Europe has always been home to myriad nations and cultures, a fact that’s crucial to understanding the European economic renaissance. History has taught Europeans to keep a close eye on their neighbors. The French, for instance, worry much more about Germany or the United Kingdom than, say, the average American does about Mexico or Canada. When European nations see their neighbors prospering, they take note.
Call it learning by example, or the “envy effect”—whatever you call it, it works. In the late 1980s, awareness that life was much better in the West contributed more to the downfall of communism in Eastern Europe than any arms race. In the 1990s, the strength of the German mark persuaded France and Italy to end their spendthrift ways and bring inflation down.
Early in this decade, it was Germany’s turn to learn a harsh lesson. Corporations fled the overly complacent country to set up shop in the dynamic post-communist countries next door and in Ireland. To regain its edge, Germany had to cut taxes, wages and welfare benefits. German corporations slashed labor costs per car or machine built by 15 percent within five years. Meanwhile, the government reduced the burden of taxes and other public charges from 46.7 percent of GDP in 1999 to 43.6 percent in 2005. The result? After a wrenching adjustment period, Germany has now resumed its traditional role as Europe’s engine of growth.
This amazing revival has not been lost on France. Neither has the job boom in London, now the most promising labor market for ambitious French youngsters. Already the envy effect is facilitating change in the euro zone’s second largest economy. A pervasive sense of crisis, and fear of falling behind Continental peers, helped sweep Nicolas Sarkozy into power in Paris this spring.
There’s plenty for the new government to fix, especially in the rigid labor market. French companies are reluctant to hire because the current laws make it so difficult to fire if necessary. This is especially bad for young people—employers hesitate to take risks on those with no work record, creating a cycle of underemployment. Sarkozy plans to address this by curtailing the power of trade unions, effectively abolishing the 35-hour workweek and relaxing firing rules. Occasionally protectionist, at least in rhetoric (he is French, after all), he could still turn France, which has a skilled and well-educated work force, into a new powerhouse, raising the potential growth rate of the Grand Nation from 2.25 percent to a healthy 2.75 percent per year. If that happens, Italy could be spurred to address its own peculiar problems of red tape, bloated government and unsustainable pension and welfare systems.
Germany’s new prosperity will also have Pan-European effects. Two years ago, Euro-skepticism had reached a new peak. With the exception of those living in the shadow of the Russian bear, hardly anybody could see the advantage of more European integration. Why get closer to a lumbering neighbor like Germany, then growing at a sclerotic 1 percent per year, with 9.5 percent unemployment? No wonder voters in France and the Netherlands rejected a proposed European constitution, and Britain decided to skip the euro and stick to sterling.
But with the economic revival of Germany, the tide of public opinion around both European unity and the euro itself is now turning. German Chancellor Angela Merkel last month brokered a deal to revive some key elements of the failed European constitution. Nearly half the EU’s 27 members have adopted the euro as their common currency. Most of the newest members, from Estonia in the north to Bulgaria in the south, will likely switch to the euro within the next five years. That could turn these countries into even better places to do business. And it could force Old Europe to safeguard its competitiveness with further domestic reforms.
The envy effect might spread across the Atlantic. The United States generally pays more attention to fast-growing Asia than it does to Europe, and rightly so. No developed country can match the Asian dragons’ 10 percent growth rates. But over the next few decades, the only economy that will come close in size, prosperity and opportunity to America’s is the expanding euro zone. Europe and the United States may thus still have a lot to learn from each other.
