Convergence of ‘Low Cost’: Europe vs. the United States
Current Economic Debate
In recent weeks, a vigorous debate has emerged regarding the extent to which Europe is lagging behind the United States in terms of per capita income and productivity. This discussion was ignited by an article from Paul Krugman, who asserts that the Eurozone has hardly lost ground. Notably, when comparing per capita GDP adjusted for purchasing power parity (PPP), the EU27 has improved from approximately 60% of the U.S. level at the beginning of the century to around 74% in recent years. Meanwhile, the EU15 hovers close to 80%, with Spain fluctuating from just above 55% in 1990 to around two-thirds of the U.S. level.
Contrasting Perspectives
Krugman’s conclusions, while acknowledging the greater productivity growth in the U.S., suggest that this disparity does not automatically lead to an increasing gap in welfare as measured by current prices. However, economists Philippe Aghion, Antonin Bergeaud, and Luis Garicano challenge this view. They argue that comparing real growth and productivity should not change annually. Their assessment hinges on using a base year for purchasing power parity—like 2021—while respecting actual GDP growth rates adjusted for inflation. This method alters the comparison significantly.
Under this approach, the EU15, which stood at nearly 90% of U.S. per capita income in the early 1990s, would have lost 14 percentage points by 2024. The EU27 would have declined by roughly four points over three decades, with Spain down by about ten points to roughly 64%.
The Diverging Metrics
The implications of these contrasting methods are profound. Current PPP measurements reflect how much a country’s income can purchase at each year’s relative prices, while constant PPP measurements illustrate production growth while keeping price structures unchanged. Krugman focuses on relative prosperity, whereas Aghion and his co-authors spotlight productivity evolution.
Krugman’s perspective may indicate that the U.S.’s technological advances drive faster productivity growth and declining prices, which makes U.S. productivity advantages more apparent in real measures instead of current international price comparisons.
European Price Dynamics
Since 1995, the EU27, EU15, and Spain have actually improved their relative per capita GDP in current PPP compared to the U.S., primarily because European relative prices have dropped by over 20%. Unlike the expected Balassa-Samuelson effect, indicating that richer countries have systematically higher price levels, Europe seems to have depreciated in relative terms.
This shift does not imply that Europe has maintained its economic capacity vis-à-vis the U.S.; rather, the decreasing European prices raise questions about the underlying economic conditions. Although this trend helps sustain purchasing power within Europe, it diminishes the relative ability to acquire goods and services produced in the U.S., weakening Europe’s position as a global economic power.
The Importance of Global Competitiveness
While a lower price level may enhance internal consumption, it is inadequate for accessing global goods and services. A sustained per capita income in PPP bolstered by declining relative prices does not reflect genuine economic improvement. Ultimately, prosperity depends on an economy’s capacity to purchase international produce.
Key Takeaways
Recent analyses, particularly by Robert Inklaar, reinforce the idea that the divergence between PPP and national deflators regarding the U.S. is not peculiar to GDP but is evident across almost all EU nations when compared to the American economy. This situation suggests real changes in relative prices, quality differences, regulatory issues, and measurement challenges.
In conclusion, two essential insights emerge from this debate: First, U.S. real productivity growth has outpaced that of Europe. Second, reliance on current PPP shows that the EU’s welfare gap may be narrower due to relative price depreciation. Thus, Europe must not become complacent with a seemingly favorable relative income situation, as it hides the crucial issue of diminishing purchasing power against U.S. goods and services.
Prosperity demands not merely the maintenance of domestic purchasing power but also the enhancement of global purchasing capabilities, underscoring the necessity for productivity improvements and international competitiveness in the global market.