The Other Reason Europe Is Going Broke : Planet Money Europe has been experiencing an economic crisis for longer than you thought.

The Other Reason Europe Is Going Broke

People wait in line at a government employment office in Madrid. DOMINIQUE FAGET/AFP/Getty Images hide caption

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People wait in line at a government employment office in Madrid.


Below is Adam Davidson's latest New York Times Magazine column, "The Other Reason Europe Is Going Broke." Read all of Davidson's Times Magazine columns here.

One great way to start a bar fight during an American Economic Association conference is to claim that the U.S. economy is preferable to Europe's. Someone will undoubtedly start quarreling about how G.D.P. per capita doesn't measure a person's happiness. Someone else may point out that if you look at income inequality and entitlements, the average European is doing much better.

But G.D.P. per capita (an insufficient indicator, but one most economists use) in the U.S. is nearly 50 percent higher than it is in Europe. Even Europe's best-performing large country, Germany, is about 20 percent poorer than the U.S. on a per-person basis (and both countries have roughly 15 percent of their populations living below the poverty line). While Norway and Sweden are richer than the U.S., on average, they are more comparable to wealthy American microeconomies like Washington, D.C., or parts of Connecticut — both of which are actually considerably wealthier. A reporter in Greece once complained after I compared her country to Mississippi, America's poorest state. She's right: the comparison isn't fair. The average Mississippian is richer than the average Greek.

Europe is undergoing not one but two simultaneous economic crises. The first is a rapid, obvious one — all about sovereign debt, a collapsing currency and austerity measures — that we hear about all the time. The second is insidious but more important. After decades of trying, Europe as a whole still can't quite figure out how to be flexible enough to compete in the global economy.

The story of how Europe lost its flexibility can be told in three stages. First came rapid growth that economists called "convergence." With a lot of help from the U.S., Europe developed massive industrial capacity in the postwar years. Many of Western Europe's economies grew so fast that governments could easily afford health and unemployment insurance and other benefits that, by U.S. standards, were remarkably generous. Most observers expected that its wealth would soon "converge" upon that of the U.S.

But the European economy did not recover from the worldwide oil shock of 1973 nearly as quickly as its American counterpart. For more than 25 years (phase two), as its population aged, Europe's economy grew more slowly than the United States'. Its active capitals belied bloated businesses that were losing contracts to U.S. competitors or growing suburban ghettos filled with a permanently unemployed underclass.

Even its major successes — like Germany's impressive machine-tool and automotive-industrial sectors — were refinements of old ways of making money rather than innovations in new industries. Western Europe played a remarkably small role in the computer and Internet revolutions. (On the other hand, Estonia, with less than two million people, gave the world Skype.) When the economic forecasts were written during Europe's doldrums, the Continent looked destined to become a decrepit old-age home with too few young people around to pay the bills.

Enter phase three: what might be called the Principled Compromise. Increasingly since the mid-1990s, European leaders have been trying to figure out how to keep up with this new globalized digital economy. To compete with the U.S., China, India and Brazil, Europe focused more intently on broadening its internal market. It's easier for businesses to stay competitive when there are a few hundred million potential customers using the same currency and not requiring customs forms.

To many American eyes, however, Europe's creation of a common market and currency was only half the battle — and probably the less important half. It's a core view of U.S. business that success requires a degree of destruction. If workers can't be fired, companies can't drop unproductive businesses and invest in more promising new ones. If workers know they'll get generous government benefits no matter what, so the theory goes, they'll get lazy.

But just as the U.S. was dismantling much of its welfare system — replacing it with the welfare-to-work reforms of the mid-1990s — Europe was (somewhat nobly) trying to show that an economy can be humane and competitive. In 1994, Denmark modernized a system, which came to be known as "flexicurity," that offered American-style flexibility (layoffs, transitions into new lines of business) coupled with traditional European security. Laid-off workers were offered generous benefits, like 90 percent of their last salary for two years and opportunities to be retrained.

And it worked incredibly well. After Denmark's unemployment rate sank to among the lowest in the world, the flexicurity model spread throughout Europe. It has been successfully implemented, in locally appropriate ways, in Norway, Sweden and Finland. But in other countries — like Germany, France and Spain — similar reforms faced stiff resistance from workers who preferred the old way. Several countries applied the measures in a two-tier system: people who already had jobs were protected by pretty much the same old rules, while the unemployed — who were often younger — were offered less secure work at lower pay. Greek unions insisted on so much security and so little flexibility that now the country has neither. Flexibility has done little to help Italy, which remains effectively two countries. There is a rich nation in the north where workers earn great salaries in highly productive and competitive industries; many people south of Rome are living in a broken, developing economy that's considerably poorer than Greece.

Many now believe that Europe's decision to create a common currency ended up pushing much of the Continent further behind. Greece, Italy, Spain, Ireland and Portugal would arguably be much better off if they could simply devalue their old currencies and sell exports at a relative discount. Instead, they're stuck with a euro whose value is largely based on their more successful neighbors. The U.S. is in no position to gloat, but our basic mechanisms of competitiveness are still in place. We'll grow again. We just need to figure out how to distribute the spoils. And Europe, we once thought, was supposed to teach us how to do this.

European leaders like to mock the U.S. for its inequality and lack of social safety net. Though, for now, it looks as if Europe is headed for a two-tier society without any plan for improving the lot of the lower tier. How can Brussels excite a generation of ambitious young people — the ones who will determine Europe's future success — when too many of them are offered low-wage, short-term work in stagnant industries to pay for the far more generous benefits their elders receive? How can Europe compete if its youth experience the flexibility while the old get the security?