Why are English-speaking nations doing best? By Martin Wolf
Financial Times Published: January 12 2005 20:14
In 1992, when Bill Clinton was elected president of the US, he promised to learn from Germany. Rightly or wrongly, any American president who did so today would be regarded as mad. Germany is now viewed as the sick man of Europe.
This illustrates a fascinating reversal. The long decades of post-second world war decline of the English-speaking, high-income countries have ended. Since the early 1990s they have been doing better than many other long- established high-income countries and, above all, than the four dominant non-English-speaking countries: Japan, Germany, France and Italy.
Why has this reversal occurred and will it last? These questions will be addressed below. But first, one needs to understand what has happened.
Between 1991 (the trough of the US cyclical downturn before the slowdown in
2001) and 2004, the gross domestic products of Australia, the US, Canada and the UK (in that order) rose considerably faster than those of France, Italy, Japan and Germany (see chart). The picture for GDP per head (at purchasing power parity) is similar. Between 1991 and 2004, it rose by 39 per cent in Australia, 32 per cent in the UK, 30 per cent in the US and 29 per cent in Canada. It rose by only 19 per cent in France, 17 per cent in Italy, 15 per cent in Germany and 14 per cent in Japan.Chart:
Sizeable changes in relative incomes have resulted. In 1991, even after unification, Germany's GDP per head (at PPP) was 3 per cent higher than the UK's. By 2004, it was roughly 11 per cent lower. Over the same period, Italy has moved from being 2 per cent richer than the UK to being 9 per cent poorer.
If we had added Ireland and New Zealand to the list of English-speaking countries, the contrast would have been sharper still: New Zealand's GDP per head rose 30 per cent between 1991 and 2004, the same increase as for the US, and Ireland's by a sensational 131 per cent. Other relatively successful, long-established, high-income economies have been the Nordic countries (Denmark, Finland and Sweden) and the Netherlands. Spain is different: it is a catch-up story.
The comparison between the four largest English-speaking countries, on the one hand, and Japan and the three big continental European countries, on the other, is compelling. Apart from Australia, they make up the membership of the Group of Seven leading high-income countries. The four English-speaking countries contributed 48 per cent of the GDP of the Organisation for Economic Co-operation and Development in 2003, while the other four contributed 33 per cent. These are the dominant advanced economies.
To appreciate the transformation in relative performance, one needs to look at the entire period since the second world war. In 1950, the weighted average GDP per head of the four big non-English-speaking industrial countries was just 35 per cent of US levels. By 1991, this had risen to 79 per cent. By 2004, the ratio was back to 70 per cent, where it had been in
1973 (see chart).Chart:
All four of the non-English-speaking countries show much the same pattern, although Japan's has been the most remarkable. Japan's GDP per head rose from just 20 per cent of US levels in 1950 to a peak of 85 per cent in 1991, only to decline to 74 per cent by 2004. The patterns for a (here notionally united ) Germany, France and Italy are similar, although less dramatic.
The UK, Canada and Australia have had a very different history. Throughout this long period, their GDPs per head have remained much the same relative to that of the US. Canada's GDP per head rose and then fell relative to the US but these two countries both began and ended the post-second world war period with almost identical incomes per head.
Since the golden era of 1950-73, the growth performance of the four non- English-speaking countries has deteriorated over each successive cycle - the era of the two oil shocks (1973-81), then the expansion of the 1980s (1981-91) and finally the most recent expansion (1991-2004) (see chart).
While the erstwhile hares have slowed to a crawl, the English-speaking tortoises have accelerated, though only a little. These four countries have never grown quickly by the standards of Japan, Germany, France and Italy in the 1950s and 1960s, partly because they were then relatively so wealthy. But, except for Australia and the UK in the 1970s, they have also never grown as slowly over a sustained period as the non-English-speaking four have done since the early 1990s.
Chart:
Comparative productivity performance largely matches that in GDP per head. Productivity growth (measured by output per hour worked) in the four non-English-speaking countries was far higher than it was in the English-speaking countries in the 1970s but then fell sharply. Yet there was also a significant recent improvement in Australia and the US.
The story in the labour market is similar. In the 1950s and 1960s US unemployment rates were much higher than in continental Europe. Today, they are much lower: this is not because US unemployment rates have fallen but because the latter have soared. In 2004, for example, unemployment rates averaged close to 10 per cent in Germany, more than 9 per cent in France and above 8 per cent in Italy, against negligible levels in the 1960s. The US average was much the same as it had been 40 years before.
Still more revealing is what has happened to the return on investment. A simple way of understanding this is via the incremental-capital-output-ratio (Icor) - the quantity of investment divided by the increase in output it generates. In the four English-speaking countries, a given amount of gross investment has, over the last decade, generated at least twice as much output as in the other four countries.
It is not that the Icors of the English-speaking countries are lower than they were 30 years ago but that those of the other economies are so much higher. Japan is the polar case: its 10-year average Icor has been 20, against just three 30 years ago.
Chart:
This then raises three huge questions. First, why has the economic performance of the non-English-speaking countries deteriorated so much? Second, why has the performance of the English-speaking countries improved, at least relative to the nadir in the 1970s? And, third, will the relative out-performance of the latter group last?
A part of the answer to the first of these big questions is that the exceptional growth performance of Japan, Germany, France and Italy could not endure because it was based on the exploitation of a unique opportunity - to catch up on the productivity of the world's most advanced big economy. The opportunity was far bigger than for the UK, Canada and Australia, because the gap was so much larger.
Yet this does not explain why what had been a remarkable growth performance turned, over time, into underperformance. Since none of these economies surpassed US GDP per head, there was no obvious reason for them to fall behind, once again.
There are three classes of explanation: first, that their success bred failure; second, that they failed to make needed adjustments to changes in global economic opportunities; and, third, that they made similar policy mistakes. Let us examine each of these in turn.
The economist who best explained the first line of argument was the late Mancur Olson. His book, The Rise and Decline of Nations, was written to explain the relative failure of the US and the UK after the second world war.* Drawing on his work on interest groups, Olson argued that, over time, the emergence of "distributional coalitions" - interest groups seeking their own narrow advantage - would ossify economies. Defeat in the second world war had destroyed many of these coalitions in Japan, Germany, France and Italy, thus enabling the great catch-up era.
Chart:
All good things come to an end. The better things are, the more complacency sets in. Distributional coalitions re-emerged with great force because economic success made higher taxes and regulations seem next to costless. In the 1960s and 1970s, public spending, welfare benefits and regulations jumped in the three continental countries. Over time, these sapped economic flexibility and slowed innovation and adaptability. This then showed itself in declining productivity growth and rising unemployment.
The second line of argument - that these outstandingly successful economies failed to adjust to changed opportunities - itself has three components. One is that these have been high-saving, high-investment economies. But, as they grew richer and their labour forces ceased to grow (indeed, started to shrink in the case of Japan, Germany and Italy), the opportunities for investment diminished. As a result, they have tended to end up with chronically excess private savings and chronically deficient aggregate demand (particularly in Japan and Germany).
The second component is that all four economies, but particularly Germany and Japan, had been late-industrialisers: as a result, they had strong manufacturing and weaker service sectors. By the 1980s, however, the era of catch-up industrialisation was over. Their world-beating manufacturing companies were looking to produce more abroad where costs were lower and demand was more dynamic. At home, the service sector needed to generate new incomes and jobs was relatively weak and hampered by intrusive regulation.
Chart:
The third component is more specific. The great opportunity for high- income countries today lies in the exploitation of information technologies throughout business. To do so requires great flexibility. But, it may be argued, the huge costs of laying off workers and closing facilities have hindered this kind of adaptation, particularly in continental Europe.
The last line of argument - that they made similar policy errors - itself has two components. The first is that Japan and the eurozone both ran insufficiently expansionary monetary and fiscal policy. As a result, both suffered from weak domestic demand and undue reliance on foreign demand.
In the case of Japan, the error has been the tardy response to the collapse of the asset price bubble. In the case of the eurozone, many argue, the mistake lay with the failure to manage German unification sensibly, reinforced by excessive attention to arbitrary fiscal rules and insufficiently responsive monetary policies.
The second and far more compelling component, in the case of the eurozone, is that, in spite of weak demand, inflation has remained extraordinarily sticky: consumer prices rose by more than 2 per cent in 2001, 2002, 2003 and
2004, even though excess capacity increased year by year. This, then, reflects the weakness of market pressures. The big mistake then was the failure to deregulate.Chart:
Now turn to our second big question: why did the English-speaking countries' performance improve? A part of the answer is that their poor relative (and even absolute) performance in the 1960s and 1970s stimulated substantial reform in all four countries (not to mention Ireland and New Zealand). They not only deregulated their economies significantly but made substantial improvements in monetary and fiscal discipline, as well.
Moreover, the shift to the service sector was well suited to economies that had long been relatively weak in manufacturing. Their financial systems were also extremely well-suited to intermediating savings among households - that is, transferring money from savings-surplus (usually older) to savings-deficient (generally younger) households, thereby keeping household savings low and consumption booming.
Yet another component was that the world was short of creditworthy borrowers at a time of excess savings in a number of big economies. The English-speaking countries were ideally suited to fill this gap. Finally, their economies seemed to be relatively good at exploiting the new knowledge-intensive opportunities for higher productivity: the US, Australia and Canada showed a marked acceleration in productivity growth from the mid-1990s, although this is less evident for the UK.
This then leaves us with the last of our three big questions: will this turnround in relative performance last? Will the English-speaking countries continue to drive ahead of the others, fall behind, once again, or end up level-pegging.
Chart:
If experience has shown anything, it is the folly of extrapolating past success. The English-speaking countries have evident points of weakness: the US, UK and Australia are all running sizeable current account deficits; the UK and US have used aggressive fiscal policy to sail through the recent slowdown; and all four countries have very low rates of household savings. Corrections in any of these (interconnected) areas could be painful.
Again, the macroeconomic policy blunders that have affected Japan and much of the eurozone over the past decade must end at some point. But will entrenched interest groups allow these countries to raise returns on investment, increase flexibility of product and labour markets and so, once again, outperform the English-speaking countries? The next 10 years will provide the answer.
- The Rise and Decline of Nations: Economic Growth, Stagflation and Social Rigidities (New Haven, Connecticut: Yale University Press, 1982
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