FES07 - Ed Phelps and the shortcomings of "continental capitalism"

(Running notes from the second Future of Europe Summit in Andorra)

Edmund Phelps, Nobel Prize for Economics in 2006 (photo) gives a speech on the shortcomings of "continental capitalism" (read: continental Europe) vs "anglo-saxon capitalism", analyzing some macroeconomic factors that matter for the prospects of business activity. He says: There is first a demographic factor. I have been wondering for some time why there wasn't more attention paid to the bleak demographic future faced by Italy, Germany and to a lesser extent Spain, France and other European countries. My reasoning was that with the tremendous growth of welfare spending coming up in the decades of the 2020s and 30s there would be higher taxes to cover the costs of those pensions and other entitlements. And that was going to have a negative impact over assets and investments at that time: if you know that business assets that are accumulating now are going to have littler value, you won't invest that much. I expected that this would depress investment already now, but maybe 20-30 years are such a long time that the effect now of this bleak future is still small. But it's on the horizon. The big productivity slowdown that occurred in Europe in the mid-90s on, has mostly happened in the countries that have a demographic problem.
A further negative is that world interest rates are unlikely to remain as low in the last 10 years as they've been in the past. There will be pressure on China not to supply so much savings to the world economy, and that's gonna cause rates to go up.
On the other end, an opportunity has been presented to Europe by the acceleration of productivity that occurred in the US, Canada, South Korea and other countries. If European productivity was 100 % of the US level in 1992, now it's 72% of the US level. So there is a low-hanging fruit out there. It's just a matter of when the catch-up is going to begin. the great European catch-up after WW2 didn't start until mid-50s, it took a long time to get organized etc. Here too it's taking time for Europe to latch on to the new technologies and processes that have been developed during the Internet revolution.
What are the hurdles that are going to be overcome in Europe if there is going to be a transformation of the economy from a followership to a leadership/innovation? A lot of things have been holding Europe back:
Financial sector: it doesn't do a good job of assisting and mentoring startup entrepreneurs. There aren't enough angel investors and venture capitalists. There is still relational banking in which certain customers have inside track for loans, and that makes an inhospitable atmosphere for outsiders. Another institutional problem area is certainly the labor market where the power of unions, thanks to myriad of laws, creates lots of difficulties for companies. In the broader market, you've all the permissions, bureaucratic red tape that goes in the way of the startup entrepreneur, and also there is evidence to suggest that management is not up to standards in Europe (which is not to say that every US company is well-managed).
It's easy to talk about some of the institutional reforms that would be good to make from this point of view, but the problem is that there aren't two or three identifiable reforms that would take you most of the way: it's not that simple. I can't think of any single step that could be considered a magic bullet in raising the dynamism of the continental economies. But even if you could have a sweeping change of the entire institutional structure, even then it would be possible to overestimate the effect: there is a whole culture and attitude towards business and economy that has to be reckoned with, and if nothing can be done with this whole culture, then it remains unclear how far we can get towards restoring dynamism.
Other problems: Traditional solidarism that inspired formation of the unions. Desire for order or consensus (that leads to require virtual unanimity among stakeholders). The number of licenses needed by a startup has become a standard index of the veto powers against innovation. Ethics of egalitarianism has deterred the individual from deviating from his/her group. The effect of all this on the entrepreneurial spirit is significant. In Europe there is a strong distaste for money-grabbing. Europeans view the speculations of entrepreneurs and traders as worthless and believe that rational economic policy requires an intervention by the state. Part of the economy is still a system of state patronage and state protection of threatened companies. A whole industry could come to be protected as a national treasure (ex: the film industry), becoming social clubs in which only those with connections could come in. Companies remain private firms rather than listing on the stock exchange and they have concentrated ownership.
Can a continent with such a legacy regain economic dynamism?
I think there can be progress, I have a sense that the corporate sector itself is trying to lead the way by reforming to a degree, without necessarily having the support of the government. It's naive however to think that this recent enthusiasm for self-reform in the corporate sector will be able by itself to bring back a dynamism to continental economies. Political and economic leaders must lead a cultural revolution.

(BG: I believe that most of Phelps statements are based on the analysis of outdated data. Suffice to say that Germany for example, right now, is doing much better than the US by almost any variable -- and still can afford for example universal healthcare coverage. It always baffles me how the US model is heralded by economists without taking into account issues like the 40+ million of Americans who are health-uninsured).
(UPDATE - Ann Mettler in a subsequent speech agrees with my point about Europe doing much better than Phelps' analysis).