The productivity gap between the US and Europe is not as wide as is commonly believed. And eurozone productivity is growing, with more of that gain accruing to investors than to workers.
The accepted wisdom is that the eurozone is the graveyard of productivity and enterprise, afflicted with a rigid and inefficient labour market that creates a huge productivity gap with the US.
Yet net equity outflows from the US to the eurozone have rocketed to $8 billion a year in the past year, reversing the huge inflow into the US recorded since 1997.
The reality is that the productivity gap between the US and Europe is much smaller than the consensus would allow. And it will narrow further. Much of the gap was created by superior GDP growth in the US. That is set to wane as the credit and asset bubbles that sustain it deflate. Also, it was abundant capital investment in the US that drove up its labour productivity, but not the productivity of each capital unit invested. And capital investment is now moving towards eurozone levels.
Productivity gains in Europe are more likely to accrue to profits than is the case in the US, and a strong euro will also hold down inflation and drive reform.
Shaky statistics
Anyway the traditional argument for US economic superiority rests on shaky statistics. Measured by GDP per employee, US productivity is nearly 25% higher than the eurozone average. But this exaggerates the gap because eurozone workers work fewer hours. Adjusting for that still leaves a 15 percentage point gap. But if you then adjust for differing ways of measuring real productivity growth and the impact of faster GDP growth in the US, the gap drops to less than five points.
Indeed, when economists look at the history of productivity growth in the US and Europe, they find little difference between them in the contribution of innovation to labour productivity growth in the 1990s. New technology in Europe was just as good as that in the US. The key difference was that US companies invested more in hi-tech equipment.
US companies might have invested much more to drive up productivity, but increasingly they overinvested, and capital inputs became less productive. So, while Europe’s capital productivity has been much worse than that of the US, during the 1990s US capital productivity progressively deteriorated and converged with the eurozone’s (lousy) performance.
Europe is still behind, and must improve both labour flexibility and investment in technology if it is to catch up. The good news is that the reforms of the past five years in many parts of the eurozone are boosting labour market efficiency through more part-time working and rising participation.
Up to now, Europeans have worked fewer hours in a year than peers in the US and Japan. Slowly this is changing. The structural fall in work time in France has nearly stopped and in Germany annual hours worked per employee rose for the first time on record in 2003. The French government has now announced a relaxation of its 35-hour week law to make it voluntary.
Also, EU enlargement has allowed eastern European workers to come west where they work as hard as they did at home. That means they work longer hours for smaller wages than their indigenous peers, putting pressure on them to do the same.
Across the eurozone, companies have cut costs by reducing their workforces. The momentum behind downsizing is structural. And a secularly strong euro will keep the pressure on to cut costs. Corporate rationalization is becoming easier because the backbone of the dinosaur labour unions has been broken.
Also, the gains of increased productivity and labour flexibility are being captured more by Europe’s corporations and less by their employees, whose share of annual income is falling. As a result, Europe Inc’s profit margins are rising at their fastest rate since 1999. That’s partly because declining unit labour costs will not be passed on to the consumer in lower prices in the eurozone, unlike the US. Most important, as US productivity growth falls back, Europe’s is accelerating.
Europe favours investors
Will investors capture these gains in Europe? In the US boom of the 1990s, productivity gains went into real pay rises for employees. So whether labour or investors get the bigger share will depend on supply and demand in respective labour markets.
In the late 1990s’ boom, US and European workers were in demand and wages rose sharply. Since the recession of 2001, wage growth has slumped. In the US, where labour markets are tighter, unit labour costs are rising while they are now falling in the eurozone, where labour market reform has much further to go in releasing labour supply.
So productivity gains in the US are more likely to be captured by employees than they are in the eurozone. That’s another reason why US profit margins are at cyclical highs and have peaked. From here, growth in US profit margin expansion will stop as Europe’s accelerates and the dollar will keep falling.
