Wait: Maybe Europeans are as Rich as Americans

I’ve pointed out multiple times that despite Europe’s big, supposedly growth-strangling governments, Europe and the U.S. have grown at the same rate over the last 45 years. Here’s the latest data from the OECD, through 2014 (click for larger):

Screen shot 2015-11-06 at 5.19.42 PM

And here’s the spreadsheet. Have your way with it. More discussion and explanation in a previous post.

You can cherry-pick brief periods along the bottom diagonal to support any argument you like. But between 1970 and 2014, U.S. real GDP per capita grew 117%. The EU15 grew 115%. (Rounding explains the 1% difference shown above.) Statistically, we call that “the same.”

Which brought me back to a question that’s been nagging me for years: why hasn’t Europe caught up? Basic growth theory tells us it should (convergence, Solow, all that). And it did, very impressively, in the thirty years after World War II (interestingly, this during a period when the world lay in tatters, and the U.S. utterly dominated global manufacturing, trade, and commerce).

But then in the mid 70s Europe stopped catching up. U.S. GDP per capita today (2014) is $50,620. For Europe it’s $38,870 — only 77% of the U.S. figure, roughly what it’s been since the 70s. What’s with that?

Small-government advocates will suggest that the big European governments built after World War II are the culprit; they finally started to bite in the 70s. But then, again: why has Europe grown just as fast as the U.S. since the 70s? It’s a conundrum.

I’m thinking the small-government types might be right: it’s about government. But they’ve got the wrong explanation.

Think about how GDP is measured. Private-sector output is estimated by spending on final goods and services in the market. But that doesn’t work for government goods, because they aren’t sold in the market. So they’re estimated based on the cost of producing and delivering them.

Small-government advocates frequently make this point about the measurement of government production. But they then jump immediately to a foregone conclusion: that the value of government goods are services are being overestimated by this method. (You can see Tyler Cowen doing it here.)

That makes no sense to me. What would private output look like if it was measured at the cost of production? Way lower. Is government really so inefficient that its production costs are higher than its output? It’s hard to say, but that seems wildly improbable, strikes me as a pure leap of faith, completely contrary to reasonable Bayesian priors about input versus output in production.

Imagine, rather, that the cost-of-production estimation method is underestimating the value of government goods — just as it would (wildly) underestimate private goods if they were measured that way. Now do the math: EU built out governments encompassing about 40% of GDP. The U.S. is about 25%. Think: America’s insanely expensive health care and higher education, much or most of it measured at market prices for GDP purposes, not cost of production as in Europe. Add in our extraordinary spending on financial services — spending which is far lower in Europe, with its more-comprehensive government pension and retirement programs. Feel free to add to the list.

All those European government services are measured at cost of production, while equivalent U.S. services are measured at (much higher) market cost. Is it any wonder that U.S. GDP looks higher?

I’d be delighted to hear from readers about any measures or studies that have managed to quantify this difficult conundrum. What’s the value or “utility” of government services, designated in dollars (or whatever)?

Update: I can’t believe I failed to mention what’s probably the primary cause of the US/EU differential: Europeans work less. A lot less. Like four or six weeks a year less. They’ve chosen free time with their families, time to do things they love with people they love, over square footage and cubic inches.

Got family values?

I can’t believe I forgot to mention it, because I’ve written about it at least half a dozen times.

If Europeans worked as many hours as Americans, their GDP figures would still be roughly 14% below the U.S. But mis-measurement of government output, plus several other GDP-measurement discrepancies across countries, could easily explain that.

Cross-posted at Asymptosis.


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