Preserving a Prosperous European Union

Indermit Gill discusses successes and challenges for the European economy

Is the European economic model, marked by generous state-sponsored social services and high taxes, successful or unsustainable in the long run? World Bank economist Indermit Gill, AM’85, PhD’89, addressed that question in a campus talk Jan. 29, 2016.

He began with an analysis of the Swedish economy after the Second World War. According to Gill, the key to early Swedish success was a combination of an American market-based approach and the European approach of state solidarity, referred to as the Third Way. However, increased employment wasn’t quite what it was made out to be; in fact, it was entirely due to the development of the welfare state. Employment was centered in the public sector, the government picked up about 90 percent of childcare costs, and the marginal tax rate rose sharply. Ultimately, unemployment rose, the Swedish GDP fell, and banks collapsed.

As the Europeans adopted the Euro, there was a global boom and the lessons of Sweden were forgotten. Then, in 2010, things collapsed.

Gill then came to the crux of the issue: despite numerous efforts, Europe’s growth rate remains very low. Does this mean the system is fatally flawed? To answer this question, Gill focused on six principal components of a growth model: trade, finance, enterprise, innovation, labor, and government. On the whole, he concluded, Europe has actually been very successful.

To further illustrate his point, Gill outlined what he described as the three big achievements of Europe. The first is the convergence machine, wherein the EU takes in poor countries—Romania, for example—and transforms  them into high-income economies. This process involves a high level of trade (investment from West to East) and robust financial infrastructure, the first two components of the growth model.

In terms of convergence between richer and poorer countries, Europe outperforms Latin America and Southeast Asia. Ultimately, Gill remarked, Europe is lifting hundreds of millions of people from middle-income to high-income, a feat more difficult than lifting the same number from poverty to middle income, as in the case of China. Of the achievements, the convergence machine is the easiest to maintain in the future, as Europe continues to do well in the areas of trade and finance.

The second European achievement Gill analyzed was the “global brand” of Europe. This brand is noted for a focus on form and function, design and engineering. Exemplified by companies like BMW, the global brand is linked to the enterprise and innovation elements of the growth model.

Gill noted that European enterprises from 1994 to 2012 did pretty well at creating jobs, making workers more productive, and generating exports. There have, however, been lags in productivity gains, particularly among Europe’s leading economies. Gill put this down to specialization in low-innovation sectors. The US, he explained, does well in sectors that didn’t exist in 1975, while Europe flourishes in older, less innovative sectors.

The Nordic countries are doing better because they are more like the US than their neighbors. Gill suggested that it would be challenging but possible to maintain the European global brand in the future, as enterprise continues to flourish and certain areas of the region continue to do well in innovation.

The final achievement is the “European lifestyle superpower.” Coined in 1990s Japan, the term indicates that Europe contains the best places in the world to live and work. Gill linked this achievement to the labor and government components of the growth model. In general, superpowers spend a lot to protect their influence, and in Europe, spending on social protection—also known as social welfare— is as much as that of the rest of the world combined.

For example, Europe spends a great deal more on the elderly, as Europeans define elderly differently than the rest of the world. Europeans are living longer and retiring earlier, and the labor force that pays for social welfare is shrinking. Taking a step back to look at the difference in growth between Europe and the US, the reduced GDP growth rate is entirely due to higher spending on social welfare, Gill pointed out.

Of the three achievements of the European Union, it is the lifestyle superpower status that will be the most difficult for Europe to maintain. A dwindling labor force, high unemployment, and difficulties in the government aspect of the growth model mean that Europe will have to fight to maintain its achievement in this area. The key, according to Gill, is to either make spending very efficient or to simply cut spending.

Gill ended his talk on a positive note: despite alarmist talk to the contrary, the European economic model has actually achieved remarkable things. Europe is a good place to be if you’re a middle-income country. Europe has global influence and a quality of life that is highest in the world. Ultimately, however, Europe has changes to make in order to maintain what it has achieved.

Amelia Snoblin