When it comes to “more government”, Americans should be rather skeptical. But the US is now relying on the state to change the economy by making trillions of dollars available to consumers and even more directly interfering with industrial planning.
In government-loving Europe, political restrictions can prevent a comparable economic upturn.
Next week, the European Union will begin approving member states’ spending plans under the bloc’s € 673 billion pandemic recovery package. Analysts expect Europe to recover strongly from Covid-19, but in contrast to the US predict permanent economic damage.
More money will flow to the countries most in need: Spain and Italy will receive grants of 6% and 4% of their gross domestic product, respectively. Although spread over many years, this is not insignificant. Spanish officials believe it could boost economic growth by 2 percentage points a year.
But can it also help address the deep productive imbalances that have made European stocks chronic underperformers? A comprehensive analysis of the Italian and Spanish proposals suggests that only 11% and 22%, respectively, of the funds are used to promote certain sectors in which underperforming countries could have an advantage.
In fact, most of the money seems to be going to projects like building renovations, upgrading infrastructure, and helping small businesses digitize – all worthy goals that will increase demand and help the climate but are likely to be less transformative.
Economists have found out a close connection between prosperity and the export of complex products and services, which expresses both American technology leadership and German manufacturing power.
In the course of the economic integration of Europe, the periphery has fallen further behind the more industrialized north in terms of GDP per hour worked – with the exception of some Eastern European countries, which have benefited from offshoring. While the South still retains some skill in making automobiles, after the 1990s it suffered disproportionately from deindustrialization in less advanced sectors dominated by suppliers whose innovation depends on other companies.
Italy’s Ministry of Finance found in a 2018 analysis that 59% of its exports face significant competition from China due to the country’s focus on textiles and labor-intensive parts of the manufacturing supply chain, compared to around 40% from its peers. Particularly damaging was the loss of the ability to devalue the currency after the introduction of the euro in 1999. Spain is still too dependent on tourism and has diversified into less complex goods.
The question is how this deadlocked division of labor can be changed.
Since the 1980s, economists and policymakers have rejected “vertical” industrial strategies, based on Alexander Hamilton’s 1791 Report on Manufactures, on the grounds that picking winners and losers creates inefficient companies. EU law also prevents members from unfairly benefiting their industry.
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Instead, most Western officials have focused on “horizontal” spending promoting basic research and modernization in all sectors. The argument is that if the governments in Italy and Spain wrote better regulations and invested more in technology and education, they would not get stuck with small firms that focus on low-tech products and are kept alive by low interest rates.
But in the past few decades, horizontal policies alone have done little for the laggards. The Pentagon’s research funding may have boosted the internet, but EU cohesion money spent in the south failed to increase productivity. Meanwhile, both Covid-19 vaccine development and breakneck growth in East Asia are examples of the power of government pre-emption agreements and vertical planning to fuel innovation and find a way out of underdevelopment.
Now that the West fears that it will lose its economic advantage, it is slowly switching. On Tuesday the US Senate passed a $ 250 billion bill designed to help American companies hold their own against China, which includes building domestic semiconductor capabilities. The EU grants antitrust exemptions for a climate-oriented industrial policy.
Northern Europe, however, seems more inclined to identify preferred sectors. Italian and Spanish officials remain cautious, although Spain ranks first – ahead of India and Turkey – on the Harvard Kennedy School of Government’s Atlas of Economic Complexity in opportunities to switch from less skilled exports to more complex products in areas such as machinery and pharmaceuticals .
Certainly the EU’s green agenda has created a welcome back door for some vertical betting. Spain plans to invest 10 billion euros in the automotive sector and build an electric vehicle battery factory near Barcelona, as well as spending another 1.6 billion euros to promote clean hydrogen production. But these are overcrowded areas: in 2019 the EU already released 3.2 billion euros for the development of batteries, three quarters of which went to “core” countries. So far, the European race to build battery factories has been led by the Swedish company Northvolt.
Investors should welcome Europe’s move away from austerity, but remain skeptical of solutions to the one-sided economy. The redistribution of wealth is difficult to reconcile with productive investment as the political balance of the bloc is fragile makes it difficult for the south to build companies that challenge the industrial hegemony of the north.
Europe may want more government, but not always where it is needed most.
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