Transcription
For the past month or so, Eon Twitter has been dominated by a debate over whether or not Europe is actually falling behind the US economically. With a contingent of mostly American economists arguing that Europe's decline is overstated and another contingent of self-flagellating Europeans arguing that Europe's stagnation is in fact real. And well, after a fair bit of back and forth and since we did our last video on the topic, it looks like the Americans have essentially won the argument. So, in this video, we're going to explain why.
According to best data available, Europe is actually keeping pace with the US and why it matters. Despite its overwhelming presence, there are still a handful of EU countries not using the Euro. Why is this? And what's going on with the Euro's missing members? That's just one of the 80 pages in the magazine, because there's more to too long than you'd expect. Purchase your copy by clicking the link in the description.
Broadly speaking, the debate is centered around the question of how to best compare European and American GDP. You can't really use a Euro dollar exchange rate because this is affected by all sorts of funky stuff. Most obviously, the US dollar is the world's reserve currency, which means that demand for the dollar spikes during times of turmoil. This is why economists generally prefer purchasing power parity, which basically tries to figure out how much people can actually buy in a given country.
The way this works is you create a basket of goods that an average household might buy: food, housing, clothing, etc. You then find out how much this basket would cost in each country and use that to create a new exchange rate. If the basket costs $100 in the US, for instance, and €50 in the EU, this will give you an exchange rate of 2:1 because a euro goes twice as far in the EU as a dollar does in the US. You would then take the EU's GDP in euros, multiply it by two, and compare it to America's dollar-denominated GDP.
However, while this works well for comparisons in a single year, it becomes more complicated if you want to make comparisons over a longer time period. For this, you have two options. You can either repeat the basket exercise each year and create what's known as a current price series, or you can do the basket exercise in one specific year and then extrapolate into the future or past by using each country's GDP data to create what's known as a constant price series.
Broadly speaking, our self-flagellating European economists were arguing that we shouldn't use the current price series because it minimizes productivity growth. This argument is easier to understand with an example. So, let's imagine, for instance, that America's iPhone industry produces 1,000 iPhones in 2026, each valued at $1,000. Let's then imagine that America's iPhone industry doubles in productivity, and America produces twice as many iPhones in 2027 as it did in 2026. America's economy has clearly grown. However, if this doubling in production leads to a halving of prices, then it won't show up in current price sales. After all, according to current price sales data, in 2026, the US produced $1 million worth of iPhones, and in 2027, it again produced $1 million worth of iPhones. This clearly overlooks some real productivity gains, and it's the main reason to use the constant price series.
In response, our American economists made two counterarguments. The first is that extrapolating out a basket of goods from one specific year forces you to rely on real GDP estimates from national statistics agencies, which are calculated taking their country's nominal GDP and accounting for inflation. The problem here is that different agencies use wildly different methodologies. To illustrate this, let's go back to our iPhone example. Some statistical agencies might look at the price. The iPhone got 50% cheaper between 2026 and 2027, and well, that's it. Others, however, might try and factor in the fact that the iPhone got better in some way. Maybe the battery life got better. These statistical agencies will then try to adjust for this and thus conclude that the "quote unquote" real price of an iPhone fell by more than 50%. And well, it turns out that America's statistical agency does this more aggressively than anyone else. This is why, for instance, America's statistical agency thinks that TVs' prices fell by 85% between 2005 and 2015, while Japan's statistical agency thinks that they increased by 8%. America's statistical agency is trying to account for the fact that the TVs also got better in this time. Japan's isn't. The net effect of this is that America consistently claims that it has lower inflation than other countries and therefore higher GDP growth. This persistent methodological difference explains why on the current price series, America outperforms Europe with suspicious consistency. This consistency ultimately yields some absurd results. The OBC's current price series, for instance, which uses 2021 as the anchor year, thinks that Western Europe's economy was 30% bigger than the US's in 1990 and that even Italy was 20% more productive. This is just not true. And it's clearly the result of the fact that this methodological quirk overstates America's growth to the point that if you work back from 2021, you'll end up claiming that America's economy started off behind Italy in 1990. Because this is the only way to fit all of this overstated growth in.
The second counterargument, and arguably the knockout blow in this debate, is that our European economists are essentially conflating two separate things, namely productivity and purchasing power. It's true that a constant price series is better at capturing changes in productivity, but well, if it's productivity you're interested in, there are better and less convoluted metrics than PPP series anyway, which is specifically designed to measure purchasing power. Purchasing power is probably a better proxy for economic well-being, and the current price series is clearly better at this because, well, who cares how much an iPhone used to cost? What matters is how much it costs today. And well, on this measure, Europe looks like it's doing just fine. According to the Penn World Table, which is probably the most accurate current price series available, Europe's purchasing power has basically kept pace with America's, especially once you account for working hours.
Now, this does create somewhat of a paradox. How come American productivity gains, which has grown faster than Europe, haven't been translated into better living standards? Well, this isn't a total answer, but it's worth noting that most of America's productivity gains have come from its tech sector. That this hasn't translated into a meaningful increase in American living standards suggests that the subsequent profits that have accrued to producers haven't been redistributed across the American economy or its workers. Furthermore, on the consumer side, Europeans have benefited just as much as Americans. After all, iPhones have gotten cheaper on both sides of the pond.
Now, to be clear, this does not mean at all that the European economy is perfect. However, it does mean that if the question is, "How do we improve European living standards?", then "become more like America," which is many European policymakers' default response, isn't necessarily the correct answer.
The latest issue of our magazine is out now. And if you want our best value ever, subscribing and using code SUMMER26 gets you your first copy for as cheap as £4.99, as well as 20% off as long as you stay subscribed. I told you about one of the articles at the start of this video, but this issue is truly jam-packed with content from all around the world. Obviously, the headline section is our rundown of Trump's wars around the world, discussing all the different countries and regions that have faced Trump's military wrath, going nation by nation through our timeline and reaching the ultimate question: Has Trump created the modern holy war? From there, we dive into our regional sections, starting with the UK, where we unpack the results of the recent elections, take a look at the UK's odd foreign posture, and discuss if Britain has become ungovernable. Then in our EU section, we discuss how Russia's sphere of influence is fading, while Europe's energy transition isn't what you'd expect, as well as looking at the Euro's missing members. Finally, in the global section, we discuss whether we're seeing echoes of the First World War, what's next for Iran, as well as what really came from the Gen Z protests we saw emerging last year. That's not even everything. With this 80-page issue, our joint longest ever, there's even more to read than I've been able to mention here. So, click the link in the description to learn more and grab your copy today.