China, Europe and the Netherlands: Opportunity Is Knocking at Our Doors

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ach of the world’s major economies – the Euro-
pean, the American and the Chinese economy – 
is slipping into its own “new normal” and each 
one is unhappy in its own way. These economies offer 
an escape from poverty. But Europe is seriously lacking 
in self-support. America is woefully lacking in prosper-
ity. And all of them are, to varying degrees, lacking in 
human flourishing.
The European Union
Measured by its gross domestic product, the econ-
omy of the European Union is very large – larger than 
American and Chinese economies. Its decline acts to 
reduce wages in the rest of the world. More important, 
Europe was – for more than a century – a major source 
of new products and a key source of advances in science 
and the arts. We will all be the poorer if Europe goes on 
failing to recapture its brilliant past.
In the past two decades it has become apparent that 
the European economy is in very poor condition. It is 
common ground that, now, in 2015, the aggregate out-
put – the Gross Domestic Product – of the European 
economy is far below the previous trend path – below 
the trend line we might fit to historical data up to 1995. 
Yet European economists believe with few exceptions 
that nothing is radically wrong with the European 
economy – nothing that would require structural 
rehabilitation extending to the entrepreneurial heart 
and innovative brain of the economy. Nevertheless it is 
interesting to note what these economists, observing 
that the economy is not well, are diagnosing and 
Europe, 
America 
and China
 
Have the Same 
Economic Problem
By Edmund Phelps
Each of the world’s major economies 
– the EU, America and China – are 
slipping into its own “new normal”. 
While they offer an escape from 
poverty, all of them are, to varying 
degrees, lacking in human flourishing.
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prescribing
. And we may learn something that may 
sometime be useful in our own economies.
Many economists speak of a loss of competitiveness, 
particularly in the south of Europe – in Greece, Italy 
and Spain. They imply that output is down, relative 
to trend, largely because wages got out of line with 
productivity, forcing firms to cut back – a case of wage 
misalignment. Taking this perspective, German econ-
omists argue for wage deflation in the affected econo-
mies; the Keynesian economists argue for monetary 
stimulus in order to raise prices (relative to wages) 
and state investment in infrastructure to create some 
more jobs.
The background to the adoption of this perspective 
is the sharp productivity slowdown that hit Germa-
ny, Italy, France and Spain around 1998; and Britain 
around 2005. Although wage rates have remained in 
line with productivity in Germany and Britain – and 
employment has held up pretty well there – wages 
got out of line with productivity in Italy, Spain and 
Greece during the boom years of the late 1990s, and 
in the early 2000s wages got ahead in France and 
farther ahead in Greece. These wage misalignments 
may very well explain the drop in the employment of 
men – relative to the population of men – from the 
period 1990-1995 to the period 2010-2012 in Italy and 
Spain as well as Greece. But, in Italy, France and most 
conspicuously in Germany, we see a bigger drop of 
the employment-to-population ratio from the 1970s 
(in Germany and Italy) or the 1980s (in France) to the 
1990s. Were those drops in employment also the result 
of wage misalignments? Is every fall of employment a 
market failure? Of course not! No one would believe it 
is mainly an accumulation of such misalignments that 
has brought declining employment and thus output 
not keeping up with its trend path. There must be some 
other forces at work.
Economists have staged a fierce debate over two 
warring schools. In the classical view, which I myself 
have expounded (in the 
Financial Times
), it is to some 
extent a contraction of labor supply that has led to a 
decline of employment – and thus to lagging output. 
And it is largely outbreaks of fiscal profligacy in Eu-
rope, most pronounced from the mid-1990s to the mid-
2000s, that led to that contraction: In Greece, Italy 
and, to a lesser extent, France, there were tax cuts and 
spending increases, which added to households’ esti-
mates of their private wealth in relation to their wage 
income, and there were expansions of entitlements to 
future benefits, which added to people’s estimates of 
their social wealth relative to their income. (The Eu-
ropean Union also donated lavish “structural funds” 
to Spain and Greece, which further increased people’s 
wealth relative to their productivity. Brussels made 
some of them rich. Even public sector wage rates rose 
to the sky in Greece.) Bloated with wealth, many em-
ployees must have lost some of their incentives to per-
form well, so companies’ costs of production went up; 
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