One of the subjects I have been mulling over for a blog entry for some time has hit the blogosphere: the increasingly fraught relationship between Europe and the US. There's the article by Steven den Beste, and the follow-up by Eric Raymond. Both were touched off by this must-read article. Regular readers of this blog will know that I am not exactly optimistic on the future of Europe. The economic gap between Europe and the US is widening simply because of the economic structures that have been put in place. These discourage investment, risk taking and hard work, while at the same time they provide an excellent and cozy resting place for those who want to live more or less comfortably on government handouts. But the demographics of Europe make the situation even worse. Not only are European economies not capable of generating endogenous growth, the changing age distribution of the population is going to lead to major dislocations within the next decade. Unfunded pension systems are a financial catastrophe waiting to happen, and averting disaster is becoming ever more expensive to do. This problem also exists in the United States, but to a far lesser extent. For one, immigration is keeping the age distribution more favorable (immigrants tend to be young), while many more Americans have capital-funded pensions. The only countries in Europe that have comparable funded pension coverage are the UK, the Netherlands and Switzerland. All other face a huge black hole of unfunded pension liabilities that in themselves could cause serious damage to the economy. The pay-as-you-go systems that are now in place will become too expensive to fund from taxation. This problem will also have to be faced by America's great pyramid scheme, Social Security. The relative size of the problem is still far smaller than in Europe.

America's solution to its demographic problem is not available to Europe for political reasons. Unemployment is high already, and the current immigrant population is poorly assimilated and generally a drag on the economy rather than a boost to it. To put things into perspective: America's unemployment rate is just below 6% coming out of a recession, while the recent cyclical low in Europe-wide unemployment was around 8% (and this includes some low unemployment countries such as the Netherlands and Ireland). While Europe has not been able to provide jobs to its stagnant population, the US economy has had essentially full employment while at the same time absorbing huge numbers of immigrants, both legal and illegal. But on virtually every aspect of economic performance the US is beating Europe, and it's been getting worse from the European point of view. In 1981, Europeans worked on average around 1750 hours a year, and Americans about 1820. By 2001, the American is still working about 1820 hours a year, while the average European is down to 1550. The huge improvement in US productivity, which has not been mirrored in Europe at all, has meant that even in the areas in which Europe used to have an advantage, the situation is now reversed. Real GDP per hour worked is increasing at a faster pace in the US than it is in Europe.

Steven den Beste spends much of his article talking about the brain drain from Europe to the US, and the relative paucity of high-tech companies here. A big part of the problem is the lack of entrepreneurial spirit, which the socialist welfare state sucks out of all but the most enterprising soul. It also reminds me a joke a German friend of mine (now living in the US) told me (except when he told it, it was funny): if Steve Jobs and Steve Wozniak had been Germans, they would never been able to build a big successful company (Apple), because running a business in a garage is illegal in Germany. It does not meet the regulatory requirements for work-spaces (Thou Shalt Have Daylight), and besides, incorporating is an amazing bureaucratic hassle that takes forever. Or how would brilliant minds (well, Woz's anyway) have fared at a big European company? By now, they might have done all sorts of brilliant things for the company, and risen to the ranks of middle-management making $60,000 a year. Then again, since they were college drop-outs, they would not have been hired in the first place. Actual achievement is not the criterion; the right papers are.

In listing the European companies that den Beste thinks are worthy of being called high-tech, he mentions amongst other Siemens and Philips. Now, it is true that both these companies have good research staff and have produced some interesting advances in technology. However, as companies, they're not doing well at all. Siemens is a GE-wannabe, producing everything from light bulbs to nuclear reactors. Its financial performance has long been a blot on the German industrial landscape. (Whether GE's performance is as good as the myth would make it seem is a different matter. GE Capital is a large and opaque part of GE's overall balance sheet.) Philips is somewhat similar, although it's one of those companies that has been trying to find the right reorganization to really get it going. It too is a conglomerate; Philips originally started as a light bulb producer and then branched out. Everybody agrees there's a lot of potential in Philips; it just somehow seems it never gets realized. So while their research may be top-notch, the companies themselves are not. This is partly due to poor management, but to even greater degree it's also due to the fact that management's hands are tied by Europe's "social" legislation that makes firing people difficult. Closing inefficient parts of the business should be a management decision, but in Europe, it's a socialized decision in which the labor unions have considerable say. And the cost of closing down an inefficient factory or division can often exceed the drag that it poses on the bottom line. In fact, closing a marginally profitable factory is seen as an act of evil; it makes money, does it not? Never mind that the return on equity is far below cost of capital, and that having to drag these underperforming elements along hurts the company in the long term. Still, the process of moving companies abroad is continuing. At the current rate, most of the productive assets of big European companies will have been moved outside of western Europe in ten or twenty years' time, just like Sweden has been losing productive assets to lower-tax countries elsewhere in Europe.

Den Beste also mentions the large numbers of Nobel laureates (in the sciences) who live and work in the US rather than in Europe. I was in Italy when the physics nobel prize was announced, and the newspapers were full of stories about Riccardo Giacconi, an Italian who emigrated to the US after getting his degree, and who's been an American citizen since 1977. I only had time to read two newspapers, the Corriere della Sera and Il Sole 24 Ore. Both carried soul-searching editorials asking the question why. Why does Italy not have scientists who stay in Italy and win Nobel prizes? In the interview with the Corriere della Sera, I remember how Giacconi explained it (I can't find the interview online, alas). His advisor told him: Go West. He was a brilliant and ambitious man, and his advisor told him that if he wants to fulfill his potential, he has to go to a place that allows him to do that. And that place was the US.

All of this is well and good, but it's all descriptive and provides for no answers. There are two questions:

1) how can Europe escape from its trap?
2) what should be done about US-European relations?

Answer to question 1 is simple in the abstract: unshackle the economy, let inefficient companies die, encourage risk-taking. In short, make Europe more like the US. That's where the abstract part ends, because that's not going to happen. At least, it's not going to happen fast enough. Compared the European economies now and 10 or 20 years ago, there is considerable progress on liberalization and privatization. The job needs to be carried much further, without being undermined by statist ruses such as "tax harmonization" or "social protection." Moving to a more efficient economic structure ultimately can only be done with the consent of the European electorate, and there's pain involved. Voters don't like pain, not unless the pain of not doing anything is greater. We are nowhere near that point yet. Although the pain threshold for Europeans is likely to be lower than for the Japanese, the situation will have to deteriorate further before the electorate is ready to accept radical economic surgery. The problem is that time is running out. By 2010, the demographics in countries like Germany will be tipping into the danger zone.

The second question is much harder to resolve. It pains me greatly to see this upsurge of anti-American sentiment washing over the continent, so soon after the end of the cold war which was won for us by America. Yet I fear I must agree with Zinsmeister's analysis that Europe and America are growing apart. This is actually more important from a European point of view than an American, as Europe is sliding into irrelevance, so the tension between the US and Europe will be of ever less important over time. But as America's position relative to Europe will strengthen, Europe will have the choice of either being friendly with the most powerful country in the world, or whether it will make life difficult for itself by antagonizing the US. The process of accepting the reality of European decline will probably tend to the latter option; countries who've lost their empires have seldom taken it well. Although Europe is not losing an empire, it will be losing its pre-eminent position as the center of civilization. Europe will become Greece: a place that once upon a time had a sparkling civilization, but whose vestiges are only found in museums now. Worse, because it did have that contribution to the world all those centuries ago, it will feel entitled to be respected for that. And when that respect (and its attendant freebies) are not forthcoming, it will add further to the psychopathology that's poisoning the mind. Can you say "victim complex?"

The accumulated wealth of Europe will keep it muddling along for many decades yet. I also agree with Eric Raymond's conclusion that the situation in Europe could turn very nasty indeed if the economy collapses and ethnic tensions burst into flame. The first signs are already upon us.

None of this makes me feel better about living here, but I do not feel an immediate urgency to leave. There's still time, and my situation is not so desperate that I have to pack up and leave immediately. It's just a matter of finding the right job and I am out of here.