That '70s show

The European Disease February 8, 2006; Page A16

Thousands of union workers and politicians marched in France and Germany yesterday against any and all attempts to tweak their rigid labor rules. What a perfect demonstration that eurosclerosis, that ugly word from three decades ago, is back.

The growth trends in the Europe's three largest economies should put all doubt to rest. GDP per capita in Germany, France and Italy is falling, relative to the U.S., to levels below those recorded in the 1970s. (See nearby chart). And according to a study released yesterday by the Paris-based Organization for Economic Cooperation and Development, EU countries have made scant progress adopting policies necessary to boost growth.

This relative decline raises uncomfortable questions about the Continent's ability to finance its welfare state, stay competitive and even sustain its geopolitical alliance with America. "At current trends, with demographics the way they are, the average U.S. citizen will be twice as rich as a Frenchman or a German in 20 years," Jean-Philippe Cotis, chief economist at the OECD, told us. The divergence between the continents will make it harder to share the mutual defense burden.

Labor markets are an obvious culprit. The rate of employment for people age 50 and older is glaringly low in Europe. Echoing Nobel laureate Edward C. Prescott, the OECD says Europeans don't choose to work less than Americans; they respond to perverse incentives to leave the labor pool at significant cost to taxpayers. Efforts to remove the tax incentives to retire early have gone nowhere in the EU, though at least some countries (Denmark and the Netherlands) have started to overhaul sick and disability benefits.

The policy reforms under discussion in France and Germany are politically brave but economically insufficient. German municipalities want to increase the working week to 40 hours from 38.5, sending public sector unions into a fury. French Prime Minister Dominique de Villepin got 170,000 off the jobless rolls by loosening hiring and firing guidelines for small companies, among other steps. He now wants to make it easier to employ people age 26 and under, but this "first job" proposal sparked yesterday's nationwide protests.

Barriers to the movement of capital and services are also a serious drag on Europe's growth, says the OECD. Take banking. Mr. Cotis estimates that aligning the financial regulatory regime in countries prone to banking protectionism with the OECD average could add as much as 0.5 percentage points to annual GDP. The top three countries in the share of cross-border loans in total domestic borrowing -- one measure of international competition -- are Iceland, Ireland and Luxembourg. These are also three of the richest.

Open markets go further in boosting innovation, and thus competitiveness, than any state-led effort to increase spending on R&D or education. The U.S. regulates product markets less than any OECD country but has one of the strongest intellectual property regimes. Staying faithful to this policy mix, America is the world's leading innovator.

Europeans don't lack for good advice, as the OECD's exposure of policy shortcomings shows. The problem is finding the political will to change. For Europe to keep its current living standards, much less improve them, this '70s show needs to be cancelled.

	URL for this article: http://online.wsj.com/article/SB113936869263768032.html

Copyright 2006 Dow Jones & Company, Inc. All Rights Reserved