Don't undermine free markets

Written by Philip Whyte [1], Simon Tilford [2], 08 October 2008
From International Herald Tribune

Commentators and politicians have been falling over themselves to read the last rites to "Anglo-Saxon" capitalism. Anglo-Saxons have undoubtedly been guilty of profligacy and hubris. Inevitably, opponents of flexible labor markets or competition in services have seized on the financial crisis to argue that it discredits every aspect of the model. This is mistaken and bodes ill for Europe's long-term economic prospects.

There is no question that the crisis has been a poor advertisement for aspects of the "Anglo- Saxon model." Credit has grown too rapidly for far too long in the United States and Britain, contributing to unsustainable economic imbalances. Securitization was supposed to have spread risk, but seems only to have ratcheted it up. Risk management in many banks has been inadequate. Some institutions have behaved recklessly, and taxpayers are rightly furious at having to bail them out. The long-term price for the financial sector will be a tightening of the regulatory screw.

Anglo-Saxons, then, have unquestionably been guilty of financial excess. But it would be simplistic to lay all the blame at the door of their model of finance. For one thing, crises are inherent to the financial sector itself, not just its American-British variant. Countries with very different models of finance, such as Japan, Sweden and a number of East Asian states, have experienced similar crises over the past 20 years. Besides, a host of other countries, notably in Central and Eastern Europe, have experienced credit bubbles.

What of the wider charge that the financial crisis invalidates the U.S. model in its entirety? During the 1990s, no one ever suggested that Japan's travails meant the country's previously admired strengths - such as the ability of Japanese firms to turn ideas into commercially successful products - had been a mirage all along. Similarly, it would be a mistake to fall into the trap of believing that the superior performance of the U.S. economy over the past decade is simply the result of debt-fueled excess. The fundamentals of EU economies are no stronger, whatever some Europeans may believe. And the strengths of the United States will return to the fore once the current crisis is over.

The U.S. remains easily the world's most innovative economy. Its companies dominate most high-tech sectors, it spends considerably more on higher education than the EU, and it has hugely impressive productivity levels. The United States is likely to experience two or three years of weaker-than-normal economic growth, but America has an amazingly good record of recovering rapidly from recessions; it may well emerge from this one more rapidly than many EU economies. In many ways, the United States remains the benchmark by which the European Union should judge its own economic performance.

European economies continue to exhibit greater underlying weaknesses than America. Progress on the Lisbon agenda of economic reforms has been patchy. For all Europe's vaunted economic recovery in the past year, productivity growth continues to lag behind that of the U.S. by a wide margin. The diffusion of new technologies remains slower in the EU than the U.S., and the EU struggles to develop fast-growing high-tech companies. Domestic demand in some EU countries, most strikingly Germany, remains very weak.

The current financial crisis is bound to embolden opponents of economic reforms in Europe. But it must not be allowed to obscure the challenges facing European economies or the underlying strengths of the United States. America is by no means perfect. On some measures, such as health care, European countries get better outcomes - and at lower cost. European economies also use energy much more efficiently than the Americans. But European economies remain less dynamic and have much higher levels of structural unemployment.

Europe's prosperity depends on becoming better at developing and deploying new technology. Unless it can do this, its productivity will remain well below America's. Any re-regulation that makes it harder to switch resources from slow-growing or declining sectors into higher-tech, knowledge-based ones, will undermine the drive to improve Europe's economic performance. This, in turn, will leave the Continent poorly placed to cope with it aging population.

In short, the damage wrought by a backlash against economic liberalization could be every bit as debilitating as the more immediate impact of the financial crisis on Europe. More than ever, it is crucial that careful analysis prevails over political sloganeering.