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Are we lagging the continent?

In the great Euro-debate of our time the Europhiles regularly deploy a powerful debating weapon. 'Ho, ho' they say, 'if the continent is that terrible, how come that Germany and France are so much richer than us?' Out then roll the statistics of Gross Domestic Product, GDP, per head (of population) which indeed seem to show Britain lagging behind.

This is a dry topic. Eyes glaze over, the point is registered in an uneasy way, and we all go back to talking about unemployment which we understand.

Well, dry it may be but today I propose that we roll up our sleeves and get down to it. The starting point must be those statistics measuring GDP, all that the economy produces in its geographical area (with no deduction for depreciation of the capital stock). It is a measure of what those resident in that area could 'enjoy'. Of course they spend it in all sorts of different ways which we will deal with later.

The first important question, having measured GDP per head in domestic currency, is how to value it for purposes of comparison with other countries. Converting it all into US dollars would be a start; but it is not enough because exchange rates fluctuate for all sorts of reasons away from a true conversion of purchasing power. In other words, things can cost more in Britain or Germany than in America when converted into dollars; how often have we not heard that complaint from visiting American tourists? Since we want to know what the residents of a country 'can enjoy' we must clearly adjust their dollar GDP for the prices of what they buy. If they pay more in dollars then clearly they can enjoy less. So GDP at Purchasing Power Parity is the result of dividing each country's dollar GDP by the dollar price in that country of a basket of goods and services typically bought in America. This measure is the same as converting GDP at PPP exchange rates (i.e. those that convert so that the US basket's price in dollars is the same everywhere).

On that basis West Germany is today (1999) about 14% richer than the UK, All Germany about 8%, and France about 7%. Yes, ahead but not probably by as much as you thought. These figures, which are only rough orders of magnitude, come from the Penn World Tables, updated using OECD figures (both can easily be found on the Internet).
But what do these figures mean as indicators of the success of these countries' systems relative to ours? Well, first, GDP is a lagging indicator of performance; it measures the sum total of years of economic policy, just as someone's position half-way through a marathon reflects their efforts in the first six miles as well as the next seven. In the post-war world we got off to a very bad start, obsessed as we were with building a welfare state, while our continental neighbours got stuck into rebuilding their economies, letting welfare and 'social justice' take a back seat. West Germany famously had the 'Economic Miracle' of freeish markets under the policies of Ludwig Erhard. It was really not until the 1970s that they began to shackle themselves with social costs; and not till 1979 that we began to unshackle ourselves. So for some three post-war decades the continental economies were growing much more rapidly than ours, as they pursued better policies. By the early 1980s their GDP per head had greatly exceeded ours; West Germany by 25% and France by 20%.

So the first point is that in judging our new post-Thatcher way of running our economy we must not include the effects of pre-Thatcher policies. That means in effect we must compare the difference in our GDP per head relative to the continent between now and then. Of course that comparison shows a massive improvement- by 11% against West Germany and 13% against France- due to our relative improvement in productivity and in getting people into work. It takes time for differences in policy to show up in output; but they are now clearly doing so.

But matters do not stop there. The ultimate aim of an economy is to support the living standards of its people. GDP does not measure that. For example the government may take a large slice of output and waste it on things that people do not much want. Or industry may spend too much on inefficient plant and equipment. Both these divert output away from supporting people's living standards.

Both are highly relevant to the continental comparison. Public spending takes some 10% more of GDP on the continent than here, thanks to their greater interventionism. The productivity of capital is lower than here (some 7% lower in both France and Germany according to the 1998 McKinsey report) probably because of higher industrial subsidies, a less competitive capital market (takeovers are more difficult with cross-shareholdings), and also the incentive to substitute capital for expensive labour; this implies that for the same output industry has to invest more and can pay out less in total wage bill to remain competitive.

The startling effect of these differences on the UK's relative living standards has been set out in Keith Marsden's Handicap Not Trump Card for the Centre for Policy Studies. For example, according to the OECD's 'Tax/Benefit position of Employees', a single man on average manufacturing earnings in 1996 was 6% better off here than in Germany and 32% better off here than in France. A more general measure of living standard is private consumption per head, which in common with the US represents some two thirds of our GDP against 53-58% among our two big neighbours: we now consume 9% more per head than West Germany and 7% more than France. Twenty years ago we consumed 6% less than West Germany, and 13% less than France. In other words, living standards here have been growing 0.7% a year faster than in Germany and 0.9% a year faster than in France.

This shows not merely catching-up with the continent, but overtaking in the fast lane. We have to carry on eating our spinach, and resist the Euro-lure of too much garlic and sauerkraut.

Patrick Minford is professor of economics at Cardiff Business School  

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