technological progress is influenced by a number of factors such as education and innovativeness of the economy. Finland and Sweden had the highest levels of education spending (relative to GDP) among EU countries, but there appear to be no systematic relationships between this factor and growth for EU countries.
The amount of regulation is one determinant of the degree of competition among firms, which in turn influences innovativeness. In many, though not all, cases the successful countries have done well in terms of indicators of deregulation, venture financing, and R&D spending.
The analysis put forward in this chapter leads to several policy conclusions. First, the EEAG recommends that the Lisbon strategy should be modified.
The Lisbon strategy argues for the creation of a uniform model of a high-tech information society for the EU, whereas the European experiences suggest that there are different routes to success. Instead, the EU should allow for a flexible strategy for growth, in which there is scope for high-tech driven growth as well as growth based on more traditional means of capital accumulation, increased labour input and imitative adoption of new technologies from the leaders.One key element in growth policy is improvement of the educational systems.
This should be done at both the national and EU levels. Education influences growth through the accumulation of human capital, and there are also important complementarities between education and the ease of adoption of innovations and new technologies. An important question concerns the level of education at which improvements should be focused.Countries that are close to the frontier should specifically focus on improving the tertiary education system, as high-technology innovations require more advanced skills than lower-level innovations. The latter are often process improvements and rely on imitative adoption of known technologies.While the US does not stand out in the quality of secondary education, it is well ahead of EU countries in university education, which is likely to matter the most for economic growth of the most advanced countries.
The best universities in the US compete strongly with each other for the best graduate students and researchers. In European countries, the university system is largely not exposed to strong competition, though the UK with its national research and teaching quality audits is partly an exception.
A third policy conclusion concerns the potential to increase labour input to enhance economic growth. In most EU countries, labour input has not grown much, and in some countries labour input growth was even negative for some periods. Labour input can be raised through labour market reforms such as reduced unemployment benefits, increased employment tax credits, and lower marginal tax rates on labour and pensions to provide incentives to a longer working life.
Decentralized collective agreements that allow lengthening working hours (as in Germany) and reversals of earlier legislated working time reductions (for example in France) are other desirable measures.
Another policy conclusion concerns the regulatory policies in the EU. Europe tends to have a relatively high level of regulations that limit competition by restricting entrepreneurial activities, entry and labour market adaptability, which in turn can suppress innovation and technological advancements.
Growth effects of competition appear to depend on the distance of the industry from the technology frontier, so that increased competition yields the largest productivity gains in sectors that are far behind the frontier. Technology policy should focus on provision of opportunities for creation of new firms and industries and less on glorifying national champions.
Improvements of venture capital financing and R&D continue to be important policy areas for the EU countries. There are big variations in the amount of venture capital investments in the EU, and Europe is lagging behind the US in this respect. Also, competition policies should focus more on facilitating entry of new firms to improve innovativeness of European economies.
Reduction of trade barriers to competition and entry in the service sector is important, as exporters of services tend to be subjected to national regulations in both the country of origin and in the host country. Since the service sector makes up around 70 percent of both GDP and employment in the EU-15, lower trade barriers for services have potentially large growth effects. For this reason, the EU Services Directive it was important agreed on in December 2006 not watered down.3 A related issue is that the imposition of national pay conditions on posted workers from other EU member states prevents effective cross-border price competition.
This limits the gains from trade in services to economies of scale, more effective organization and greater product diversity. It also means that the old EU member states forsake the welfare gains that could come from allowing service providers from the new member states to compete effectively by compensating for lower productivity through lower wages. Such competition is a natural exploitation of different comparative advantages. It is not “unfair wage dumping”. Wage competition among countries in trade with services should be allowed in the same way as in trade with goods.
Growth-enhancing policies for new EU member countries include facilitating technology transfer and improvement of productivity in industries that are mostly behind the high-technology frontier. Education policy and financing of new firms and innovations continue to be major items in the policy agenda of the new EU members.
