Out of The "Usual Topic"

I want to share this post from economist Paul Krugman published today on his Substack (which I highly recommend you subscribe to), as it - obviously - resonates with my French/European citizen concerns.

I think that Krugman, atop of his professional skills, also has a knack for explaining even technically complex things in simple terms so that laypersons like you and me can make sense of them.

Is Europe in Economic Decline?

Interrogating the conventional wisdom that Europe is lagging America

PAUL KRUGMAN MAY 10 An ASML chipmaking machine I’m in Europe for a few weeks, giving myself some physical (if not mental) distance from Trumpland. So I decided to take a short break from my healthcare series to write about the European economy — specifically the perception that Europe is in economic decline. According to conventional wisdom, Europe is falling far behind the United States. It has lost any dynamism it once had and is quickly becoming a museum of its former glories. This perception is widespread: at Davos in January Howard Lutnik, Trump’s Commerce secretary, gave a speech that was so insulting toward Europe that Christine Lagarde, the president of the European Central Bank, walked out. The Wall Street Journal recently published an article under the headline “What happens when Europeans find out how poor they are?” which asserted an equivalence between the European economy and the poorest U.S. states, such as Alabama and Mississippi. Granted, what would you expect from an Epstein pal, stablecoin profiteer, Trump minion like Lutnick? Yet smart Europeans are also concerned: in 2024 Mario Draghi, one of history’s greatest central bankers, issued a report on EU competitiveness that highlighted Europe’s lagging productivity and raised serious alarms. But how accurate is this perception of European underperformance? While there are valid reasons to be concerned about Europe’s future, the trash talk reflects ignorance of the real issues. And even economically sophisticated, Draghi-type discussions are, I would argue, misleading. Europe is simply not poor the way Mississippi is poor. Moreover, by many measures — arguably the most important measures — Europe is, in fact, keeping up with the United States. Europe, along with China and the United States, is an economic superpower. And, at this point in time, it is arguably the world’s only democratic superpower. However, misperceptions about its economic performance keep it from playing the global role that it should and is so desperately needed. So while this primer is primarily informational, intended to give an overview of Europe’s long-term economic performance and how it compares to that of the U.S., it is also a wake-up call to Europeans to stop being gaslit by American triumphalism and to realize their own strengths – strengths that are critically needed in a world of encroaching authoritarianism. Beyond the paywall I will address three questions: 1. Does Europe have a lower standard of living than the U.S.? 2. Is Europe falling behind the U.S.? 3. Has Europe failed to match its global influence with its economic power? Does Europe have a lower standard of living than the U.S? When comparing the economic performance of various countries, economists often begin with measures of gross domestic product (GDP) per capita at purchasing power parity. GDP is the total value of goods and services produced in a country, and GDP per capita is a relevant measure of the country’s overall standard of living. “Purchasing power parity” (PPP) corrects for differences in national price levels, which is especially important because fluctuations in exchange rates between currencies, such as the relative values of the dollar and the euro, can cause temporary fluctuations in measured GDP that have nothing to do with underlying economic performance. Here is PPP GDP per capita in the three big European Union economies as a percentage of the United States over the past 25 years: Chart 1 European economies do produce less per person than the U.S. does. Indeed, as many observers have pointed out, France and Italy have GDP per capita comparable to poor U.S. states like Alabama: Chart 2 But let’s step back for a moment and ask: how reasonable is it to compare the economic performance of France, and Europe in general, with the poorest states in America? Let’s start with impressions: France definitely doesn’t look or feel as poor as Alabama or Mississippi. Granted, subjective impressions are no substitute for hard data. But the “walking around test” isn’t worthless, either. If the look and feel of an economy don’t match up with the story told by standard numbers, that’s at least a gut check, a reason to look for the sources of the dissonance. More substantively, nonmonetary comparisons between Europe and the United States are unlike the usual comparisons when one stacks poor nations against a richer country. Consider the following items: · Globally, rich nations normally have higher life expectancy than poor nations. But life expectancy in France is 4.7 years higher than in the United States — and 9 years higher than in Alabama · The overall US literacy rate is well below rates in other wealthy nations, and far below levels in Europe · While the US and China dominate most information technology industries, with Europe a distant third — more on that later — access to and use of IT are basically comparable in the US and Europe Understand that I’m not saying that the GDP numbers are wrong. What I am saying, however, is that the story “Europe is poor” is misleading. A clearly important issue that is not captured by GDP per capita comparisons is income inequality, which is much higher in the US than in Europe. It is arithmetically inescapable that the high share of US income going to the top 1 percent and the top 10 percent renders most Americans worse off than the overall high level of GDP per capita would indicate. However, quantifying this effect is, to be frank, a statistical can of worms, especially because some important goods and services — notably health care — are mainly government-provided in Europe while a significant share is privately-provided in the United States. My colleagues at the Stone Center on Socio-Economic Inequality, who are experts on the topic of income inequality, are not convinced by some widely cited analyses of this issue. So for now, I will simply assert that the role of income inequality in underestimating the performance of Europe versus the US is an important component, but one to which I can’t put exact numbers. Finally, if we look at the sources of low GDP per capita, they are very different in Europe than in poor U.S. states. More than 30 years ago I wrote that “productivity isn’t everything, but in the long run it is almost everything.” Nations become rich by increasing labor productivity — real GDP per hour worked. So you might assume that relatively low GDP per capita in Europe compared with the US is mainly a result of Europeans’ relatively low productivity. But that’s a mistaken inference. The Organization for Economic Cooperation and Development has estimated productivity for a number of countries, with estimates that are similar to those from other sources. Here’s how those numbers for Germany and France, plus my own calculation for Alabama, compare with GDP per capita: Chart 3 At 85.7%, per capita GDP in Germany is nearly 14 percent lower than the US average, yet German productivity, at 96.7%, almost matches US productivity. Thus the productivity gap explains only a little more than a fifth of the GDP gapin the case of Germany. French per capita GDP is 27 percent lower than in the US, but French productivity is only slightly lower than German productivity. Therefore, the productivity gap explains less than a third of the GDP gap in the case of France. What do these numbers mean? They mean that head-to-head comparisons of GDP per capita are misleading without also understanding comparisons of labor productivity. While Europe has lower GDP per capita than the U.S., its labor productivity is relatively close to that of the U.S. What explains this divergence? The answer is that America is the “no-vacation nation.” Historically, Americans were more like Europeans, taking part of the gains from productivity growth in the form of shorter work hours. But that process stopped after around 1970. Europeans, however, do take vacations, and as a result work fewer hours per year. This means lower GDP, but with the offsetting benefit of more personal time. In short, lower European GDP per capita can be viewed largely not as a problem but as a choice — a choice to spend less time working but more time on other things. Which side of the Atlantic is making the right choice? I’ll leave that up to readers. By contrast, poor U.S. states are poor not because of lifestyle choices but because they have low productivity. The productivity gap between Alabamians and other Americans explains more than three-quarters of Alabama’s low GDP per capita compared with the U.S. national average. As I said, then, while GDP comparisons aren’t wrong, they can be misleading: Europe isn’t poor the same way that Alabama or Mississippi are poor. On the whole we should think of Europeans as being as competent at producing goods and services as Americans, but with lower monetary income because they’ve made different choices about how to use their time. Thus it’s misleading to conclude that Europeans have a clearly lower standard of living than Americans when they have essentially just made different choices. However, it is important to ask if Europeans’ choices are sustainable. Many Americans and some Europeans would say no — that Europe may look as if it is doing OK now, but this ignores the reality that it is steadily falling behind the U.S. So let’s turn next to examining that claim. Is Europe falling behind the U.S.? The Draghi Report was intended to be a call to Europeans to act to address what Mario Draghi portrayed as a near-crisis in European economic performance, driven by lagging productivity. The foreword declares that a wide gap in GDP has opened up between the EU and the US, driven mainly by a more pronounced slowdown in productivity growth in Europe. Europe’s households have paid the price in foregone living standards. The report describes what it calls an “innovation gap,” and offers a striking chart: Chart 4 As portrayed by Draghi and many other observers, Europe achieved rapid convergence with U.S. productivity in the decades that followed World War II, but this convergence stalled and went into reverse in the late 1990s. One would expect this difference in productivity growth to be reflected in differences in overall economic growth. That is, we should expect the U.S. to have higher overall economic growth than Europe given the purported difference in productivity growth. Economists usually calculate a country’s economic growth by estimating the growth in output measured in fixed prices — the prices prevailing in a base year. Here’s the growth in GDP in 2021 prices in the US, Germany, and France: Chart 5 The difference is striking: between 2001 and 2024 real GDP per capita rose 37 percent in the U.S. but only 24 percent in Germany and 18 percent in France. So the total GDP gap between America and major European economies must have widened substantially, right? That is, doesn’t this mean that in the U.S. income and hence purchasing power must have grown substantially faster than in Germany or France? But it didn’t. Look back at Chart 1. In 2001 French GDP per capita, measured at purchasing power parity, was 74 percent of the US level. In 2024 the ratio was basically the same: 73 percent. German GDP per capita actually closed some of the gap with the US. By this measure, a comparison between European and US living standards looks about the same today as it did 25 years ago: Europe is not falling behind. How is this dissonance — the subject of a revelatory post by Seth Ackerman— possible? Are some of the numbers wrong? No. The key to understanding US-Europe comparisons is to realize that higher measured US growth is overwhelminglydriven by a small part of the American economy: “tech”. As the Draghi report acknowledges, essentially all of America’s faster productivity growth has been generated by rapid productivity growth in information technology, which the US currently dominates. Due to the narrowness of the US advantage, comparisons of GDP growth over time and comparisons of relative levels of GDP at each point in time tell different stories – differences that are more of a reflection of the growth of the U.S. tech sector than anything else. As I wrote a few months ago, The EU and US economies produce different mixes of goods, with the US dominating information technology industries, which have also seen much faster productivity growth than other industries. And this difference in industrial mix causes differences in real GDP growth that aren’t reflected in different trends in living standards. Think of it this way: Rapid technological progress in IT industries shows up as rapid measured economic growth in the locations where those industries are concentrated. And those locations are predominantly Silicon Valley and other US tech clusters. But who actually benefits from this growth? Do the gains stay in America or are they shared with the tech sector’s customers, wherever they are? As I wrote in December, The answer to this question crucially depends upon whether there is competition among technology companies. If there is, then the answer to the question is no: rising productivity will be passed on to consumers in both countries through lower prices. Even if the competition is imperfect, so that there are big profits for a few firms, many of the benefits of technological progress will still diffuse worldwide. Also, what is good for Mark Zuckerberg isn’t necessarily good for America. Furthermore, Europe can use antitrust policy to limit the excess profits of tech oligopolists and ensure that its own consumers benefit. In practice, at least so far, the benefits of technological progress have in fact been widely shared. A few months ago I illustrated this point with a stylized numerical example. If you find this example unconvincing or find it hard to believe that the US lead over Europe in IT hasn’t translated into a comparable rise in relative US living standards, consider a domestic comparison: California versus Texas. Here is the growth in real GDP per capita, measured in 2017 dollars, in the two most populous US states since 2007: Chart 6 Per capita GDP at fixed prices has risen substantially faster in California, with its large tech clusters, than in Texas: 44 percent versus 33 percent since 2007. Yet the government of Texas — which has seen faster population and employment growth than CA — isn’t commissioning reports warning about the state’s declining competitiveness. Implicitly, Texas officials realize that rapid progress in IT may lead to faster measured economic growth in California, but that the benefits of that progress are diffused across the United States and the world in general rather than staying in California. In economic (not cultural!) terms Europe is to the United States as Texas is to California. Rapid technological progress in a narrow sector, in which the other country/region is dominant, leads to faster measured growth in that foreign country/region. But because that sector is largely competitive in nature, consumers in other countries/regions will benefit from that sector’s growth. What predominantly matters for incomes is having the income and sophistication to purchase and use the technology rather than producing the technology oneself. This explains why the divergence between Europe and the U.S. in measured GDP growth has not been accompanied by a divergence in living standards. Europe, then, is not a museum to its past glories. It is not poor. In terms of current measures of living standards, it is not falling behind the U.S. And, more to the point, given the destruction that Trump II is inflicting on the U.S. economy, it is a safe bet that overall living standards in the U.S. will fall relative to Europe in the near future. But while Europe continues to be a global economic super-power, what can we say about its global influence? Has Europe failed to match its global influence with its economic power? I believe that much of the widespread narrative about European economic decline is misguided. However, in terms of geopolitics it’s undeniable that Europe punches below its weight. Look at total (not per capita) GDP at purchasing power parity: The EU is an economic superpower almost on a par with the United States and China. Its economy is vastly larger than Russia’s. Yet Europe often seems intimidated by the U.S. and until very recently has acted as if it is unable to cope with the Russian threat on its own. Are there real economic vulnerabilities underlying Europe’s geopolitical cringe? European reliance on US and Chinese technology is clearly a concern, especially now that the US has become a rogue state — notwithstanding the fact that the world also relies on Europe for some key technologies, such as advanced chipmaking (illustrated by the photo at the top of this post). More broadly, however, European geopolitical weakness is mainly about internal politics — largely a combination of disunion and learned helplessness after generations of relying for security on an America that no longer exists. Europe has also been made geopolitically weak by the self-centered, backward-looking attitudes of its two big powers — Germany, which turned a blind eye to foreign threats because it wanted cheap natural gas and markets for its aging auto industry, France with its struggle to reform a dysfunctional retirement system, and so on. But European geopolitical weakness and the prospect for change is a large topic, which I’ll turn to in future posts. For now, my message to Europeans is that you’re much stronger than you seem to believe. Act accordingly.