Saturday, March 12, 2011

The Economic Performance of Europe and the United States

British Member of the European Parliament Daniel Hannan has a powerful article in the Wall Street Journal about President Obama and the Europeanization of the American economy. He writes:

“My guess is that if anything, Obama would verbalize his ideology using the same vocabulary that Eurocrats do. He would say he wants a fairer America, a more tolerant America, a less arrogant America, a more engaged America. When you prize away the cliché, what these phrases amount to are higher taxes, less patriotism, a bigger role for state bureaucracies and a transfer of sovereignty to global institutions.”

Politicians on the left rarely admit this goal, I guess since it is not popular. There is little doubt however that a large portion of the American left believes that Western Europe has higher quality of life than the United States (probably wrong), and that the higher level of income equality and lower crime is primarily caused by welfare state policies (almost certainly wrong).

Americans two most important liberals outside of elected office are John Stewart and Paul Krugman, and they have both made it clear that they consider Europe a superior society compared to the United States. Most young liberals I have met also believe this, with an almost utopian view of Western Europe.

This despite the fact that Europeans have lower average income, lower median wages and higher unemployment rates. Europeans are more likely to vote with their feet and emigrate to the United States than the opposite. Contrary to popular claims, Europeans have lower self-reported happiness (a measure that I personally don’t believe in) and somewhat higher absolute poverty. Europe has much higher tax rates, but the same tax revenue as the United States.

There is one problem with Hannan’s article, which is using total GDP growth rather than per capita growth of income. This is misleading, since the United States has higher population growth than Europe. But having more people doesn’t mean your people are better off.

The growth of per capita income the last 3-4 decades have been similar in the United States and Europe. Of course this does not imply that the welfare state and high taxes is a free lunch. Economists have longed recognized that the adverse effect of taxes is mainly on levels of GDP, not the growth of GDP. I write about this here and here.

What is remarkable is that Western Europe appears to be “stuck” at a permanent lower level of income than America, even though poorer countries tend to conditionally grow faster than richer countries, due to “low hanging fruits”.

These two graphs illustrate what has been going on. The two most archetypical European welfare states, Sweden and France, were rapidly converging to American output levels for three decades following the war. However this stopped in the late 1970s/early 1980s, and even reversed.

This is a big deal. Richer countries on the technology frontier are not supposed to maintain their advantage for long or even outperform less avancerad nations. However the American economy managed to do exactly this, which is one reason I refer to it as the Super-Economy.

My interpretation is that Europe slowed and America gained ground because of expanded welfare policies in France/Sweden and supply side reforms in the United States.

Sweden (but not France) later implemented its own far reaching supply side reforms as a response to the poor economic performance. Sweden (but not France) is again converting to American levels.

Since we don’t have controlled experiments for entire nations, this historical analysis is speculative, and reflects my ideological biases. But at the very least we can conclude that the growth patterns of Western European welfare states and the United States is consistent with what Chicago style economics would predict.

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