Monday, June 25, 2007

Nobel prizewinning economist, Robert Fogel, has recently produced a paper that makes alarming predictions for those of us living in Western Europe. He identifies 6 main economic regions in the world - the USA, the EU (prior to accession of the 12 new members), India, China, Japan, and a group of 6 SE Asian 'tigers'. In the year 2000, the EU lagged only slightly behind the USA as the region with the highest gross domestic product. By the year 2040, Fogel expects the USA's GDP to have quadrupled in size. But China's GDP by then will be three times that of the USA. India's will be roughly the same as the USA's. The EU's GDP, meanwhile, will have fallen to little more than a third of that of the USA.

In terms of per capita figures, Fogel expects the average person in China to have more than twice as much income as the average person in the (pre-accession) EU by the year 2040.

These figures imply an alarming stagnation in Western Europe. There are two reasons for this. First, Fogel expects growth per capita in Europe to be slow (just 1.2% per year in real terms - less than a third of that assumed for the USA, and one seventh of that assumed for China). Secondly, he expects population to be stagnant in Western Europe. He explains his low assumption of per capita growth by reference to the demographic time bomb - the rapid ageing of the population in some countries means that much resource will need to go towards supporting the retired (consumption expenditure) rather than investment. It is true that this might put a brake on growth in some European countries - notably Italy and Germany - but by no means all. Meanwhile, Fogel's prediction of stagnant population growth in Western Europe has already been debunked. Migration is taking care of that.

Moreover, the assumption that China can continue to grow at over 8% per year over a further period of more than 30 years is a strong one. At some stage, such rapid growth is likely to lead to inflation - the symptom of an overheated economy. Given the uneven nature of growth in China - with a highly developed seaboard and a western interior that remains poor - such overheating is likely sooner rather than later, and this will inevitably constrain the potential of that huge economy to maintain its current growth performance.

The Fogel figures seem to exaggerate the challenge faced by Europe, but this does not mean that there is no challenge. The world's most rapidly developing economies are growing partly because they are catching up with the world's richest. But partly also they are growing because the rewards to initiative, invention and enterprise are huge. Therein lies a lesson.

Friday, June 22, 2007

Things are not going well in the European Union summit. The story is that Nikolas Sarkozy, the new French president, has insisted that the commitment to 'free and undistorted competition' be watered down; it appears that this commitment may be replaced by one that aims at a 'social market economy aiming at full employment'.

Tony Blair, reaching the end of his tenure as the British prime minister, has issues of his own - he wishes to safeguard the UK's law-making and foreign policy powers. But these matters should not distract him from the need to focus also on the free market issue.

Full employment is a phrase that sounds as though it should be easy to understand - but it isn't. There are many people who choose not to work, for a variety of (usually very worthy) reasons. Full employment does not, presumably, mean that no-one is allowed to be a student, to look after children or elderly relatives, or to retire. At any time, there will also be some people who are between jobs; in many cases they can search more effectively for new employment while they are unemployed. So there will always be some unemployment. Working definitions of 'full employment' acknowledge this. What 'full employment' means, therefore, is low unemployment - a rather vague concept.

Now one way of achieving the goal of low unemployment is for the government to provide plenty of financial support to industry. In this way, when trade slumps, the threat of mass redundancies can be averted. If trade in a particular sector is set to bounce back up after a short term slump, this might indeed not be an altogether bad policy to implement - though of course it would be better if firms were managed in such a way as to weather such transient storms themselves.

The problems come when government provides substantial long term support to businesses that would otherwise be ailing. We saw plenty of this in the UK in the 1970s. The coal, steel, air travel, and car manufacturing industries hit troubled times and were bailed out by government (that is, taxpayers') money. But the tide had turned - other countries could by then produce these things more efficiently than we could in the UK. Ultimately the power of the market won out, the state support ended, the UK industries suffered, and unemployment shot up.

Providing financial support to industry is a natural thing for governments to want to do. It can alleviate unemployment - at least until the next election. It can provide short term relief for some severe social problems. But - and here's the nub - it cannot do so indefinitely. Ultimately, market pressures will win out. When they do, as they did in early '80s Britain, the bump is all the more painful.

'Free and undistorted competition' is a means to an end. 'Full employment' is an end in itself. While competition is sometimes difficult for politicians to stomach, in the long run it serves the goal of low unemployment rather well. It should not be sacrificed on the altar of a European fudge.

In the European context, free competition also means the application of strict anti-trust regulation. This protects us all from the abuse of monopoly power - the tendency for firms that are dominant in their industry to set high prices (because there are few alternatives available to their customers), and to produce at a scale of operation that is not the most efficient. Curbing the power of monopolies would seem to be an altogether desirable thing.

President Sarkozy came to power on a reforming agenda that led many commentators to draw comparisons with Margaret Thatcher. Her regime was characterised by a pretty poor record on the macroeconomy, but also by some excellent microeconomic policies which still provide benefits today - these include the promotion of competition. If the comparisons are to continue, President Sarkozy has an awful lot to learn.