The recent downward revision of historical US productivity data has interesting implications for Europeans, since they use US benchmarks to define their own reform agenda. By 1995, the Europeans had almost closed the productivity gap with the US. But the gap has widened since. It now appears that this gap is a little smaller than we thought. As an explanation of why Europeans are on average so much poorer than Americans, productivity is a partial answer at best.

Per capita gross domestic product can be split into three factors: productivity, working hours per employee and the employment rate. If the former is not the main cause behind the US/European Union income gap, it must be the latter two. The EU has a lower employment rate than the US and those with a job tend to work fewer hours. The interesting question is: why should that be so?

There are different theories. Some argue Europeans place greater value on leisure than the Americans. A recent academic conference on this subject in Italy was suitably entitled: “Are the Europeans lazy, or are the Americans crazy?” Others blame the 35-hour working week, or high indirect labour costs.

Robert Gordon, professor of economics of Northwestern University in Chicago*, has tried to account for the gap in living standards – as measured in per capita GDP – in a recent paper. The basis of his calculations are 2004 data, which show EU productivity at about 90 per cent of US levels, while the EU’s real per capita income is only about 70 per cent – broadly unchanged since the 1970s. He found the biggest single factor was the fall in hours worked per employee – Europe’s proverbial long holidays and short working hours. He calculates that the gap would be reduced by 8 percentage points if one put a fair price on an hour of leisure. This calculation assumes shorter working hours and long holidays are largely voluntary.

Europe’s relatively low employment-to-population ratio contributes little to justify the gap as it is largely involuntary. Prof Gordon also made adjustments to US GDP to account for factors not present in the EU, such as America’s high prison population. Taken together, these items reflect about two-thirds of the gap between the EU/US ratio of per capita income and productivity.

It is an interesting but subjective calculation. I would be less sanguine about the degree to which short working hours in Europe are, indeed, voluntary. While Europeans place a high value on long holidays, they are not necessarily wedded to the 35-hour week, as shown by an FT/Harris Poll published last Monday.

Perhaps the single most detrimental policy in Europe has been early retirement, which started in the 1980s. It placed a heavy financial burden on social insurance systems and had a lethal impact on the services sector. Europe’s early retirees have developed curious hobbies, such as plumbing. Even the famous Polish plumbers cannot compete with this. Europe’s do-it-yourself retirees do not mind spending hours queuing in discount supermarkets. They cook at home, rather than go to restaurants. With so much time on their hands, they do the jobs they once paid others to do.

The good news for Europe is that early retirement schemes are being phased out, as is the trend towards fewer work hours. In France, the two politicians most likely to contest the last round of next year’s presidential election have both expressed scepticism about the 35-hour week.

Prof Gordon’s analysis helps us identify policy priorities. If the EU’s problem is not lack of competitiveness or productivity, but a low rate of per capita working time, governments should focus on policies to end restrictions on working hours, to phase out early retirement schemes or to increase incentives for the unemployed to take up work. What the EU should not be doing is following diffuse reform programmes such as the Lisbon Agenda that focus mainly on competitiveness benchmarks. They add little value, but divert attention and resources away from programmes that do.

*http://faculty-web.at.northwestern.edu/economics/gordon/

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