Growing Pains

• Author: Jean Philippe Cotis
• Position: Chief Economist at the OECD
• Pages: 16-19

Dissecting the causes of Europe's lagging economic performance

Page 16

Following World War II, European economies entered a 30-year period of rising prosperity. This golden age was one of rapid catch-up with the United States in terms of GDP per capita. The pattern of growth was consistent with the conventional "convergence" view: less advanced economies grow faster than more advanced ones. During the 1980s, however, this catch-up process paused before unraveling during the 1990s as per capita output grew more slowly in large European economies than in the United States. This European setback came as a surprise. In an ever more integrated world, with low barriers to trade, global financial markets, declining obstacles to foreign direct investment, and rapid technological diffusion, one would have expected convergence paths to accelerate.

These developments prompt a number of questions. What is behind the European slowdown relative to other countries in the 30-member Organization for Economic Cooperation and Development (OECD)? What policies and reforms would help rekindle economic growth? And how should these changes be implemented?

Divergent trends

Sizable differences in economic growth have materialized over the past decade within the OECD area. Looking beyond cyclical developments, growth in the United States and a number of other, mostly English-speaking economies, including Australia, Canada, and New Zealand, has averaged 3 percent or more. In contrast, long-term growth is estimated at about 2 percent in Europe as a whole and 1 percent in Japan. But nearly half the 1 percent growth gap between the United States and the European Union (EU) reflects differences in population growth. Moreover, the size of the differences is expected to widen in the years ahead because demographic decline is more advanced in the EU and Japan.

Since countries cannot do much about demography in the immediate future, comparisons of economic performance in terms of GDP per capita are more informative. These too reveal marked divergences. Over the 1990s, annual per capita output growth in the United States was half a percent higher than in the European Union and almost 1 percentage point above what was achieved in the three large euro area economies- France, Germany, and Italy. As a result of these trends, in 2002 per capita incomes converted using purchasing power parities (PPPs) were almost 30 percent lower in the EU than in the United States (see Chart 1). If, on the other hand, the rate of convergence recorded during the 1970s had been maintained, the three major euro area economies would by now have almost the same levels of output per capita as the United States.

Such broad-brush comparisons between Europe and the United States, however, conceal a wide disparity of economic performances within Europe. In fact, there have alsoPage 17 been extraordinary success stories. For example, in Ireland, average per capita output during the 1990s expanded by almost 6 1/2 percent, the fastest pace recorded in any OECD country. As a result, Irish GDP per capita has risen from a level well below the OECD average to one of the highest. Greece (albeit from a low rate), Luxembourg, and the Netherlands also managed to boost per capita output growth over the 1990s, as did Finland and Spain over the second half of the decade.

Short-run performances have also diverged in unexpected ways, following the bursting of the bubble in high-technology investment spending. Even though the adverse demand shock had its epicenter in the United States, its effects hit continental Europe with as much vigor as the United States. Other OECD economies resisted better, especially English-speaking countries and, to a lesser extent, the Nordic ones.

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