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http://super-economy.blogspot.com/2010/01/dynamic-america-poor-europe.html

Tuesday, January 12, 2010
Dynamic America, Poor Europe

Paul Krugman recently wrote in a column for the New York times that Europe has an economy as dynamic as the US, and that the US should be "Learning From Europe". His main argument for this was that from 1980 per capita income only increased slightly faster in America than EU.15 (in fact the US grew 72% and EU.15 grew 66%).

Other economist, such as Tyler Cowen and Greg Mankiw pointed out that Krugman ignores the much higher levels of per capita income in the US. This is important for two reasons. First, it is known in growth theory that in well functioning economies poorer regions/countries grow faster than richer ones, since they can adopt "low hanging fruits". It is remarkable that the US grew faster than Western Europe despite starting off at a higher level. Second, and most importantly, when measuring the productive powers of an economy it is the level that matters, not growth. Albania may have grown faster than Singapore one year, but no one would argue that Singapore is less productive than Albania.
From a policy perspective, if America follows Paul Krugman and Barack Obama in "Europeanizing" the American economy, what is most likely to happen is that levels of income will drop to Europeans ones (or lower, taking into account demographic differences). Once this happens, it is hardly a consolation that America will grow at the same pace as Europe.

During the current recession, the US GDP fell by a 3.3%. Theoretically if the US adopts European policies and immediately decreases to the levels of EU15, its per capita GDP would fall by 26.5%, 8 times worse than The Great Recession! (in practice the convergence would probably happen through years of reduced growth).

Here I will make three comparisons, two that have been done before (but that Krugman and his readers needs to be reminded of), and one that I believe is original.

1. First, let us compare the latest publicly available per capita GDP of 18 western Europeans countries and the US. We see that the US per capita GDP is $45.500, compared to $33.500 for EU15. Each American produces 36% more than each member of the EU15.

2. Second, let us compare the production of American States with European countries.

If France were to became an American state, it would be the 50th poorest, below Arkansas.

The EU.15 as a whole, which Krugman presents to his readers an economy as dynamic as the US, would be the 49th poorest state, below Alabama, a State that Paul Krugman ridiculed in 2005. Few Americans consider Alabama a dynamic state, because of the low average income (even though, hardly surprisingly, the poorer southern states have much faster per capita growth rates than the rich states such as New York). Why than should we consider Europe a dynamic region?

Even the richer European countries do not fare well against American states (the exceptions being oil rich Norway, financial city state of Luxembourg, free market Ireland and capitalist utopia Switzerland). Denmark and Sweden barely inch ahead of Kentucky, below Louisiana, New Mexico and Missouri. Minnesota is 34.4% richer than Sweden.

3. These comparisons are still to generous to Europe. The United States is demographically more diverse than Europe, and for example includes a larger proportion of low skilled immigrants. We also know that some groups have cultural traits that make them more productive than others, such as trustworthiness and work ethics among Scandinavians. I believe that the most fair comparison of American policy environment and formal institutions and European ones would compare apples to apples, and take cultural differences into account.

Of course America did not did not drop out of the sky, it is largely populated by Europeans. All western European nations sent a considerable share of their population to America. Therefore I will compare each European group in America with each host country (some host countries have in turn taken in large groups of non-European immigrants. I will deal with this issue later, although it does increase the advantage of the US by a few percent). The implicit theory behind this comparison is that formal institutions (such as tax rates) and informal institutions (such as work ethic) determine income, that immigrants bring some of their informal institutions with them, and that we therefore should control for what economists refer to as "fixed effects" for each national group.

I discuss method and some problems below. All countries are included, except Spain, which Census does not include (due to the problem with separating European Spanish with people from Latin America who speak Spanish). I believe generally the figures to be most reliable for groups with large immigrant shares, but less reliable for the British.

The GDP per capita for Americans from EU.15 is $53,000, compared to $33,500 for E.U15 itself. Those of European descent in America on average produce 58.6% more than they do in Europe.

In absolute terms, the $19.600 per capita wealth gap between Americans of European descent and Europe is as large as the gap between the Europe (the EU.15) and Turkey. In percentage terms the gap is almost large as the one between western Europe and Hungary.

Being the habitual cheater he is, Krugman asks his readers to compare America to Paris, London and Frankfurt.

"For those Americans who have visited Paris: did it look poor and backward? What about Frankfurt or London? You should always bear in mind that when the question is which to believe — official economic statistics or your own lying eyes — the eyes have it."

If you stop and think about this for a second the problem becomes apparent. These are not representative cities, they are three of the absolutely richest areas of Europe!

According to Eurostat, which contains GDP per capita figures for European regions, each inhabitant of London produces 65.3% more than the UK average. The figure for inner city London, the area most American visiting would see, is an 279%. That is not a typo. Inner city London is the richest region in Europe. Paris has a per capita income 272% higher than the French average. Lastly Frankfurt, the financial hearth of continental Europe, has a per capita GDP 278% higher than Germany as a whole. (Stockholm earns 37% above the Swedish average, for those curious).

These figures overestimate the wealth disparity somewhat, since cities contain more jobs than people, especially important for financial centers (one reason why Luxembourg is so rich). But statistics are not fooling us, central Paris is rich, which our eyes would confirm. The suburbs and most of the rest of France is not. The correct comparison for Frankfurt would be Manhattan, not the US average.

A meaningful question is not if 3 of the richest cities of Europe (randomly chosen by the dear professor for the benefit of his readers, no doubt) are backward, it is if typical Europeans earn less than typical Americans. Which they do, which the data confirms, and which an in-depth journey in Europe or a comparison of starting wages of various professions would verify. The lesson? Trust your eyes, just never trust Paul Krugman.

Suggested by Tyler Cowen, I also constructed a "virtual Europe". This is what would happen if each European country had a per capita GDP level of their descendants in America (so instead of multiplying the Italian-American income by 17.8 million Italian-American we multiply it by 58.9 million Italians). The per capita income of this "virtual Europe" would be $53.600. Soon Europe will attempt a new version of the (largely failed) Lisbon Strategy. They should keep this figure in mind in setting their goals.

The total GDP of EU.15 is 13 trillion dollars. Assuming Spain performed at an average level, an EU.15 working at American wealth producing figures would have a total GDP of 21 trillion dollars! If we believe all the differences in outcome between Americans and Europeans is due to culture and policy (Krugman has no problem assuming all differences in health outcomes is policy alone), the loss in income for Europe from following Krugman's advice instead of current American policy is 8 trillion dollars, every year.

Milton Friedman famously said that there is no poverty among Swedish-Americans. Indeed their poverty rate is only 6.7%, half the national average. It would be interesting to compare absolute poverty between Swedes in Sweden and their American cousins.

For one country, Sweden, I have calculated the figures when excluding immigrants to Sweden. This reduced the American advantage from 55.4% to 50.5%. If we believe that this is representative of Europe (Sweden has a higher share of foreign born than most other European nations) the American advantage should be around 53%.

Krugman's dogmatic ideology aside, there is no doubt which economy that is most "dynamic".

Tino Sanandaji, PhD student Harris School of Public Policy

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PeakTrader said...
The U.S. will become more like the E.U. where taxes and prices are higher.

Obama is stirring-up and promoting hatred towards U.S. corportions, including banks, insurance, health care, and energy firms. Raising taxes and regulations on U.S. firms will be passed through to consumers. U.S. firms will still make an accounting profit, although they'll produce less and there may be fewer of them. Ultimately, U.S. households and consumers will be burdened with more taxes and higher prices.

The banking and economic crisis was caused by the failures of government, including "too big to fail," the Bernanke Fed restrictive monetary stance, contractionary fiscal policy, allowing Lehman to fail, and massive government spending on inefficient programs.

Can we really blame Wall Street or the banks for creating and capturing trillions of dollars in the global economy, through massive efficiencies, distributing that wealth to the masses, including lower income Americans, and earning profits in the process?

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http://3.bp.blogspot.com/_otfwl2zc6Qc/S1G-wHWbexI/AAAAAAAAMfI/F4sC-3b78XE/s1600-h/euusa.jpg

The chart above is based on data in the 2004 Timbro study "EU vs. USA" (Table 3.3) which finds that the average poor household in America has 25% more living space (1,228 square feet) than the average European household (976.5 square feet), and the average American household has 92% more space (1,875 square feet) than the average European household.

Adjusted for differences in household size, the average poor American household has 11% more living space per person than the average European, and the average American has 82% more living space per person than their European counterpart.

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http://2.bp.blogspot.com/_otfwl2zc6Qc/S1G0KKd2DjI/AAAAAAAAMfA/JN1sFmb3VyQ/s1600-h/eu2008new.jpg

My recent comparison of per-capita GDP for various U.S. states and European countries using 2007 data has now been expanded and updated using 2008 data, and a summary is presented in the table above (using BEA data for state GDP, Census data for U.S. state population, and World Bank data for Europe's per-capita GDP-PPP). The updated data show that if European countries had been added as American states in 2008:

1. Italy ($30,756), Greece ($29,361) and Portugal ($30,756) would rank as the three poorest U.S. states, below even Mississippi in per capita GDP ($31,233); Portugal would be 26% poorer than Mississippi.

2. Spain ($31,955) would be America’s second poorest state, ranking between West Virginia ($33,978) and Mississippi ($31,233).

3. France ($34,045) and Belgium ($34,493) would rank #48 and #49 as U.S. states, just barely ahead of Arkansas ($34,437).

4. Germany ($35,613), U.K. ($35,445) and Finland ($35,426) would rank among the poorest 15% of American states, with per capita GDP below Alabama ($36,469).

5. Although Switzerland (not an EU country but included here), Netherlands, Austria, Sweden and Denmark rank among Europe's wealthiest countries, they would be below average as U.S. states measured by GDP per capita, ranging between 9.5% below the U.S. average for Switzerland to 22% below the U.S. average for Denmark.

6. Luxembourg is the only EU country that would rank above average and would in fact be the wealthiest American state, but behind the District of Columbia in per-capita GDP.

Bottom Line: Professor Krugman claims that “Europe’s economic success should be obvious even without statistics.” Unfortunately for Krugman, the economic statistics tell a much different and bleaker story about Europe than Krugman portrays, and suggests that "America's economic success should be obvious - just look at the statistics."

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http://www.cato-at-liberty.org/2010/01/15/america-vs-europe/

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http://demographia.blogspot.com/2009/01/australia-usa-have-largest-houses.html

Square feet based on population density is an oversimplification. The average new house constructed in the U.S. is 2,200 square feet compared to 1,900 square feet in Canada, which may be more like the E.U. than the U.S.

Also, I stated before, Europeans can raise their living standards substantially by selling their assets, exchanging euros for dollars, and moving to the U.S.

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http://www.oanda.com/currency/big-mac-index

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http://1.bp.blogspot.com/_otfwl2zc6Qc/S1cKZEB3xLI/AAAAAAAAMhw/U6o2OnQooVM/s1600-h/eu1.jpg

http://2.bp.blogspot.com/_otfwl2zc6Qc/S1cKY1PV9ZI/AAAAAAAAMho/tYs2sOgyMc0/s1600-h/eu2.jpg

MP: The chart above shows real GDP per capita from 1969 to 2009 for the EU-15 and the USA, using data from the USDA. The chart below displays the difference in real GDP per capita between the USA and the EU-15 over the same period, and shows that the USA-EU difference has more than doubled, from $4,000 as recently as 1982 to more than $8,000 by 1999, and has been as high as $8,794 in 2005. For 2009, the difference in per capita real GDP was $8,236 (US $41,646 - EU $33,410).

Jeppen said...
According to your graph, in 1969, the EU-15 had 16/21 = 76% of US GDP.

In the year 1982, the EUs best relative year, it had 21/25 = 84% of US GDP.

Currently, the EU has 34/42 = 81% of US GDP.

So, not much happens - I'd say the EU-15 GDP seems to oscillate around 80% of US GDP.

PeakTrader said...
The increases in real GDP per capita of the U.S. and the E.U were roughly parallel in the 1970s (because the difference was basically flat between $4,000 and $5,000, from 1969-82, which was one of the worst U.S. economic periods).

However, from 1982-09, the U.S. difference in the increase in real GDP per capita compared to the E.U. more than doubled, while it seems E.U. real GDP per capita continued to increase roughly at the same rate as the U.S. rate in the 1970s.

Also, I may add, given the U.S. consumed much more than produced, in the '80s, '90s, and '00s, other countries GDPs were raised at the expense of U.S. GDP (since exports increase GDP and imports decrease GDP).

The U.S. has been the main engine of global economic growth. I suspect, the E.U. would fall into recession if it attempted to pull the rest of the world's economies, similar to the U.S.

It was remarkable U.S. GDP was able to expand in the 2000s, given the large increases in U.S. trade deficits [U.S. current account deficits were 4% to 6% of GDP in 2000-08].