Posted by: Dirk | April 20, 2009

The Ned Flanders explanation of divergent growth in US and EU

Bart van Ark, Mary O’Mahony and Marcel P. Timmer have published a study called The Prodcutivity Gap between Europe and the United States: Trends and Causes in the JEP recently. Their main findings are (p.41):

The resurgence of productivity growth in the United States appears to have been a combination of high levels of investment in rapidly progressing information and communications technology in the second half of the 1990s, followed by rapid productivity growth in the market services sector of the economy in the first half of the 2000s. Conversely, the productivity slowdown in European countries is largely the result of slower multifactor productivity growth in market services, particularly in trade, finance, and business services. This pattern holds true for Europe as a whole, and also for many individual
European countries.

Let me propose an explanation for this pattern. First, look at the following graph, which shows US net capital inflows in US-$ per quarter:

The simple explanation is: inflows of foreign capital. Since I lack time to do something more elaborate, let me tell you how it could have happened. In the 1980s, capital began to flow into the US on a net basis (more flowed in than flowed out). This lead to a stock market bubble with a subsequent crash – Black Monday. After the crash, the savings and loans crisis hit. In the mid 90s, capital inflows increased a lot. (Always keep in mind that net capital inflows come with net imports, which keeps inflation down.) The money went into the IT bubble, culminating in the burst of 2000/01. Hence the increase in productivity in IT. After the bubble, trust was eroded again and net capital inflows stopped.

With the willingness to run big current account surpluses by accepting dollar-denominated assets, countries like Germany and China then fuelled the next productivity increase – that of the fianancial market. Productivity there is measured by transactions per worker. That certainly went up, pulling productivity with it. That the capital was invested in a very bad manner did not matter for productivity. So the advantage in US productivity, I would argue, is the result of net capital inflows from the rest of the world to the US. Have a look at the graph above, and then re-read the text by van Ark et al. It would really be a big coincidence if those stories are completely unrelated.

So, the US is like Homer Simpson, borrowing tools from the European Ned Flanders. Since Ned Flanders buys the tools and then Homer Simpson appears to use them productively, Homers’s productivity is relatively high. When it turns out that he is an utter failure at his work, he returns the tools to Ned Flanders – they are used, and probably broken. That is why both are worse off in the end.

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