In a recent speech at Prague Castle, Finnish President Alexander Stubb called on those present to remember how positively the EU had changed their lives over the past 30 years.
Jakub Landovsky, a diplomat and now the Czech government’s plenipotentiary for NATO commitments, responded on social media: “In 1996, the EU had 15 members and 28% of global GDP. Today, it has 27 members and 15% of global GDP.”
So what is the reality?
If Defense Burdens Were Shared Differently
That the European Union is falling ever further behind the United States economically is hard to dispute. Numerous leading European economists have pointed it out. The key reason is Europe’s lag in productivity.
Productivity is a fundamental economic indicator because it shows how much value is created in a given amount of time. It can be raised, for example, by investment in research and development, an area where Europe also trails the US. The same applies to research and development investment as a share of sales, which is significantly higher among American technology firms than among European ones.
If the EU kept pace with the US in productivity, its share of global output would still be declining, but far more slowly than it has in reality.
And what about the argument that the US is buying growth with debt?
Productivity growth cannot simply be bought. It has to be invented through research and development. It is an intensive indicator, not an extensive one, in the sense of growth measured in tonnes of steel produced.
There is more. If, after 1990, the European NATO countries had shared defense spending with the US on a 50:50 basis, the EU’s public debt today would be around 115% of GDP, instead of about 80%. US debt would be around 100% of GDP, rather than 120%. The EU’s debt is lower than America’s only because of the generous security dividend that the US taxpayer has provided over recent decades.
The Union’s Core Is Losing Momentum
Those who play down the EU’s economic lag behind the US by pointing to the economic boom and rising living standards in its newer member states over the past 30 years or so are also mistaken. They are confusing two different things.
A look at the data shows that the EU functions as a convergence machine for countries that joined the bloc later, allowing them to catch up with the EU average through relatively rapid productivity growth. In the Czech Republic, for example, hourly labor productivity grew by 81% between 1995 and 2019, while in the EU as a whole it rose by only 38%. The Czech Republic even outperformed the US, where it increased by 62%.
The problem for the EU is that its leading economies are hitting a technological frontier. Germany, France and Italy cannot push that frontier forward as quickly as the US, leading to the bloc’s overall relative decline against the United States.
The situation is particularly critical in Italy and Spain, where productivity grew by only 9% and 16%, respectively, over the same period. That is a disastrous result.
The Euro’s Role
The euro bears a major share of the blame for the decline of both countries, for three reasons.
First, before it was introduced, both Italy and Spain regularly dealt with declining competitiveness by devaluing their national currencies, the lira and the peseta, which made their exports cheaper. With the euro, they lost that option.
Second, joining the euro brought a sharp fall in interest rates for southern countries, taking them down to Germany’s level. In Spain, cheap credit sparked a massive investment boom, but it was concentrated in construction and real estate rather than technology. While it temporarily boosted GDP, hourly productivity stagnated because those sectors have low added value.
In Italy, by contrast, cheap money allowed the state to postpone painful structural reforms that might have made Italian exporters more competitive without devaluation, since high debt had suddenly become cheaper to service.
Third, in the first decade after the euro was introduced, wages and prices in Italy and Spain grew faster than in Germany, but without corresponding productivity growth. After the creation of the eurozone, large amounts of new capital flowed into its southern countries, but ended up in low-productivity sectors such as Spain’s real estate market. That created what is known as real overvaluation, making the economies of Italy and Spain expensive and uncompetitive.
State Intervention
Alongside the euro, one major source of Europe’s lag is the state’s growing interference in the economy.
Take the Czech Republic as an example. Today, some are lamenting that capitalism in the country has reached its limits, for instance because housing is expensive. Yet there have been only two major moments in the past 10 years when capitalism would have made housing significantly cheaper without state intervention. In both cases, government action prevented that from happening.
First, between 2013 and 2017, the state, or rather the Czech National Bank, prevented deflation, meaning a general fall in prices, by creating more than two trillion Czech crowns from nothing. That made mortgages historically cheap, effectively subsidizing them through state monetary policy, and drove hundreds of billions created at the stroke of a keyboard into real estate.
Later, during Covid, the state did not allow the value of property to fall by hundreds of billions of Czech crowns. Instead, it poured that money into the economy. On top of that debt, it saddled future generations with unaffordable housing.
In both cases, this happened with the encouragement and applause of precisely those who now lament the limits of capitalism. In fact, they are recognizing the limits of statism that those with foresight warned about years ago.
The United States is a more capitalist economy than the Czech Republic and the countries of the EU. That is also why it is economically outpacing the old continent.
Originally published at lukaskovanda.cz.