Harry Geels: Distressing difference productivity growth Europe vs US

Harry Geels: Distressing difference productivity growth Europe vs US

Harry Geels

By Harry Geels

There are many reasons why Europe lags behind the US economically. The most distressing is the enormous lag that Europe is showing in productivity growth. The relatively large size of European governments is probably a good explanation for this.

Over the past decade, American economic growth has been more than one percentage point higher than that of the eurozone annually. Over the past thirty years, the American economy has grown twice as fast as that of Europe. There are several reasons for this, as I explained in an earlier column, including better functioning capital markets, a better functioning currency union and the positive influence of private equity.

What remained underexposed at the time was the difference in productivity growth. Figure 1 shows that US productivity has been more than twice that of Europe over the past two decades. Furthermore, the credit crisis in Europe has had a much more negative impact on productivity than in the US (which is not surprising when we know that the banking sector in the eurozone, in assets, amounts to 228% of GDP, while in the US is only 90%). Furthermore, the US also did much better in terms of productivity during the corona crisis. Over the past year and a half, the US has also taken a significant lead over Europe in terms of productivity growth.

Figure 1: Productivity growth US versus Europe as of January 2004
MU 20240702 - Fig 1 - Productiviteitsgroei VS vs Europa, sinds 2004
US non-farm output per hour, Eurozone and UK output per hour worked (real, rebased)
Source: Financial Times, LSEG, National statistics offices

Different types of labour productivity

labour productivity is the most common measure and is calculated as GDP per hour worked, or per employee. In addition, we have capital productivity, a measure of the efficiency with which physical capital (such as buildings, machines and equipment) is used to generate output. It is often measured as output per unit of capital. Finally, there is total factor productivity (TFP), which measures the efficiency of all production factors. There are measurement problems. For example, increased quality is not always properly taken into account.

Figure 2: Labour productivity in the US is now increasing mainly due to the use of AI, after a fifteen-year plateau.
MU 20240701 - Fig 2 - Arbeidsproductiviteitsstijging VS
Note: average revenue over the past twelve months per employee in the S&P-500 companies
Source: BofA Global Research, BofA US Equity % Quant Strategy, FactSet, Bloomberg

Why the big differences between Europe and the US?

There appears to be a complex set of reasons underlying the productivity growth differences between Europe and the US. US labour markets appear to be more flexible. We saw this especially in the credit and corona crises, in which American companies generally fired people faster than European companies. In addition, the Fed also intervened more quickly during the credit crisis by purchasing toxic investments from American banks, while European banks were still struggling with these investments for years. During the corona crisis, the American labour market proved to be much more flexible. Unemployment rose from 3.5% to 14.7%, to now 3.7%, while in the eurozone it went from 7.2% to 8.7% to now 6.4%.

But there is another, more fundamental development: over the past twenty years, the role of governments and the partly related increasing regulatory burden in European economies has been faster and greater than that in the US. Until the early 1980s, governments in most major European countries, measured in terms of expenditure as a percentage of GDP, were even smaller than those of the US (in the early 1970s the US government still spent relatively much on the Vietnam War). Now the roles have been reversed. For example, the size of the French government is 55% of GDP, the American government 36%.

Stifling business environment

The bigger the government, the more severe Baumol's disease. A  KPMG report further highlights excessive bureaucracy and high energy costs, for example in Germany, where there is an increasingly urgent need to reduce bureaucratic hurdles to make the country more competitive. The European Business Review reports  that many German companies are moving their activities abroad, with high energy prices and strict regulations being important factors.

The Federation of German Industries (BDI) found that almost 16% of medium-sized companies have already started relocating and another 30% are considering doing so. This exodus is partly driven by the high costs associated with Germany's green energy agenda and the ongoing energy crisis exacerbated by the conflict in Ukraine. In addition, DW noted that the US Inflation Reduction Act, which offers significant subsidies, is luring companies away from Germany.

The Netherlands also has a heavy bureaucracy. For example, since yesterday, large companies have to keep track of how their employees travel to work. The question is whether the cure is not worse than the disease. Previously I wrote wrote about the three underlying causes of increasing government patronization. The government has taken over the role of the church as guardian of morality and also believes that more rules provide a counterbalance to the frayed edges of neoliberalism. In addition, we see an increasingly compelling role for supranational organizations such as the EU, the IMF and the UN.

Productivity growth versus climate

Some people are not so concerned about Europe's relatively lagging productivity growth. They point out that this actually amounts to even more growth and therefore even more potential climate damage. On the other hand, these are also often the people who point out the increasing power of China and the US and that Europe must arm itself against this. The best weapon is an innovative Europe. Furthermore, higher productivity growth and fewer markets patronized by the government can also be used  to serve the climate transition.

This article contains a personal opinion from Harry Geels