by Simon Tilford

Many European policy-makers and business leaders believe that a country's economic growth prospects depend on its ability to capture a growing share of global markets. Indeed, European policy-makers are obsessed with national 'competitiveness' and genuinely appear to think that prosperity is synonymous with trade surpluses. Of course, imports have to be financed by exports. But the focus on trade competitiveness risks drawing attention away from Europe’s underlying problem, which is very weak productivity growth.

The idea of economic growth being determined by a battle for global market shares in manufactured goods is easy for politicians to grasp and to communicate to their electorates. Countries have little in common with firms, but referring to Deutschland AG, or UK plc, is conceptually attractive and seductively easy. Economies running external surpluses are regarded as 'competitive' irrespective of their productivity or growth performance. The trade balance is seen as a country's 'bottom line', as if countries were firms. The trade balance is nothing of the sort, but is simply the difference between domestic savings and investment or more broadly, between aggregate spending and output. 

Governments obsessed with national competitiveness are likely to pursue damaging economic policies. If economic growth is seen as being dependent on the cost competitiveness of exports, governments will focus on things that might make sense for exporters but not for their economies as a whole. A fixation with exports leads to labour market policies aimed at artificially holding down wage growth, which redistributes income from labour to capital and exacerbates inequality. The secular decline in the proportion of national income accounted for by wages and salaries over the last 10 years in nearly every EU economy is a major obstacle to a recovery in private consumption. The flipside of the decline in wage and salaries – a steep rise in the proportion of national income accounted for by corporate profits – has not resulted in booming investment. This is no surprise. An individual firm can cut wages without undermining demand for whatever good or service it produces. But this does not work if all firms attempt this simultaneously. The resulting weakness of overall demand depresses companies' incentives to invest, and with it productivity growth.

In short, cutting the proportion of national income accounted for by wages, accepting a secular rise in inequality and boosting the proportion of national income accounted for by corporate profits is no way to deliver sustainable economic expansion. But it is what happens when governments believe that economic salvation lies in winning a growing share of export markets. 

The EU's economic prospects will largely be down to its domestic rate of productivity, not the size of its trade surplus. There is a very strong correlation between growth in labour productivity and economic growth, which holds for countries with trade surpluses as well as those with deficits.

Unfortunately, the data show a remarkable decline in productivity growth across Europe, from around 3.5 per cent annually in the 1970s to barely 1 per cent in the 2000s. And productivity growth has been almost as weak in the eurozone's core as in its troubled periphery. Governments across the region should focus on raising productivity – not just in the most internationally exposed sectors like manufacturing, but in less tradeable sectors such as services too. Service sectors now account for around two-thirds of economic activity. Without stronger productivity across the service sector economic growth will prove elusive.

Why has Europe's productivity performance, with a few notable exceptions been so bad? There are two core problems. The first is inadequate skills levels. Europeans are terrifically complacent about labour skills. Some countries – the Nordics, the Netherlands – do well. The picture elsewhere is patchy at best. Germany has good vocational training, Britain more than its fair share of top universities, France good technical education. Other countries, especially in the south, perform poorly in most areas. The second cause is inadequate competition. In too many sectors, incumbents are protected. This is justified in terms of upholding 'social justice' or defending 'national champions'. What it leads to is so-called rent-seeking; the ability of particular groups in society to extract disproportionate rewards for their work. Where this tendency is strongest, productivity levels are weakest.

Europe's economic growth prospects may be poor. But this has little to do with what is happening elsewhere. Europe’s leaders will find that improving education and throwing open hitherto protected markets is a long and arduous task. But unlike the obsession with 'competitiveness' such reforms will lead Europe onto the path of sustainable growth.

Simon Tilford is chief economist at the Centre for European Reform.