Tuesday, May 29, 2007

Eichengreen on European Economy Growth

Barry Eichengreen, The European Economy Since 1945: Coordinated Capitalism and Beyond. Princeton University Press, 2007.

The economies of western Europe grew dramatically in the golden age that followed the second world war, closing the economic gap with the United States in a surprisingly short time. In recent years, however, Europe has stagnated relative to the U.S. European growth rates (with important exceptions like Ireland) have lagged behind U.S. levels.

There are many theories that attempt to explain the puzzle of postwar European economic growth. Barry Eichengreen's impressive new economic history of postwar Europe proposes that economic and social institutions were the critical factor and he makes a very persuasive case.

Eichengreen argues that postwar Europe "inherited" a set of institutions, including trade unions, industry associations, labor market practices and government regulatory structures, that facilitated rapid economic growth using existing technologies. Together, these institutions channeled vast quantities of capital and labor into industry (so-called "brute force" economic growth), producing potent economies of scale and rapidly rising living standards. You can think of this institutional setup as one that encouraged capital formation and industrial expansion while also assuring a relatively broad distribution of the resulting gains.

So long as economic growth was largely driven by economies of scale using existing technology, Eichengreen argues, the European economies surged ahead. But when the key factor shifted from more to better (from economies of scale to technological and managerial innovation), Europe began to fall behind. The social and economic institutions that provided security for an economy that was expanding was ill equipped to provide incentives for risk taking and innovation.

This explains Europe's current dilemma. They have "inherited" institutions that worked miracles a few decades ago, but that are unsuited to the current age, where economic growth is driven more that technological change than capital accumulation. Institutional rigidities (Mancur Olson's famous term) prevent Europe from experiencing more fully the benefits of this dynamic age. Will Europe be able to remake itself and its social and economic institutions? Eichengreen holds out some hope, but he seems pretty pessimistic to me. And no wonder: Olson said that it takes a crisis to destroy institutional rigidities once they have settled in and it is hard to see what crisis could persuade the comfortable French, for example, to give up their satisfying if suboptimal economic system.

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