The Source of Economic Success in the 21st Century


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February 09, 2015 21:40 EDT

European countries must focus on their children’s skills in an increasingly competitive world, argues former Irish Prime Minister John Bruton.

A lot of attention is being given to the competition Europe and the United States will face from economic growth in Asia over the next 25 years. A survey conducted by the World Economic Forum shows that Asia is the most optimistic about its economic future. And optimism is essential to investment.

The Organisation for Economic Co-operation and Development (OECD) has estimated that between 2015 and 2060, gross domestic product (GDP) per capita will increase eight-fold in India and six-fold in Indonesia and China, whereas it will merely double in OECD countries, which include Europe and North America. This will affect the balance of power in the world. It is interesting to note that two of the top three Asian dynamos are democracies: India and Indonesia. And both of them have substantial Muslim populations.

The source of economic growth can be summed up in two words: innovation and population. If a country has an innovative and well-educated population — open to trends in the global market, able to understand them and identify the needs of the world that it can meet, and with an economic and governmental structure that allows speedy allocation of resources to those needs and away from less efficient uses — it will have a higher growth rate.

This is why the OECD, the International Monetary Fund (IMF) and the European Commission put so much emphasis on “structural reform.” Structural reform is designed to clear the arteries of the economy and allow blood to flow more quickly to activities that will yield the best return. For example, if a country has a disproportionately expensive, slow or overly elaborate legal system that will be a blockage in the arteries; if a country has disproportionately high electricity prices because it uses electricity prices to subsidize un-economic generation for regional policy purposes, which will block arteries; and likewise, if it has disproportionately costly or slow broadband communications, avoidable skill shortages, unwillingness to recognize genuine foreign qualifications, work disincentives for particular groups or a distorted market for credit that does not favor productive activities — all these things are blockages in a nation’s economic arteries.

Such blockages can also apply at a supranational level. It has been estimated that the lack of a single market for digital services in the European Union (EU) is blocking the arteries of the EU economy to the tune of €260 billion; the lack of a true single financial market is doing so to the extent of €60 billion; the lack of an integrated energy market to the extent of  €50 billion; and the lack of a single services market, including no recognition of skills certified in other countries, is blocking the arteries of the European economy to the extent of €235 billion.

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© Shutterstock

Interestingly, a European Parliament staff paper shows that one of the slowest countries to implement the structural reforms urged by heads of EU governments since 2011 is Germany. And one of the fastest, on paper at least, is Greece. These are reforms that German Chancellor Angela Merkel recommended.

One of the problems is the delays at the level of the lander. To put it another way, and using some economic jargon, Europe has a choice. According to the EU Ageing Report, the European Union can stay on its present course and, as in the last 20 years, have a total factor productivity growth rate of only 0.8% per annum. Or it can make changes, which could lift its total factor productivity growth rate to 1.1% per annum until 2020 and 1.4% per annum thereafter. A slow, long-term return perhaps, but a real one. And in the long-run, enough of you will be around for that to matter.

Structural Reforms

Some countries — not Ireland — have been artificially held back by top heavy bureaucracy, which prevents their societies from allocating resources to where they will get the best return. Societies can fail to allocate resources well, or block good reallocation of resources by political vetoes and constitutional limits.

The necessary reforms include changes to the labor market, but to a much greater extent they involve freeing up markets for the sale of goods and services — from electricity to professional services. Of course, freeing up the arteries will not solve the problem, unless there is blood flow of commercial innovations based on good research and development, accompanied by an innovative and flexible culture within government, educational institutions and in the general population.

Between 2015 and 2060, according to the OECD, the countries with the biggest potential for extra growth, which might come about if structural reforms are implemented, include: China, Slovakia, Poland, Greece, India, Indonesia, Italy and Russia. At the other end of the scale, some countries that already have relatively efficient systems, and are getting the benefit of reforms made in the past, include: Britain, the Netherlands, Ireland and the United States.

It is good that Ireland is in that position, which is an indication that the reforms we made over the last 40 years or more have yielded fruit. And this is despite the fact that Ireland still has, to a degree, many of the previously mentioned rigidities while also having room to improve in those areas. On the other hand, competitor countries like China, Poland, Slovakia and Greece have even more room to improve — or more upside potential than Ireland and may, therefore, pose a bigger challenge as soon as they get their act together.

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© Shutterstock

Comparatively efficient countries like Ireland, the Netherlands, the US and Britain will have to look beyond structural reforms on their own, if they are to make extra gains. They will have to run faster and faster just to hold their current relative position.

Structural Reforms Are Not Enough

In every society, young people are the innovators. The crucial determinant of relative success in the 21st century will be the proportion of young people in a country, and the relative mental agility of those people in comparison to those in other nations. Their potential will be influenced by formal education, but not only education. It will also be influenced by what happens to them as children, before they even go to school.

Other things being equal, a country with a large elderly and middle-aged population and few young people is unlikely to produce as many innovators as a country with a large youth population. It is also likely to have more political veto points.

To an extent, each society decides the sort of future it wants to have, when it decides how many children it will have. Societies in many European countries, including Germany, Spain, Italy and many eastern European nations, decided to have few children, and that is a choice they have made — perhaps unconsciously — about the future profile of their nation. For example, partly as a consequence of differences in past birth rates, the OECD calculates that from 2018 to 2030, Ireland’s potential employment growth rate will be 1.2% per annum and France’s will be 0.2%. In contrast, Germany over the same period will experience a potential employment decline of 0.6% a year, while Finland’s will reach 0.2%.

These differences partly explain why Germans and Finns see limits to their ability to bail out other countries such as Greece. They will soon have fewer people at work supporting an increasing number of retirees, and they will want to hold their money back for that. Unfortunately, Greece has a similar problem of an ageing and diminishing workforce and an increasing elderly population. Pensions are already 14.5% of Greece’s gross domestic product (GDP), 13.8% of France’s GDP and almost 11% of Germany’s, as opposed to just over 5% of GDP in Britain and Ireland. That difference explains a lot, at least as much as the supposed doctrinal differences between German “ordo-liberalism” and  Anglo-Saxon Keynesianism.

It is true, as Keynesian economists argue, that coordinated demand stimulus, by countries that can afford it, would help Europe’s economy achieve its jobs potential without risk of inflation, and that can come from countries whose fiscal positions are strong. But the judgment as to which European country can do that has to take some account of differences in the ageing profile of each nation.

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Incidentally, these differences also illustrate the foolishness of German anti-immigrant sentiment. Germany’s 6.6 million immigrants paid in €22 billion more in taxes and contributions than they took out in benefits, and some of that surplus is helping pay the pensions of native-born Germans. The same may apply in France.

In fact, the EU Ageing Report estimates that 55 million immigrants will have to come into the EU by 2060, in order to make up for the decline in our native-born workforce due to past decisions on family size. That can change, of course.

Meanwhile, Africa’s population will have increased by 28% in 2060, while Asia’s population will have slightly declined.

Europe’s Youth Problem: A Wasted Generation?

In the next 50 years, on unchanged present trends, the overall working-age population of Europe will drop considerably — from last year’s peak of about 300 million to 265 million. This will be a significant blow to nearly every aspect of the eurozone economy.

At the same time, the old-age dependency ratio — which expresses the ratio of residents over the age of 65 to those under that age — will rise from 28% to a staggering 58% by 2060. The causes of this challenge in Europe are manifold: declining fertility, advances in old-age care and the residue of baby-boom demographics. But the impact will be serious.

This is made even worse by the fact that so many of today’s youth in Europe are unemployed. The longer they are unemployed, the less relevant their skills become and the harder it will be for them ever to get a well-paid job. Their lifetime earning potential is being radically diminished.

The experience of long-term unemployment is devastating. That is a huge medium-term problem. Mario Draghi, the president of the European Central Bank (ECB), has recognized this as the main problem in Europe today. In 2014, he said in a speech at Jackson Hole: “The stakes for our monetary union are high. Without permanent cross country transfers, a high level of employment in all countries is essential to the long-term cohesion of the euro.”

There are two words in that sentence: “all” and “essential.” All countries in the euro must have a high level of employment. And the head of the ECB says this is essential for the euro. Not the sort of language you would expect from a central banker on the subject of employment, which shows that solving Europe’s unemployment problem is fundamental to the survival of the euro, and thus the avoidance of immense financial instability and wealth destruction that would flow from a break-up of the euro.

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Even economists like Martin Wolf, who opposed the creation of the euro currency, argue that its break-up would be an unmitigated disaster at this stage. The downfall of the euro could herald an era, between the countries now in the EU, of arbitrary savings destruction, national protectionism, competitive devaluation and mutual litigation and recrimination, which would destroy the interdependence that has allowed the European Union to be a structure of peace in Europe for 60 years. We would not be going back to the 1980s, but to the 1930s. And Draghi has linked finding a solution to high unemployment in some European countries such as Greece and Spain to finding a way to avoid that. That is what is at stake.

But in the long-run, we have another problem. We will soon not have enough young people at all in Europe. From 2030 onward, Europe’s working age population will decline, and the number of retired people depending on them will increase. Today, there are four Europeans of working age for every one retired person. By 2060, there will be only two. To be precise, Europe’s labor supply will remain stable up until around 2023 and decline thereafter — by about 19 million people — up to 2060.

As a result of these trends, Europe’s relatively small number of pre-school and primary school children of today will, later in their lives, have to support a proportionately much larger retired population than will their competitors in India, China and Indonesia. Europe will be like a horse carrying extra weight in the global competitiveness race of the mid-21st century.

In Europe, the OECD projects that from 2014 to 2030, public expenditure on health, long-term care and pensions will range from increases of 6.3% GDP in Luxembourg, 5.6% in Belgium and 4.8% in Finland, down to 2.7% in Ireland, 1.4% in Britain, and a mere 0.8% in Italy and 0.7% in Poland. This is the difference made by pension and entitlement reforms in the latter countries.

If young people are to have the future earning-capacity to bear these extra burdens, it is essential that they get every educational advantage today, no matter what the present income status of their family. That is not just a matter of social justice, although it is certainly that. It is a matter of pragmatic self-interest for today’s to-be-retired workforce and electorate. But what sort of educational investment will make a difference?

Increasing the teacher-student ratio may help, but the evidence on that is ambiguous. Some countries with high teacher ratios do less well than others with proportionately fewer teachers. In fact, it may be before children go to school at all that the biggest improvements in intellectual ability can be achieved.

A World Bank report on how Vietnam can improve its educational performance states: “Much of the inequality in learning outcomes, between different types of young Vietnamese observed in primary education and beyond, is already established before the age of formal schooling.”

This may be caused by physical poverty, including bad or insufficient nutrition, which will stunt a baby’s mental development. Similar poor nutrition will be found in a minority of homes in rich countries, too. But such things  that can be explained by lack of money are not the only factors affecting a child’s mental development.

The World Bank Report goes on: “The brain development of young children’s highly sensitive to stimulation and interaction. The more parents and care givers interact with a young child, for example through talking, singing or reading, the better are the conditions for brain development.”

The report suggests that, in Vietnam, babies from better-off families have more stimulated interaction with parents and care givers than those from poorer families. But the general point about what makes a difference applies at all income levels. And if very small children, as they develop, only see their parents for an hour or so each day and spend the rest of the time away from them, they may lose out on mental development, no matter how well-off they may be materially.

If these World Bank views about intellectual development are true, they deserve an urgent response from parents, crèches and governments in Europe. If we are going to depend on a smaller number of children to support our welfare systems over the next 40 years, we must do everything we can to enhance their earning capacity, especially by ensuring they have a happy and stimulating childhood. That may be the most important long-term economic stimulus of all.

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The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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