Based on Barry Eichengreen’s article “Innovation and Integration: Europe’s Economy Since 1945”

Based on Barry Eichengreens article Innovation and Integration: Europes Economy Since 1945

EUROPES ECONOMY SINCE 1945 INTRODUCTION 2nd half of the 20th century was a period of unparalleled growth in Europe: Real GDP per capita more than tripled in the Western countries and more than doubled in the Eastern countries Quality of life improved hours worked per year declined by more than one-third giving way to leisure time and lengthening life expectantcy However unemployment rose over the period and taxes also soared BUT, by any standard, Europeans are better off today than their parents and grandparents

Introduction (cont.) Southern Europe grew faster than Northern Europe Western Europe grew faster than Eastern Europe Growth was faster in the 2 decades before 1973 than the 2 decades after HOWEVER, the postwar period is regarded as the golden age of economic growth

Introduction (cont.) 2 exogenous conditions stimulated growth in the second half of the 20th century: 1. Backlog of unexploited technological and organizational knowledge with which Europe entered the period Military had to innovate to survive the world wars (for ex. t had to invent jet engines, radar and computing) 2. The great power conflict between the USA and Soviet Union forcing countries to conform to the form of economic organization as their dominant partner Their choice determined their subsequent economic performance Western Europe Market Capitalism Eastern Europe State Socialism

Introduction (cont.) Principal Features of the International Economic Environment of the Postwar Period: Marshall Plan Bretton Woods International Monetary System General Agreement on Tariffs and Trade These were all molded by the US Soviet conflict

Exogenous Actions Endogenous Processes To the 2 exogenous actions there were 2 reactions 2 endogenous processes 1. Transition from extensive to intensive growth Extensive growth: growing on the basis of known technologies raising output by putting more people to work at familiar tasks and raising labor productivity by building more factories along the lines of existing ones Rising capital/labor ration = extensive growth Intensive growth: growth through innovation Europe relied more on extensive growth before 1973 and more on intensive growth thereafter

Extensive Growth Facilitated by the backlog of technology Less important to innovate so long as there were known technologies still to be acquired and commercialized Easy as long as there were elastic supplies of labor (refugees from the east; repatriates from the colonies; underemployed workers from the agricultural perihery) who could be added to the industrial labor force without putting upward pressure on wages

Extensive Growth (cont.) Extensive growth was what planned economies organized on Soviet lines did best Government decides how many factories to build; directs state banks to mobilize the resources; limits consumption to what is left; decides what foreign technologies to acquire... This was a successful strategy for Eastern European countries for a while The more successfully European countries pursued this model, the more quickly they exhausted the backlog of technological and organizational knowledge

Extensive Growth (cont.) As European countries depleted backlog of technology and organizational knowledge they were forced to switch to intensive growth The centrally-planned economies were the least good at innovation because new knowledge bubbled up from below instead of raining from above This became a problem for the centrally planned economies once the technology was used and the labor force was fully employed

Exogenous Actions Endogenous Processes (cont.) 2. European Integration Globalization for Europe meant regional integration European integration was encouraged by the U.S. To fight off the Soviet influence The Soviet Union prohibited the participation of Eastern European countries to integrate with Western Europe

How Can Europe Avoid Another War? The Question and Ideologies The solution to this problem differed on beliefs about the cause of WWII and the three schools of thought in existence were: Germany was to blame: The so-called Morgenthau plan of 1944 proposed to avoid future war by turning Germany into a country primarily agricultural and pastoral in nature. The same thinking existed after WWI where the victors were rewarded with German territories and financial reparations this led to the German cycle of resentment and economic downturn that led to WWII Capitalism was to blame: Marxism-Leninism blamed capitalism for WWI and II and offered communism as a solution Nationalism was to blame: Excesses of destructive nationalism was blamed for the war and European integration was offered as a solution The 3rd view ultimately prevailed but this was far from clear in the 1940s

European Integration (cont.) Before 1913 Western Europe was at the heart of the global trade and financial system World War I (1914-1918) disrupted this The Bolshevik Revolution (1917) and the Treaty of Versailles (1919) also disrupted trade and finance World War II (1939-1945) also had negative effects Europe had to rebuild its international economic position from a very unfavorable starting point

PHASES OF GROWTH, 1820-1992

Europes Economic Growth Western Europe (Austria, Belgium, Denmark, Finland, France, Germany, Italy, Netherlands, Norway, Sweden, Switzerland and the UK) during 1950-1975 grew twice as fast as 1820-1970 Southern Europe (Greece, Portugal, Spain, Turkey and Ireland) acceleration and decelaration is more dramatic Eastern Europe (Bulgaria, Czechoslovakia, Hungary, Poland, Romania, Yugoslavia and the USSR) grew faster than Western Europe before 1973 because this region lagged behind the West in the 19th century Growth halts after 1973 not evident in any other region

Per Capital Real GDP Growth in 56 Countries, 1820-1992

European Growth (cont.) Per Capita GDP Growth = (Rate of Growth of Output) (Rate of Growth of Population) Per Capita GDP Growth is a better measure of the change in living standards Western Europe fares better due to lower rates of population growth Out of the 12 Western European countries extensive growth was fastest in Germany, Austria and Italy The slowest in the UK after 1973 the UK continued to underperform the W. European average 1973-1992 : period of intensive growth Switzerland, Sweden and the Netherlands performed even worse

European Growth (cont.) Southern Europe: Greece and Iberia (Spain and Portugal) performed better than Turkey and Ireland But the post-1973 slowdown was the least dramatic in Turkey and Ireland (best performers in S. Europe in the years of intensive growth) Eastern Europe: Growth of output per capita was relatively uniform reflects the heavy hand of planning In the extensive growth years it was the slowest in those countries that started out with high levels of output per person (Czechoslovakia and the USSR) Central planning and state trading were important in this convergence Intensive growth years led to stagnation in the region

Economic Impact of WWII WWII destroyed economic capacity (persons, factories, farms, roads, bridges,...) and economic relations Roads and etc. could still be fixed but economic organization was interrupted During and after the war: There was rationing and controls Labor and raw materials were directed to production of critical commodities Wages were frozen Government froze the prices of consumer goods like food, fuel and clothing and rationed purchases Banks were regulated Commodity imports and capital exports were controlled

Effects of Rationing...

Early Post-War Period In 1945 a family almost anywhere in Europe found themselves in a nation which was or had recently been: Ruled by a brutal fascist dictator Occupied by a foreign army OR Both As a result of these governmental failures thens of millions of Europeans were dead and Europes economy lay in ruins The 2nd WW was the fourth time in 130 years that France and Germany were at the core of increasingly horrifying wars

Aftermath of WWII (Germany 1945)

Aftermath of WWII (London 1944)

Death and Destruction in WWII Death Toll Pre-war year when GDP equalled that of 1945 Austria525.0001886 Belgium82.7501924 Denmark4.2501936 Finland79.0001938 France505.7501891 Germany6.363.0001908 Italy355.5001909 Netherlands250.0001912 Norway10.2501937 Sweden0 GDP grew during WWII Switzerland0 GDP grew during WWII UK325.000 GDP grew during WWII Source: Baldwin & Wyplosz, p. 5)

Europe, Post-WWII

Economic Effects of WWII (cont.) At the conclusion of hostilities, industrial production was no more than 40% of prewar levels in Belgium, France and the Netherlands and less than 20% in Germany and Italy From this position it was possible to boost output quickly by restoring essential infrastructure and freeing resources for peacetime use

Production in Western Europe

Rebuilding Europe Building infrastructure was the easy part Making growth self-sustaining was a difficult task 3 obstacles to self-sustaining growth: 1. Resource bottlenecks 2. Price controls 3. Political uncertainty

1. Resource Bottlenecks Europe tried to increase its industrial capacity Due to national security issues industries like steel and iron were given priority Governments wanted to increase output and capacity Problem was that Europe produced limited inputs of capital goods in this process

1. Resource Bottlenecks (cont.) Germany was the traditional producer and exporter of capital goods and its production was now limited by the occupying powers Inputs could still be purchased from the U.S. but only for dollars By 1947 Europe had no dollar reserves Since inputs need to come before outputs Europe could not use its exports to finance inputs Borrowing abroad was not possible due to the uncertain political situation

2. Price Controls So long as prices of goods were frozen below free- market levels, producers had little incentive to bring their goods to market For ex. They fattened their cows instead of slaughtering them Workers were not able to purchase goods so they spent their time not at work but with other activities Black market took off as governments ran deficits and printed money If governments left their control, then inflation would come about

3. Political Uncertainty Communists had key positions in French and Italian governments in 1947 Denmark had a weak minority government UK had embarked upon industrial nationalization It was not clear that governments in these countries would respect private property, resist to temptation impose taxes and let markets work

Nationalization in Britain...

Rebuilding Europe (cont.) Because of resource bottlenecks, price controls and political uncertainty, there were no individual investments, bank lending was minimal and companies did not invest in training their employees

Marshall Plan Aid initiative launched by the US in 1947 removed all of these obstacles U.S. Provided $13 billion of U.S. Government grants over a period of 4 years This solved the problem of having to export to import but unable to import without first exporting Countries accepting Marshall Plan aid had t osign bilateral pacts with the U.S. Agreeing to: Decontrol prices Stabilize exchange rates Balance their budgets This prepared them for the market economy

Marshall Plan Map of Cold- War era Europe and the Near East showing countries that received Marshall Plan aid. The red columns show the relative amount of total aid per nation.

Marshall Plan (cont.) Helped to resolve political uncertainty by tipping the balance of political power toward centrist parties The US did not want to give aid to socialist governments so countries with communist and socialist governments saw the exit of these politicians Marshall Plan was the choice between plan and market The Plans effects on price decontrol were immediate: Stores empty one day were fully stocked the next day Absenteeism among workers fell Import restrictions were slowly lifted

Marshall Plan (cont.) The Plan became the choice between plan and market USSR refused to allow its satellites to take any aid

Marshall Plan (cont.) Those nations accepting Marshall Plan aid saw the exit of socialist and communist politicians and policies...

Marshall Plan (cont.) Also encouraged European integration U.S. Aid was given on the basis of a collective strategy for using the funds Marshall planners envisioned a United States of Europe where war would be inconceivable European integration was a way of reconciling other countries, France in particular to higher levels of German industrial production and Of disarming those who insisted on pastoralizing the German economy Marshall Plan helped to eliminate ceilings on German industrial production and cancelling its debt due to reparations Germany could now go back to being the heart of the European economy

Marshall Plan (cont.) As seen vividly in this poster for Marshall Plan aid, the aim was European integration...

Marshall Plan (cont.) Marshall planners also wanted to stimulate Europes trade In the immediate postwar years, there was bilateral trade But bilateral trade agreements made it hard to move towards the free-market (multilateralism) However, liberalization needed to be taken by all of the European countries at once. If one liberalized and others did not, that one country would be flooded with imports THIS PUT THE MARSHALL PLAN IN JEOPARDY!

European Payments Union (EPU) Each countrys net balances with each other country were reported at the end of each month to the Bank for International Settlements the EPUs fiscal agent which cancelled ofsetting claims Countrys now had liabilities/claims not on other countries but on the EPU as a whole Countries no longer cared who they did trade with Countries could also run temporary deficits

European Payments Union (cont.) U.S. Contributed $350 million of Marshall Plan funds to the EPU This helped to stimulate trade (from $10 billion in 1950 to $23 billion in 1959) Also made sure that Germany committed to free and open trade EPU was a stepping stone toward collective governance The next move towards collective governance was the European Coal and Steel Community (ECSC) Laid the seeds for the European Economic Community

European Payments Union (cont.) AB C Exports Total Payments: 1820 100 120 290 320 520 470 A B C 20 30 40 Bilateral Settlements Total payments: 90 EPU AB C 10 20 10 Clearing Total Payments: 40

Investment and the Labor Market If trade was needed for European growth, the second thing that was needed was investment Plant and equipment were needed to implement new technology requires investment Countries used their money differently, for ex.: Norway used its money to rebuild its infrastructure Belgium used its money to keep declining industries alive Countries with high returns on investment experienced high rates of growth of the labor force

Investment and the Labor Market (cont.) Payoff on investment high where ther is expanding labor force with which additional capital could be put to work Growing labor force also helped curb wage increases Firms could put the money saved back into the company as investment

Investment and the Labor Market (cont.) Germany had expanding labor force due to East Germany until the erection of the Berlin Wall Netherlands had expanding labor force due to the return of Dutch settlers from the East Indies colonies France and Italy underemployed agricultural workers had the same effect as they shifted to manufacturing and services

Postwar Social Contract European societies also developed corporatist structures to restrain wage growth and see that profits were put back into investment Governments wanted to guarantee that the union strikes over wages and work conditions would not happen again They needed to guarantee to the unions that in exchange for a limit on their wage demands, the industrialists would put the profit they received back into the firm Governments were concerned that if unions pursued wage increases and management paid out profits, investment and growth would suffer

Postwar Social Contract (cont.) Government implemented a series of negotiations with capital and labor resulting in a few different institutions: 1. Firms agreed (by law) to put profits back into the firm and workers had more say (both in supervisory boarda dn investment policies of firms) This was the set of institutions that monitored the compliance of the parties to their agreement to exchange wage moderation for the reinvestment of profits

Postwar Social Contract (cont.) 2. The second set of institutions created bonds that would be lost in the event that either party reneged on its agreement Firms received industrial input from government at submarket prices, investment-friendly monetary policies were implemented by the central banks to encourage more investment Labor was also bonded by a parallel set of government programs: paid vacations, limited work hours and social security structures were adopted in exchange for wage restraint sick pay, retirement incomes, tax and social insurance concessions...

Postwar Social Contract (cont.) 3. Third set of institutions coordinated bargains across firms and sectors Bargaining was centralized in the hands of a trade union federation and national employers association and governments intervened to harmonize the terms of the bargains reached by different unions and employers Departure from laissez-faire There was a shift from low-production agriculture to high-productivity manufacturing and services in the Western European countries

Eastern Europe and the Planned Economy Eastern Europe was more heavily agricultural than the West Eastern European State Planning Offices saw the expansion of the industry as the most direct way of raising labor productivity Government did not support agriculture like the West did In fact, Eastern European planners set lower prices for agriculture and high prices for manufacturing to shift labor

Eastern Europe and the Planned Economy (cont.) During the 1950s Eastern Europe started to report impressive rates of growth However, those produced were not always of good quality By 1949 most major branches of industry and finance were owned and operated by the state they allocated a majority of their investment to industry However, they built along the lines of existing factories (extensive growth) innovation was not rewarded

Achievements and Limitations of Central Planning The Cold War and Stalinist ideology led planners to push the industrialization process too far Traditionally Central and Eastern Europe had been the continents agricultural resource Planners starved these regions of these resources Light crafts (like cobblers, masons, balcksmiths, tailors...) also began to dissapear In the West, increases in output also meant increases in living standards this was less so in Eastern Europe

Achievements and Limitations of Central Planning (cont.) Resources were wasted in central planning since managers protected themselves against the risk of missing production by over-ordering raw materials and employing too many people This over-production did not improve the quality of the goods produced or the variety (ex. The Hungarian footwear industry in the 1950s produced just 16 different types of shoes)

Achievements and Limitations of Central Planning (cont.) Public dissatisfaction, Stalins death and a slow-down of growth led planners to experiment with decentralizing the planning mechanism Managers were given more freedom and given rewards on economizing resources However, this did not increase innovation Also, prices at home and abroad where free-market principles dominated made free trade with the rest of the world difficult if not impossible

Achievements and Limitations of Central Planning (cont.) Self-sufficiency was also not desirable since each country had different resources The solution was to encourage trade within the Eastern Bloc The Council for Mutual Economic Assistance (CMEA) or Comecon was established in reaction to Western European integration under the Marshall Plan

CMEA / Comecon

CMEA / Comecon (cont.) CMEAs founding members: Bulgaria, Czechoslovakia, Hungary, Poland, Romania and the Soviet Union (in 1949) East Germany joined in 1950 Moscows idea: Czechoslovakia and E. Germany: concentrate on the production and export of industrial goods Romania and countries like it: concentrate on agriculture in international socialist division of labor Romanian leadership was not pleased Relations within the CMEA were strained However, intra-bloc trade expanded under the CMEA

CMEA / Comecon (cont.) A Soviet poster reading "COMECON: Unity of Goals, Unity of Action"

Regional Integration in Western Europe Eastern Blocs commitment to Comecon was strengthened by regional integration in the West Western European Integration: European Economic Community, established in 1958 allowing free trade among France, Germany, Italy and the Benelux countries in less than 10 years Free trade allowed these countries to specialize in goods they had a comparative advantage in and to better exploit economies of scale and scope It eroded the power of monopolies and cartels forcing sheltered producers to shape up or ship out

Regional Integration in Western Europe (cont.) U.K. Declined to join the EEC rejecting the Franco- German call for deeper integration Yet, attraction of a Common Market, proved irresistable and Britain and 6 smaller European countries (Austria, Denmark, Norway, Portugal, Sweden and Switzerland) established the European Free Trade Area (EFTA) in 1959 a more limited entity Finalnd joined in 1961, Portugal also joined at a later date Spain and Greece negotiated with the EEC and the EEC chose to open itself to these 2 countries Growth accelerated in both the EEC and EFTA

Regional Integration in Western Europe (cont.) Britain remained the sick man of Europe The corporatist system of wage restraint never took hold in Britain This was due to early industrialization which had left behind a fragmented system of industrial relations Many small trade unions fought the efforts to coordinate an economy-wide wage bargain Poor wage constraint, resistance to the introduction of new technologies and forms of work organization produced poor results for Britain Britain had the lowest investment rates in Western Europe Government tried to get additional output but it led to inflation and balance-of-payments deficit so the authorities raised interest rates

Economics of Intensive Growth As the backlog of technology inherited from WWII dissapeared, the challenge became to innovate new products and processes The U.S. Had a leg up on this process. In 1963 it devoted 3.5% of its GDP to R&D spending. By the mid-1960s the U.S. Was spending 5 times as much as all of Western Europe on R&D in the computer industry European governments took steps to close the gap With increased spending the countries of Western Europe increased their share of global exports of research-intensive goods

Documents

Based on Barry Eichengreen’s article “Innovation and Integration: Europe’s Economy Since 1945”