A decade ago, prospects were looking very bright for "old Europe," as Donald Rumsfeld likes to call it.
Its companies set the standards for quality and productivity in many industries. Economic integration held out the promise that Europe's economy would soon rival that of the United States in terms of scale, wealth and innovation. And just as the United States had Mexico and Japan had Southeast Asia, Europe looked to the formerly communist countries to the east as an important new market and source of low-cost production. On top of that, of course, was a lifestyle unmatched anywhere.
As things turned out, however, the ensuing years found the economies of western Europe falling even further behind the United States. Growth rates have been about half those in the United States, while its unemployment rate has been running at twice the U.S. rate. Industries that were once global leaders, such as pharmaceuticals and precision engineering, have lost their competitive edge. And the machinery of the European Union, rather than being a source of economic strength, is now widely viewed as a threat to national pride and prosperity. Meanwhile, Eastern Europe has emerged in the collective imagination as more of a threat than an opportunity.
It's even gotten to the point that France and Germany have fallen back onto thoroughly discredited strategies such as bailing out failing companies and blocking foreign acquisitions.
So gloomy is the economic outlook that two books topping the bestseller list last year were "France in Free Fall" and "The French Disarray." Demographic forces threaten to bankrupt prized pension and health care systems. And while many Americans would chuckle at the modesty of the reforms put forth for curing Europe's economic disease -- cutting back on one of Italy's 15 national holidays, lengthening the 35-hour work week in France, requiring Germans who have collected unemployment benefits to seriously consider a job -- the politicians who proposed them have the lowest poll ratings in the postwar era.
Has the European economic model become hopelessly dysfunctional? Probably not. In a new paper, Olivier Blanchard, a formidable French economist at MIT, notes that more than half the measured prosperity gap between Europeans and Americans reflects the preference of Europeans to take their productivity gains in the form of more leisure time rather than cold cash. Productivity levels and growth rates, he argues, are roughly equivalent on both sides of the Atlantic. And while progress has been halting, Blanchard says, the new E.U. machinery deregulated enough industries, eliminated enough subsidies and opened enough markets that the heightened competition will eventually force reforms in Europe's labor markets that politics alone has been unable to accomplish.
A more sober view is put forward in a new book by William W. Lewis, late of the McKinsey Global Institute. Lewis argues that the virtuous cycle by which innovation and increased productivity usually generates lower prices, higher incomes and yet more innovation has been short-circuited in Europe by a web of market-distorting taxes, subsidies and regulations. He cites minimum wages too high for companies to hire low-skilled workers, zoning regulations that prevent the kind of large-scale housing developments that lower home prices, and rules that have kept more efficient retail chains from entering many markets. While such rules are often meant to further laudable social goals, Lewis writes, they have become the blunt instruments by which overpaid workers and inefficient companies have protected themselves from the disciplines of market competition.
As I start out on a little field trip to explore these issues, I'm inclined more to the Euroskeptics such as Lewis than to those, like Blanchard, who have confidence that "old" Europe will once again muddle through with style. In truth, many Europeans have never fully embraced the whole idea of creative destruction that underlies market competition. Nor do they seem to fully understand the competitive challenge that confronts them.
Or think of it this way: A prosperous society that tolerates 20 percent unemployment among its young people, year after year, but won't even think about giving up a day of vacation to make its companies more competitive -- that's not a society that's suiting up for battle.