Europe cannot ‘compete’ with old economics

Mario Draghi’s report needs to address competitiveness from a systemic perspective, focusing on underlying productivity.

In December last year Robert Solow passed away, at the age of 99. He was awarded the Nobel prize in economic sciences in 1987 for his contribution to the theory of growth. Although growth theory has developed considerably since his invention of the neoclassical growth model in the 1950s, almost all students of an introductory course in economics since then should have at least a vague clue about its main underpinnings.

More specifically, growth in gross domestic product occurs when more labour or capital is added to the production process, or when we become better at combining such physical and ‘human’ capital. This latter is often referred to as ‘total factor productivity’ and approximates the rate of technical change. Of course, there are many complexities around this basic set-up, but the main ideas are very much alive in our contemporary policy debate.

In an interview for the Freakonomics podcast, months before his death, Prof Solow said that the extraordinary strong productivity growth seen over the last hundred years or so had been critical for rising real wages and increased prosperity. At the same time, this remarkable development had caused the negative effects on the climate we all see today.

The world’s leading neoclassical growth economist during the postwar period therefore argued for a fundamental intellectual and political change—from conventional indices of productivity and GDP to broader measures of economic and human development. GDP was only a measure of economic activity, not of economic wellbeing, he said.

Moral obligation

A similar approach was foundational in this year’s trio of Lionel Robbins lectures, given by Nicholas Stern in March, identifying his growth agenda for the coming two to three decades. He argued it was not possible to separate the economic discussion from our moral values and how we should organise our society. They were highly intertwined and we had a moral obligation to act, if we wanted to maximise the probability that future generations would have at least the same standard of living as our own.

During the postwar period, Prof Stern said, the economic system had been very successful in increasing the amount of goods and services produced but had also caused the climate crisis. Income disparities had grown rapidly within countries and the life-chances of younger individuals had become more dependent on their parents’ position on the economic and social ladder. The enormous concentration of wealth was not only economically irrational but morally unacceptable.

A naïve market ideology had reversed some of the social improvements made during the first decades after the second world war. Austerity had triggered populism and support for far-right political parties had soared. Trust in society and our fundamental institutions was under threat. The demand for simple answers to complex questions was higher than ever.

With these ecological, political and social challenges, it was not enough to measure progress in terms of GDP. A broader approach was needed, preferably based on the United Nations’ 17 sustainable-development goals.

With these goals as the point of reference, the growth strategy should entail, according to Lord Stern, a more active role by the state. There were many market failures, which government could correct and so make the economy work more efficiently. Industrial policy could be good policy. Not least, government had to give direction in terms of climate policy and steer economies along that path. With the support of government, the green-technology revolution had to continue.

More investments were urgently needed, not least in green tech but also in inclusive growth more generally. It was only a matter of a few per cent of GDP and the future costs would be much higher if that investment were forgone today. It was good economics as well as good for the broader development of our societies. It would make economies more productive and therefore reduce the debt-to-GDP ratio. Growth-enhancing debt was good debt.

In line with the 2021 review of the economics of biodiversity for the British government by Sir Partha Dasgupta, such investments will create the highest economic and social return if we broaden our definition of capital. Of course, machinery/buildings and human capital are paramount, but there are also other types of capital in the balance sheet of our societies.

Most importantly, this concerns ‘natural’ and ‘social’ capital. The fundamental challenge for policy is to make sure that all types of capital develop in the right direction. The future of productivity should therefore rely not only on explicitly discussed moral values and a more active role for the state, but also on a broader, more realistic and more human definition of productive capital.

Technocratic approach

This systemic perspective on productivity—sketched through the lenses of Solow, Stern and Dasgupta—was, unfortunately, more or less lacking in the speech given by the former Italian prime minister and ex-president of the European Central Bank, Mario Draghi, in Brussels on April 16th. He was presenting the ideas underlying his report on Europe’s ‘competitiveness’, commissioned by the president of the European Commission, Ursula von der Leyen, and anticipated in late June.

Draghi’s focal point was competitiveness, not productivity. This entails taking a relative approach to Europe’s economic development—primarily, how it compares with that of the United States and China. It is, however, hard to see how the long-term competitive position of Europe’s enterprises and societies will strengthen without major improvements in the absolute level of productivity. Hence, productivity growth is a necessary condition for improved competitiveness.

Within this constrained perspective, it is easy to agree with Draghi that European Union member states have focused too much on competing with each other, not least on labour costs and fiscal austerity. This has only reduced domestic demand while undermining the European social model. It is also easy to support his contention that a major challenge for the EU is the lack of co-ordination, effective decision-making and appropriate financing. A union of independent—though interdependent—countries cannot fully benefit from its collective size.

In a turbulent geopolitical world, with the US and China applying many strategic policy measures to reduce their economic and social vulnerabilities and to improve their competitive positions, the construction of the EU becomes an even bigger challenge. Draghi called for no less than a fundamental redirection of the European project, similar to what the founders of the European Coal and Steel Community had achieved 70 years ago. The uneven playing-field and the need for more strategic autonomy required new institutional and policy solutions on the EU level.

We hope that Draghi´s report, in contrast to his April 16th speech, will contain some fragments of the thinking Solow, Stern and Dasgupta provide. The solution to the EU’s long-term productivity challenge is not a narrow, technocratic approach based on outdated economics. In the end, we are all value-driven humans striving for a higher quality of life.