Commentary

Free to Adjust

By Olaf Gersemann
July 23, 2004

America is not the only land of the free. Look at the just-released 2004 edition of the Economic Freedom of the World report. The index in this report shows the degree to which a country’s policies and institutions are supportive of economic freedom. Taking the index as a yard-stick, Hong Kong gets the most favorable rating, closely followed by Singapore. The United States comes in third, along with New Zealand, Switzerland, and the United Kingdom.

The report — published by the Fraser Institute, the Cato Institute, and other think tanks — also shows that since the 1980s there has been a close link between economic freedom and economic growth. What is more, however, is that there is evidence that the link between freedom and prosperity has become stronger over the last quarter century.

To see why, compare the U.S. to the Big Three among continental European countries. In the new report, Germany is ranked 22nd; Italy, 36; and France, 44. This placing reflects the fact that these countries have not kissed big government goodbye. There has been no German Ronald Reagan and no French Margaret Thatcher.

However, the post-war economic systems of France, Germany, and Italy have always been more restricted by regulations and high tax burdens than America’s. Still, in the first decades after World War II, this did not stymie economic growth in continental Europe. The prosperity gap between America and Europe’s Big Three shrank. Then, starting in the early 1980s, the gap slowly but relatively steadily widened again. The result is that in recent years the prosperity gap between France and Western Germany on the one hand and the U.S. on the other was as big as it has been since the late 1960s. In other words, for quite a while European-style “comfy capitalism” seemed to work as good as U.S.-style “cowboy capitalism”. But that is no longer true.

What happened? Firstly, there was a time in which economic policy mistakes had little impact, if only because there were many other governments that made far more basic mistakes — remember communism? After all, it’s easier to compete with countries whose governments systematically destroy their economies’ dynamism. But today, according to the Economic Freedom report, Estonia has a freer economy than Germany has; Hungary is ahead of Italy; and Latvia and the Czech Republic do better than France.

Times are a-changin’ in another sense as well. Globalization and the revolution in information and communication technologies necessitates that capital and labor are increasingly directed into new jobs, new technologies, and new corporations. It’s exactly the ability to adjust in such a way that makes a relatively unrestrained capitalism like America’s look superior.

Take, for instance, unemployment benefits. In times of slow structural change, Germany’s generous unemployment benefits didn’t cause much trouble; they weren’t even costly for taxpayers because the unemployment rate, up until the early 1970s, was below one percent in Germany.

Now, as globalization and technological progress make many old jobs redundant, those benefits have created a bizarre situation. On the one hand, there is mass unemployment in Germany. At the same time, because people don’t go to where the jobs are, companies in certain regions and industries are unable to find employees, and the costly bill is picked up by those who are lucky enough to still have a job.

In America, the difference between the U.S. state with the lowest unemployment rate and the one with the highest was 4.3 percentage points in May. Meanwhile, in Germany, a country the size of Montana, the range of unemployment rates among the 16 states was 13.5 percentage points.

Or take Europe’s strict employment-protection legislation, which makes it costly, if not impossible, for a company to fire anyone.

The downside of this policy, certainly, is that companies get very reluctant to hire people in the first place. In times of little adjustment pressure, this may not do too much harm. In an era, however, in which technological progress calls for the creation of whole new industries, strict employment protection legislation does damage big time. According to a study by the Paris-based Organization for Economic Co-operation and Development, start-up companies on average expand their staff by 13 percent in France and by 24 percent in Germany within the first two years; in the U.S., the increase amounts to 161 percent. Thus, while America has witnessed the rise of IT producers such as Cisco, Dell, Hewlett-Packard, Intel, Microsoft, Oracle, and Sun Microsystems, no German IT start-up ever went on to become a global player; the only exception is SAP, a software company.

The price countries pay for burdening their citizens and corporations with big government is huge. Voters, whether American or Argentinean, Australian or Austrian, might want to consider that before they cast their ballot next time.

Olaf Gersemann is the Washington correspondent for the German business weekly, Wirtschaftswoche, and author of the forthcoming Cato Institute book, Cowboy Capitalism: European Myths, American Reality.