The European Productivity Slowdown: How Lack of Political Will has Allowed European Productivity to Lag

Dangerously low inflation is only one of the Eurozone’s many ailments. Mario Draghi can try to “do whatever it takes” to bring economic revival, but more aggressive monetary policy will not change the underlying weaknesses of the Euro Area. The shortcomings of the European Union developed long before the string of recent crises. Once a booming region of rapid growth in productivity and improvements in standards of living, Europe has experienced significant economic hardship since the mid-1990s. Although European economic performance converged to U.S. levels from 1980-1995, it has since diverged. As productivity growth in the European Union has declined over the past few decades, it has significantly accelerated in the United States.
Economists explain that the productivity gap largely stems from the difference in growth of the service sector. This is an important factor, considering that the service sector accounts for more than 70 percent of GDP in the United States and the European Union. The United States has superior economic performance in the service sector due to its greater investment in information technology and the growing participation of high-skilled workers. On the other hand, Europe has experienced a slower emergence of its knowledge economy, a system in which economic success is based on the use of intellectual capital. This is evidenced by the significantly higher share of college-educated workers in the service sector in the United States, as compared to Europe.
Failed Attempts
Europe’s strategies to deal with this productivity gap have flopped. The Lisbon agenda, which aimed to make the Eurozone “the most competitive and dynamic knowledge-based economy” by 2010, was overly ambitious and vague, but largely failed due to lack of political will. According to the economist Charles Wyplasz, peer pressure underpinned the viability of the plan. Each country was required to produce an annual document describing its progress against pre-set objectives. The Commission would comment on the progress. Although early reports from the Commission were pointed and precise, according to Wyplasz, the system of peer pressure eventually broke down. The comments were seen as embarrassments to heads of state, so the Commission was asked to be more “diplomatic”.
The Bolkestein Directive of 2004, which aimed to establish a single market for services within the European Union, had a real chance of closing Europe’s productivity gap with the United States. Yet again, this proposal was politically unpalatable. The three pillars of the proposal included free entry into market services, the country of origin principle, and harmonization. Free entry into market services allowed a firm that supplied market services in one European Union country to provide those services in any other country in the union. The country of origin principle referred to the labor laws applied to services expanding into other European Union countries. The principle held that laws pertaining to long-term benefits would be subject to those of the country of origin, while other regulations, such as safety standards, would be subject to the laws of the country where the service would be delivered. Harmonization tried to foster a legal system to create an even playing field for foreign companies to expand into other member states.
Many European Union countries and industries disliked the single market idea, fearing that workers from Eastern Europe would inundate wealthier countries and work for lower wages and benefits. France vetoed the vote, leading to a watered down and ineffective version of the proposal: free entry and harmonization were made voluntary, and the country of origin principle was rejected.
Lost Potential
Implementation of the original Bolkestein Directive would have allowed more efficient reallocation of resources in the service sector. A single market strengthens competition and increases productivity. The revised directive failed to liberalize the sector that underpins the EU.
Establishing a single market is not easy—the U.S. has still not perfected it even after 200 years—but the single market is a huge contributor to the outstanding performance of U.S. market services. The Bolkestein Proposal was the European Union’s best chance for addressing the lag in European productivity. But it failed, just like the Lisbon Agenda. Europe 2020, the plan to replace the Lisbon Agenda, does not include a single market in services. Despite decades of trying, European leaders are still unable to find a growth strategy that truly responds to Europe’s growth lag.
Image credit: Wikimedia Commons

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