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Restoring the lustre of the European economic model


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Fifty years ago, the American Economic Review published a short article titled “The Golden Rule of Accumulation.” In it, Edmund Phelps, an American economist, proposed a simple rule for a nation’s wealth to grow and provide the highest standard of living for its citizens—present and future. The rule essentially specified how much people had to work, save, and invest today so that future generations could be at least as well off as they were. The golden rule had European origins as well. The paper used the insights of economists from France, Hungary, the Netherlands, and the United Kingdom…

Chapter 1: The European growth model

When this report was being finalized in late 2011, Europe was in crisis. The nations of Europe that had given up the most prized symbol of sovereignty - their currency - in exchange for the euro had the most troubled economies in the world. The countries that had ostensibly integrated the most were the ones deepest in trouble - surely a sign of a deeply flawed growth model...

Spotlight one: Europe - convergence machine

Economic growth has helped Europe rise from the devastation and misery of World War II to unprecedented wealth, technological sophistication, and the world's best quality of life. Since the war, Western Europe's output has tripled and Eastern Europe's doubled. The European Union, itself an unprecedented achievement, is in many ways the world's largest economy. European societies have developed market-based systems combining high levels of economic activity with equity and social inclusion...

CHAPTER 2: Trade

Škoda Auto used to be the butt of jokes in the 1980s: Why do Škodas have rear-window heating? So your hands do not freeze while pushing them. In 1989, the company sold about 150,000 cars in the former Czechoslovakia, despite having a monopoly. In 1991, Volkswagen AG bought a 30 percent stake in Škoda Auto, and by 2000 it had taken over the company. The subsidiary initially made the simpler parts that VW required for its cheaper cars. Škoda now makes more complicated transmissions and even engines for its parent. But it still makes its own cars—more than 750,000 of them in 2010—in plants at home in the Czech Republic and in the Slovak Republic, Ukraine, the Russian Federation, and India. Škoda tops consumer satisfaction surveys in the United Kingdom and India, beating Ford, Honda, and Toyota and inspiring loyalty instead of derision. And the company made almost $2 billion in profits for Volkswagen last year...

CHAPTER 3: Finance

In the boom years leading up to the financial crisis of 2008–09, Western European banks moved aggressively into emerging Europe.1 Austrian, Italian, and Swedish banks were especially active; Belgian, French, and Greek banks a little less. Almost 80 percent of the banking sector in some countries that looked to Europe for trade and finance - such as Bulgaria, Croatia, Czech Republic, and FYR Macedonia - were foreign owned. It was big business. In 2007, Austria's Raiffeisen and Erste banks had, directly or through their subsidiaries, about $300 billion in assets in emerging Europe, equivalent to almost 80 percent of the country's gross domestic product (GDP)...

CHAPTER 4: Enterprise

Mr. Rossi (not his real name) owns a small mechanical firm in Northern Italy. The company repairs valves and other components for manufacturing plants, serving mostly the agroprocessing businesses in the region. Mr. Rossi’s father started the company more than 40 years ago and it remains a family-run enterprise with five or six employees and some family workers. The business is profitable. But it has not grown since its first few years. When asked why, Mr. Rossi’s answers: “Do you know what I would have to deal with if my business employs 40 people? To start with, my workforce would be unionized by law. I would have to employ ‘a socially useful worker.’ The tax police and other government agencies like the labor safety agency would enforce stricter controls...

CHAPTER 5: Innovation

Google did not exist in 1995. Today, its market value is about $150 billion. Google's story epitomizes the success of the American "innovation machine." In 1999, roughly a third of the world's 1,000 largest firms by market capitalization were based in the United States, and of these, 35 percent were founded after 1950. Europe had only 181 firms among the 1,000 largest, and of these, only 14 percent were founded after 1950 (Cohen and Lorenzi 2000). Europe is a "convergence machine" but not an innovation machine. Over the past 15 years, with a few exceptions in the north, Europe has started falling behind the United States in productivity growth (see spotlight one)...

CHAPTER 6: Labor

In February 2000, the world watched as France instituted the 35-hour workweek, down from the 39 hours expected of French workers, and over 40 in most developed countries. The reasoning was that because there are only so many hours of work needed, it would be better to share them among more workers. Unemployment in late 1999 was about 10 percent, so cutting the number of hours by about 10 percent might take care of the problem. Economists call this the “lump of labor fallacy.” Another reason was the belief that French workers should be rewarded for their high productivity by allowing them to work less. Researchers had found that the output per hour worked was higher in France than in almost every other country. Getting employers to pay overtime wages for work beyond 35 hours would help labor capture more benefits of high productivity...

CHAPTER 7: Government

To make sense of the relationship between government and well-being in Europe, Sweden might be a good place to start. The quintessential European welfare state, Sweden does well in social outcomes: children and students enjoy free education, the elderly receive a decent pension, everyone relies on a public health system that helps them live long and healthy lives, and social trust is high. The welfare system redistributes wealth and contributes to an equitable distribution of income...

Spotlight two: Greening Europe's growth

Europe's success in adopting an environmentally sustainable growth model depends on companies developing cutting-edge products, generating jobs at home, and competing successfully abroad. Gamesa, a Spanish wind turbine manufacturer, is considered a European green growth success story. Founded in 1976, the company moved into wind energy in 1994, and within 10 years it became the world's secondlargest turbine maker. Gamesa's experience shows h ow growth comes with both opportunities and challenges...

CHapter 8: golden growth

In the early 1960s, an American professor named Edmund Phelps published a paper proposing a simple rule for a nation to grow economically and provide the highest standard of living for its citizens, present and future (Phelps 1961). The rule specified how much people had to work, save, and invest today so that future generations were at least as well off as the present. The goal was to maximize consumption in an economically sustainable way. The rule implied that today's generation should consume just enough - no more, no less - that their children would neither pity nor resent them. The paper cited the work of three economists - from the United Kingdom, the United States, and Australia - but the arguments built on the insights of a Dutchman, a Frenchman, a German, and a Hungarian, among others.1 Phelps called it "The Golden Rule" of economic growth...

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