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«WHY WAS EUROPE LEFT AT THE STATION WHEN AMERICA’S PRODUCTIVITY LOCOMOTIVE DEPARTED? Robert J. Gordon Working Paper 10661 ...»

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NBER WORKING PAPER SERIES

WHY WAS EUROPE LEFT AT THE STATION WHEN AMERICA’S

PRODUCTIVITY LOCOMOTIVE DEPARTED?

Robert J. Gordon

Working Paper 10661

http://www.nber.org/papers/w10661

NATIONAL BUREAU OF ECONOMIC RESEARCH

1050 Massachusetts Avenue

Cambridge, MA 02138 August 2004 This research has been supported in part by the National Science Foundation. I am grateful to Bart van Ark and Robert McGuckin for the data underlying Tables 2 and 3, and to them, and Martin N. Baily, Jean-Paul Fitoussi, and Edmund S. Phelps for many discussions of the central ideas. The views expressed herein are those of the author(s) and not necessarily those of the National Bureau of Economic Research.

©2004 by Robert J. Gordon. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source.

Why was Europe Left at the Station When America’s Productivity Locomotive Departed?

Robert J. Gordon NBER Working Paper No. 10661 August 2004 JEL No. N0, N10, O30

ABSTRACT

After fifty years of catching up to the United States level of productivity, since 1995 Europe has been falling behind. The growth rate in output per hour over 1995-2003 in Europe was just half that in the United States, and this annual growth shortfall caused the level of European productivity to fall back from 94 percent of the United States level to 85 percent. Fully one-fifth of the European catch-up (from 44 to 94 percent) over the previous half-century has been lost over the period since 1995.

Disaggregated studies of industrial sectors suggest that the main difference between Europe and the United States is in ICT-using industries like wholesale and retail trade and in securities trading. The contrast in retailing calls attention to regulatory barriers and land-use regulations in Europe that inhibit the development of the big box retailing formats that have created many of the productivity gains in the United States. For many decades, the United States and Europe have gone in opposite directions in the public policies relevant for metropolitan growth. The United States has promoted highly dispersed lowdensity metropolitan areas through its policies of building intra-urban highways, starving public transit, providing tax subsidies to home ownership, and allowing local governments to maintain low density by maintaining minimum residential lot sizes. Europeans have chosen different policies that encourage highdensity residential living and retail precincts in the central city while inhibiting the exploitation of greenfield suburban and exurban sites suitable for modern big box retail developments.

The middle part of the paper draws on recent writing by Phelps: economic dynamism is promoted by policies that promote competition and flexible equity finance and is retarded by corporatist institutions designed to protect incumbent producers and inhibit new entry. European cultural attributes inhibit the development of ambition and independence by teenagers and young adults, in contrast to their encouragement in the United States. While competition, corporatism, and culture may help to explain the differing transatlantic evolution of productivity growth, they reveal institutional flaws in both continents that are inbred and likely to persist.

The final section of the paper identifies the roots of the favorable environment for innovation in the United States compared to Europe. Elements include an openly competitive system of private and public universities, government subsidies to universities through peer-reviewed research grants rather than unconditional subsidies for free undergraduate tuition, the world dominance of United States business schools and management consulting firms, strong United States patent protection, a flexible financial infrastructure making available venture capital finance to promising innovations, the benefits of a common language and free internal migration, and a welcoming environment for highly-skilled immigrants.

Robert J. Gordon Department of Economics Northwestern University Evanston, IL 60208-2600 and NBER I. Introduction After a half century following World War II of catching up to the level of U. S.

productivity, since 1995 Europe has experienced a productivity growth slowdown while the United States has experienced a marked acceleration. As a result, just in the past eight years, Europe has already lost about one-fifth of its previous 1950-95 gain in output per hour relative to the United States. Starting from 71 percent of the U. S. level of productivity in 1870, Europe fell back to 44 percent in 1950, caught up to 94 percent in 1995, and has now fallen back to 85 percent. What were the causes of this stunning setback?

This paper argues that the discussion of policy reform in Europe has been too narrowly focussed on the deregulation of product and labor markets. A broader set of social choices matters for productivity, and some of these differences between the U. S. and Europe may be irreversible. Much of the surprising acceleration of U. S. productivity growth since 1995 originates in the trade sector, particularly retail trade, and goes far beyond the use of information and communication technology (ICT). The retail sector in the U. S. has been revolutionized by the ʺbig boxʺ format epitomized by Wal-Mart, and perhaps the most important factor of production in making this format possible is a large plot of virgin land which is much more widely available in the sprawling American metropolitan areas than in tightly regulated European environment of land-use planning and protection of old central city retail zones. The American explosion of productivity growth in retailing calls attention to basic life-style choices that constitute yet another form of ʺAmerican Exceptionalism.ʺ While the American form of metropolitan organization may promote productivity growth, Europeans are rightly skeptical of unmeasured costs of low urban density in America as promoted by explicit government policies. Europeans decry side-effects of the American system that may promote productivity without creating consumer welfare, including excess energy use, pollution, and time spent in traffic

–  –  –





A second set of major differences originates in what could be called ʺEuropean exceptionalism.ʺ As Phelps has argued, European growth is still retarded by corporatist institutions which are designed to protect incumbent producers and inhibit new entry.

European cultural attitudes inhibit the development of ambition and independence of teenagers and young adults, who are cradled in subsides such as free tuition for higher education while American teenagers are expected to get out into the marketplace, work, and contribute real money to their own college education. The differing behavior of productivity growth since 1995 helps to call attention to differences between Europe and the U. S. which have long been present but seemed unimportant during the five decades prior to 1995 when Europe was rapidly catching up to the American level of productivity.

A third issue raised by the U. S. post-1995 productivity revival has been an explosion of innovation in the production and use of ICT. The past decade has witnessed a growing concentration of innovative activity in the United States, not only in computer hardware and software, but also in pharmaceuticals and biotech research. The sources of this innovative advantage call attention to European shortcomings that cannot be easily cured by deregulation. These include the continuing U. S. advantage of a unified market unincumbered by differences in customs, language, or electric plugs; the competitive U.

S. system of private and public universities; the system of peer review that guides U. S.

government support of research; well-enforced patent protection; a dynamic capital market able to fund promising start-ups; and the welcome extended by the United States to foreign graduate students in all fields and especially to highly skilled immigrant engineers.

It is important at the outset not only to set out the topic issues discussed in this paper, but also those that are outside its purview. We have nothing to say here about the well-trodden issues in the functioning of the European labor market, deregulation of labor

–  –  –

e.g. shop-closing hours. Also, while this paper highlights life-style and cultural differences, it does not attempt a comprehensive comparison of standards of living, and its several dimensions of praise for the American system should not be interpreted as an endorsement for well-known failures such as the lack of universal government-financed health care in the United States.1 The paper begins with basic data on productivity growth in Europe and the United States over selected intervals since 1870 and displays the relative level of European productivity, falling behind until 1950, catching up until 1995, and then falling behind since then. Data on differences at the sectoral level are then displayed, highlighting the role in the U. S. revival of ICT-using industries, especially retailing. The paper then continues with a comparison of the retailing environment in the U. S. vs. Europe, followed by attention to broader cultural issues. It concludes with a multi-part comparison of the stimuli and barriers to technical change and innovation on the two sides of the Atlantic.

II. Data on Trans-Atlantic Productivity Differences: Growth Rates and Levels The long history of productivity growth and levels is displayed in Table 1. The data from 1870 to 1990 come from Maddison (2001) and refer to the total economy, that is, real GDP per hour. These data are updated for 1990-2003 with OECD data on the private economy. While productivity growth in the private economy is usually slightly faster than in the total economy, this is true both in the U. S. and in Europe, and so the break in coverage at 1990 should not affect our main point of concern, that is, transatlantic

–  –  –

differences in growth rates and their implications for relative levels.2 The left section of Table 1 shows average annual percentage growth rates of productivity in the U. S., Europe and the U. S. - Europe difference, for selected intervals since 1870. The familiar story is that Europe fell behind from 1870 to 1950, then caught up after 1950. Less familiar is the extent to which Europe has fallen behind again after 1995.

As shown in the right section of Table 1, Europe had almost closed the gap in productivity levels by 1995, but its slow growth since then has caused its relative productivity level to slip back from 94 to 85 percent, eroding 9 points of its 50 point catch-up between 1950 and 1995.

A closer look at the divergence is provided by Table 2, which contrasts the 1990-95 period with 1995-2003 and provides a uniform treatment of the total economy based on a new Conference Board pamphlet by McGuckin-van Ark (2004). The initial European slowdown evident in data for 1995-2000 worsened with data for 2000-2003, whereas the U.

S. sustained its productivity growth revival. We should note that the 1995-2003 difference between U. S. and European productivity growth is less than in Table 1, and so the extent of European retrogression depends on whether we use the post-1990 data on the private economy, as in Table 1, or on the total economy, as in Table 2. Given the well-known difficulties in measuring productivity in the government and non-profit sector, we prefer to emphasize the greater difference shown in Table 1.3

2. The Maddison data refer to 12 countries weighted by relative GDP; these are the 15 members of the EU minus Greece, Portugal, and Spain. The post-1990 OECD data refer to all 15 EU members. While the Maddison are available through 1998, he provides no intermediate data between 1990 and 1998, and we choose 1995 as a preferable break date which highlights the starting point of the transatlantic productivity growth divergence.

3. The less impressive U. S. performance in Table 2 is due to the use by McGuckin and van Ark (2004) of household employment figures to calculate economy-wide productivity, unlike Table 1 where the OECD follows U. S. practice by calculating private-sector productivity based on the slower-growing payroll employment data. For a discussion of this discrepancy, see Gordon (2003, p. 258-61 and the sources cited Leaving the Station, Page 5 The right-hand column of Table 2 displays the change in output, hours, and output per hour between 1990-95 and 1995-2003. The post-1995 acceleration in output growth was slightly less in Europe than in the U. S., 0.6 vs. 0.9 percentage points, respectively. Most of the literature on the failure of Europe to achieve a post-1995 productivity growth acceleration treats Europe as overregulated and stuck in the mud. On the contrary Europeʹs performance in hours of work was the diametric opposite of the U. S., accelerating by almost two percentage points compared to pre-1995, whereas there was no change in hours growth in the U. S. As a result, the productivity change between 1990-95 and 1995was the mirror image of the hours change, with an acceleration of almost one percent per annum for the U. S. and a deceleration of more than one percent for Europe.

Understanding Europe: Distinguishing the Stars from the Basket Cases If the decomposition of growth sources is a booming academic industry on the west side of the Atlantic, laments about Europeʹs performance are the corresponding concern of academics on the east side of the Atlantic. While the U. S. enjoyed a productivity growth revival after 1995, as we have seen in Tables 1 and 2, a growth deceleration occurred in numerous European countries as well as in the European Union as a whole. This EuropeU. S. contrast seems to fly in the face of the widespread evidence (Oliner-Sichel, 2000, 2002;

Jorgenson-Stiroh 2000) that investment in information and communications technology (ICT) was the basic source of the U. S. achievement. How could ICT be the main source of the U. S. growth revival, while Europe fell behind? Business firms, not to mention university professors, use the same PCs and Microsoft software everywhere in Europe, and Europe is widely acknowledged to be ahead in the use of mobile telephones.



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