WHY AMERICA GROWS FASTER THAN EUROPE

December 14, 2005

In the past 10 years, the economies of what is now the euro area have grown about around 2 percent a year, while America managed a full percentage point more. Researchers Philippe Aghion and Peter Howitt find several reasons why.

First, the authors argue that Europe's institutions are not designed to be cutting edge; they are designed to catch up to America's economy. Institutions and policies best suited to countries at the leading edge need not be the right ones in less advanced places. For instance, education is much more important to a country on the cutting edge, but Europe underinvests in education:

  • America spends around 3 percent of its gross domestic product (GDP) on tertiary education; the European Union spends only 1.4 percent.
  • More than a third of Americans have degrees; fewer than quarter of Europeans do.

Second, economic growth is likely to be higher if markets are open to new entrants, which either drive less efficient incumbents out of business or scare others into investing, updating their technology and seeing off the raiders. The destructive process appears to have a freer reign in America than in Europe.

Finally, America has better developed capital markets, which allows good companies to borrow money through recessions and survive. This lets many good businesses to survive economic downturns (who will get loans), while letting poor companies fail. European capital markets are less developed and thus have less capability of sparing good companies from economic downturns, say the authors.

Source: "Closing the growth gap," Economist, October 29, 2005; based upon: Philippe Aghion and Peter Howitt, "Appropriate Growth Policy: A Unifying Framework," 2005 Joseph Schumpeter Lecture, 20th Annual Congress of the European Economic Association, Amsterdam, August 25, 2005.

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