Europe's Jobs Turnaround

Economists are rightly cautious about the recovery. Spain and Ireland have been devastated by the bursting of their construction bubbles: the Spanish unemployment rate is already 16 percent and will hit 19 percent in 2010. Hungary and the Baltic States are deeply troubled. Italy is turning into a perennial also-ran. The German recovery owed something to a one-off cash-for-clunkers scheme. Besides, 0.3 percent growth rates are hardly enough to set either the Seine or the Rhine on fire.

Still, renewed growth represents a dramatic turnaround from the white-knuckle free fall of the last quarter of 2008, when both the European Union and the euro zone contracted by 2.5 percent. The French and Germans can be forgiven for a certain amount of crowing after years of being told that their Eurosclerotic regimes are being left in the dust by the Anglo-Saxons. The dirigiste French have not been forced to rescue a single big French bank from collapse, let alone nationalize one. An Italian company, Fiat, is now ensconced in the Chrysler building in Detroit, America’s secondlargest office complex after the Pentagon.

A new talent war?

The European recovery is already restarting the talent wars. European engineering companies are once again combing the world for talent. Zug, one of Switzerland’s most economically vibrant cantons, is touting its investment opportunities in Mayfair, London’s hedge fund district. The Swiss calculate that some 20 percent of Britain based hedge funds could decamp in the next year or so, put to flight by British Prime Minister Gordon Brown’s proposal to raise the top income tax rate to 50 percent.

Continental Europe’s recovery is further evidence of the wrong-headedness of former U.S. Defense Secretary Donald Rumsfeld’s dismissal of “old Europe.” Continental Europe, with a 30 percent share of the world economy, boasts a large number of world-class businesses. According to a 2005 survey by McKinsey & Company, Europe has 29 percent of the world’s top 2,000 companies. And, half of the world’s 30 leading companies by revenue are from mainland Europe, according to a 2006 survey by Forbes magazine. Small European countries such as Switzerland, the Netherlands and Sweden are home to a remarkable number of the world’s best global companies.

Consolidation

Liberal economic policies, instituted by the European Union and national governments, have also had a benign effect. The single European market has created a tidal wave of consolidation as companies have reorganized to attain Continent-straddling scale and scope. In 2007, mergers and acquisitions in Europe were worth $1.59 trillion, compared with $1.54 trillion in the United States. The single European labor market has turned Polish plumbers and Italian restaurant workers into heroes to consumers across the Continent. Thanks to Chancellor Angela Merkel’s welfare reforms, Germany’s long-term unemployment rate dropped by 40 percent between 2007 and 2008, the first time the number has fallen since the 1960’s. At the same time, venture capital has been flooding into Europe. Between 2003 and 2006, European venture capital investment grew by an average of 23 percent a year, compared with just 0.3 percent in America. Indeed, Denmark and Sweden have bigger venture capital industries, relative to the size of their economies, than the United States.

Yet the revival of the talent wars so soon into the recovery is also an indicator of an enduring constraint on Europe’s ability to grow: its problem-plagued labor market. One-tenth of Europe’s workers are unemployed. But talent-hungry European engineering firms are already claiming that they face a choice between recruiting from the developing world and moving their most value-producing operations offshore. Benot Potier, the chief executive of Air Liquide, one of the world’s largest makers of industrial gases, told The Financial Times that the French group is hiring most of its skilled workers in emerging markets.

Dismal demographics

The Continent’s demographic future is dismal. The number of people of working age (i.e., 15 to 64 years-old) will decline from 395 million today to 255 million in 2050. At the same time, the number of elderlypeople will increase from 80 million to 140 million, putting an ever growing burden on an ever shrinking number of workers. By 2012, Germany will suffer from a deficit of 2.4 million people of working age, costing the economy more than a trillion dollars in lost productivity, according to McKinsey.

Europe’s antiquated social policies are contributing to this demographic disaster. European labor laws divide workers into insiders, who enjoy lavish protections, and outsiders, who find it increasingly hard to get permanent jobs. This polarized structure is creating a permanent underclass of the unemployed who are unavailable for work in good times as well as bad and so fail to exert a downward pressure on labor costs. It is also producing horrendous levels of youth unemployment: about one-quarter of the French population under age 25 is unemployed. This points to a paradox: the very automatic stabilizers, such as generous unemployment pay, that have helped Europe deal with the global recession will also make it more difficult for it to profit from the recovery.

The best and brightest

While Europe may be condemning millions of people to idleness, it is also failing to mobilize the talents of many of its brightest young people. Most of the Continent’s universities are more wedded to the welfare state than to the new economy. France’s universities, with the exception of the exclusive grandes écoles, are overcrowded and lackluster. Germany’s universities, shadows of their former selves, are exclusive without being excellent. Germany has one of the lowest graduation rates in the advanced world. Many of Italy’s universities are marginal at best.

Europe has no choice but to import people to dig itself out of its demographic ditch. But the Continent’s immigration policies are in disarray. Europe continues to import an army of low-skilled workers who are failing to find a place in the labor market. The number of foreign residents in Germany more than doubled from three million in 1971 to 7.5 million in 2000, but the number of foreigners in the work force did not budge. At the same time, Europe is struggling to attract the most highly skilled workers. Only 1.7 percent of the working population are classified as skilled immigrants, compared with 3.2 percent in the United States.

This situation is creating a rising tide of popular resentment against immigrants that is roiling politics in almost every country. One poll shows that only 19 percent of Europeans think that immigration is a good thing for their countries while 57 percent think that their countries have “too many foreigners.” At the same time, the malfunctioning immigration system is making it even more difficult to attract the people needed to fill the skill gaps of the future. It will be impossible to produce a workable immigration policy without reforming the welfare state.

Europeans can be forgiven for celebrating their early emergence from what they regard as a made-in-America recession. But if they treat this as an excuse for abandoning American-style reforms of their labor markets, they will be making a grave mistake and condemning themselves to remaining the losers in the talent wars that are defining the 21st-century economy.

Adrian Wooldridge is the co-author of several books and is the management editor for The Economist. He is based in London.