European golden age

Why was there a slowdown in growth?

Towards the middle of the 20th century, Europe was experiencing a “Golden Age” in economic development.  Surpassing both America and Asia in the increase of it's GDP per capita growth, at an average of 4.1%(compared to 2.6% and 3.6% respectively), rapid acceleration in growth rates were prevalent everywhere across Europe. Paired with full employment, low inflation and an increasingly open trade market, it seemed as if the economic boom had no signs of stopping. Even the manufacturing giant America, which had previously adopted isolationist policies opted to lower tariffs from 48% to just 14% from the 1930s to 1950, thus resulting in an unprecedented level in free trade. Thus it was shocking when growth rates took a dramatic turn in the 1970s, dropping to just 2% until the 1980s. Faced with increasing levels of unemployment and the onset of stagflation, it could even be said that Europe was facing a huge economic crisis by 1973. Then, the question of what caused the abrupt halt to the “Golden Age” becomes crucially important.

One reason why the high levels of growth in the 1950s was due to the fact that resources were not efficiently allocated in the post-world war II years. Due to trade being largely disrupted during the inter-war years, many European countries had allocated much of their resources into the agricultural sector in an attempt to be more self-sustaining given the uncertainty with regards to the duration of the war. As a result, with the increasing trade liberalization in the post-war years, European countries had huge potential for growth which required a simple reallocation of resources into the manufacturing and service sector. Additionally, as a consequence of the interwar years, the US had achieved a significant technological lead over Europe which would allow Europe to enjoy compensatory gains in the following years.

As such another reason why the European Golden Age ended was due to the fact that the “catch-up” growth previously enjoyed by Europe was no longer possible by the 1970s. During the 1950s, America had a huge productivity lead over Europe especially in the manufacturing sector. Taking advantage of the open market and reduced barriers to trade, Europe adopted many designs from the American manufacturing system which greatly enhanced their productivity. Notably, mass production was applied to an increasing amount of European industries, mechanizing difficult tasks and standardizing production of complex goods. This would serve to minimize the skill level required of the population to efficiently assemble quality products and therefore increasing the output per capita of the workforce.  Evidenced by the aggregate decreasing rate of GDP per capita growth in the years 1950-1970, it can be concluded the ability for Europe to enjoy “catch up growth” from America was coming to its end. This decline in productivity was also a consequence of European countries achieving higher levels of total factor productivity such that resource allocation to achieve gains in output was no longer possible. This however does not mean that Europe was even close to achieving the manufacturing ability possessed by America simply due to the fact that America had been endowed ideal factors to sustain a manufacturing boom namely, abundant natural resources and a large domestic population.

The breakdown of the Bretton Woods system (BWS) would further serve to invoke economic turmoil in Europe. Faced with economic crisis in 1973, the United States had just 2 options. Devalue their currency to maintain an external balance or use expansionary fiscal and monetary policies. Maintaining the use of expansionary policies would prove the wiser option as a devaluation would achieve external balance at the cost of having low output and high unemployment. Additionally it was not a viable option to devalue the US dollar as it was the central currency tied to gold that was used by the BWS. Therefore, unwilling to neither increase taxes significantly, reduce government purchases nor reduce the money supply growth, inflation of the US dollar was inevitable. With many of the European countries unwilling to import inflation from the US, given their already deteriorating circumstances it was no surprise that they opted out of the BWS thus leading to its collapse. Implications of this would manifest in the reversal of trade liberalization, with countries putting up an increasing number of non-tariff barriers to trade to prevent the import of inflation. Repercussions of this include increasing prices of natural resources (supply decreased) which would serve to drive up inflation. This cost push inflation would be intensified by OPEC oil crisis which would result in an exponential increase in the price of oil by 400% from 1973-4. The increasing price of essential commodities and resources would render it impossible for growth to continue at levels in the 1950s.

Additional implications of the breakdown of the BWS would be the end of fixed exchange rates that previously existed. As a result, induced inflation was now very possible. Attempting to increase employment in their home countries, European policy makers tried to exploit the Phillips curve which displayed a correlation between wage inflation and unemployment. Monetary policy was therefore used to significantly expand the money supply and hence generate “surprise inflation” in the hopes of increasing employment levels. This however would result in disaster as the Philips curve would soon break down upon trying to exploit it resulting in extreme levels of inflation and unemployment. The high inflation would be further fueled by protests by the trade unions. Due to the almost full employment previously experienced, positions of trade unions were strong and were able to demand better working conditions. This would manifest in wage explosions, reduced working hours and an increased number of strikes. Consequences of this would be a cycle of inflation driven by the wage explosions paired with a slowdown in productivity due to the reduced working hours and strikes. With the raging stagflation, many people were forced into poverty as the welfare state was unable to support the increasing number of poor. This strain on the welfare state was further amplified by the undermining of the social contract. With so many now unemployed, taxes collected by the working generation could hardly support the pensioners resulting in a huge decreased in standard of living for the elderly.