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Old Europe’s poor innovation record is a harbinger of long-term stagnation

Posted by on June 16, 2016 in Euro-zone, Markets | 1 comment

Old Europe’s poor innovation record is a harbinger of long-term stagnation

The economic debate around Brexit has been disappointing.  Far too many of the points focus on the short-term.  Would Brexit precipitate a sterling crisis?  Well, if it did, at some point the currency would bounce back?  Would it tip us into a recession?  Maybe, but recessions come to an end.

The key economic question, not just in the Brexit debate but one which faces the West as a whole, is what is going to happen to the long-term growth rate of the economy.  It is the long term growth rate which determines living standards, which determines how much we can afford as a society to spend on health, education and pensions. Long-term growth rates reflect the underlying productive potential of the economy.

On this criterion, the Leave camp seems to have the debate in the bag.  There is a strong consensus across economists, regardless of their views on Brexit, that the main determinant of long-term growth is innovation.

The European Commission pays a great deal of lip service to this, but Europe in general still lags considerably behind America in terms of innovation.  Innovation is by definition disruptive.  It creates new companies and industries, but at the same time destroys existing ones.  The willingness of a country to embrace rather than resist change is crucial.

Old Europe, to use Donald Rumsfeld’s notorious phrase for the original, core members of the EU, has an abysmal record.  True, the Germans implemented important structural reforms in their labour market in the 2000s, mirroring those introduced here by Mrs Thatcher in the 1980s.  But long term growth rates in Old Europe have been falling now for nearly fifty years.

The average growth rate over a sufficiently long period is a good indicator of long-term potential.  Over twenty years, for example, the short-term booms and busts will even themselves out.  In the 1950s and 1960s, growth in the core EU economies was very high, at 7 per cent a year, reflecting the huge post war boom.  In 2015, the average over the past two decades was barely above 1 per cent.  In contrast, the 20 year average growth rate in the UK has been pretty stable.  In 1970, it was 2.8 per cent a year.  It is now 2.4 per cent.

Remaining shackled to a system which appears to prefer regulating to innovation does not seem such a good bet.  But we have to take into account the likely response of the major players in the EU to Brexit.   The fear is that the UK deciding to leave the EU would trigger similar responses across the continent.  It would certainly give huge encouragement to already strong anti-EU feeling in many countries.

So the only rational response is to be punitive towards us, to try and make life as difficult as possible over as long a period as possible.  Whether they love us or loath us, the EU would have no alternative.  Couples getting divorced may wish the process were harmonious. But in reality, it is often nasty, messy and the bitterness can last for years.

Paul Ormerod

As published in CITY AM on Wednesday 15th June 2016

Image: Economy by Stefan Powell is licensed under CC BY 2.0

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