The Golden Age of European Economic Growth

Transcription

1 The Golden Age of European Economic Growth A Cliometric Perspective Nicholas Crafts Contents Introduction... 2 Growth Performance... 3 What Explains the Golden Age of European Growth?... 7 The Janossy Hypothesis... 7 Macroeconomic Stability Structural Change The Marshall Plan and the European Economic Community Social Capability and Technological Congruence High Investment/Wage Restraint Cooperative equilibrium Relative Economic Decline in the UK What Explains the Big Slowdown After the Golden Age? Incomplete Catch-Up Social Capability in Different Technological Eras Supply-Side Policy The Celtic Tiger Insights for the Golden Age Conclusions Cross-References References Abstract This chapter surveys cliometric research on economic growth in Western Europe from 1950 to the early 1970s, the so-called Golden Age. Several hypotheses to explain the very rapid growth of that period are examined including those proposed by Abramovitz, Eichengreen, Janossy, and Kindleberger. Cross-country variation in growth performance is highlighted and explanations for it are N. Crafts (*) CAGE, University of Warwick, Coventry, UK N.Crafts@warwick.ac.uk # Springer-Verlag GmbH Germany, part of Springer Nature 2018 C. Diebolt, M. Haupert (eds.), Handbook of Cliometrics, 1

2 2 N. Crafts explored. Further insights into the Golden Age are obtained by considering the reasons for the subsequent growth slowdown. It is concluded that research in this area has made substantial progress in the last 30 years informed by ideas from new growth economics. Keywords Catch-up growth Growth regressions Relative economic decline Social capability Technological congruence Introduction The focal point of this chapter is the study of Western Europe s Golden Age of economic growth, which lasted from the early 1950s through the mid-1970s. The retrospective analysis of this period by quantitative economic historians only really began in the late-1980s although, obviously, this built upon the earlier work of applied economists. At that point, this historical research received a massive stimulus from the revival of interest in growth economics, which produced potentially appealing new theoretical ideas together with a much more empirical focus which was initially noteworthy in particular for its stress on issues relating to catch-up and convergence. Hitherto, formal growth theory had been dominated by the neoclassical growth model in which long-run productivity growth was a result of exogenous technological change and changes in the investment rate only affected the level of output per person rather than its growth rate. The key feature of the endogenous growth models, which appeared during the 1980s, was that they made long-run growth rates a result of investment decisions (relating to a broad concept of capital) based on microeconomic foundations. Two different types of models were developed, namely, AK models of growth in which diminishing returns to (broad) capital accumulation were assumed away, and endogenous innovation models in which the rate of technological progress is a result of profit-seeking investments. Two well-known variants of the former type were Romer (1986), based on constant returns to physical capital, and Lucas (1988), where endogenous growth could be the result of human and physical capital accumulation combined, with the former generating externalities. Two well-known variants of the latter type were the quality-ladders approach of Grossman and Helpman (1991) and the Schumpeterian growth model of Aghion and Howitt (1992). The relevance of both these types of models is that well-designed institutions and supply-side policy can have positive growth-rate effects through their effects on incentives to invest and to innovate, rather than just levels effects as in the neoclassical growth model. Empirical analysis of economic growth was also changing in the 1980s as new data sets became available, notably an early version of what became very wellknown estimates of long-run real income levels for OECD economies (Maddison 1982), and a much improved version of the Penn World Tables (Summers and Heston 1984). These permitted more sophisticated international comparisons of

3 The Golden Age of European Economic Growth 3 performance and underpinned the development of a huge growth regressions literature. Very early contributions to this by Baumol (1986) and De Long (1988) debated whether the historical record showed a general experience of convergence of income levels among advanced countries. Notions such as conditional β-convergence (Barro 1991) and social capability for catch-up and convergence (Abramovitz 1986) emerged as attempts were made to examine the roles that institutions and policies had played in growth outcomes. Already in the 1980s, there were some excellent economic-history-textbook accounts of postwar European economic growth using a traditional approach, for example, Van der Wee (1986). The historiography also featured well-known interpretations of the Golden Age including Kindleberger (1967) and Olson (1982). Against this background, the cliometric contribution came in three main ways. First, it provided superior international and inter-temporal comparisons of growth performance based on much improved measurement techniques and a better articulated conceptual framework. Second, it pursued statistical testing of hypotheses that had previously been evaluated quite informally. Third, it developed more sophisticated ways of thinking about the role of institutions and policies in underpinning the Golden Age and explaining cross-country differences in growth outcomes. Two (linked) questions are central to this topic, namely, what explains rapid economic growth in Western Europe during the Golden Age? and why did Western European growth slow down so markedly after the Golden Age? The first of these questions has produced a substantial body of work without by any means arriving at a complete consensus, but the second is still relatively underresearched by cliometricians. In each case, important insights can be gained from considering the variance of growth performance across countries and the correlates of relative success and failure. Growth Performance The basic data on growth are set out in Table 1 which is based on the original work of Angus Maddison, in particular with regard to establishing levels of real GDP measured at purchasing power parity. Several points should be noted. First, for European countries the growth rates of real GDP per person (Y/P) and of labor productivity (Y/HW) were much faster in the Golden Age than subsequently. The medians for were 3.62% and 4.58% per year, respectively, compared with 1.76 and 2.54 during Second, median European growth rates of Y/P and Y/HW were well above those of the United States in the Golden Age, but from 1973 to 1995 while labor productivity continued to grow faster in Europe than the United States, real GDP per person did not. Catch-up in income levels was rapid during the Golden Age but not thereafter. Third, in each period there is a clear inverse correlation among European countries between initial levels and subsequent growth rates of GDP per person so that in this special case the data exhibit unconditional β-convergence, as is confirmed by the regressions in Crafts and

4 4 N. Crafts Table 1 Initial levels and subsequent rates of growth of real GDP per person and per hour worked ($1990GK and % per year) (a) Y/P, 1950 Y/P Growth, Y/HW, 1950 Switzerland Switzerland Denmark United Kingdom United Denmark Kingdom Sweden Netherlands Netherlands Sweden Belgium Belgium Norway Norway France France Y/HW Growth, West West Germany Germany Finland Italy Austria Finland Italy Austria Ireland Ireland Spain Portugal Portugal Spain Greece Greece United United States States (b) Y/P, 1973 Y/P Growth, Y/HW, 1973 Y/HW Growth, Switzerland 18, Switzerland Sweden 14, Sweden Denmark 13, Netherlands West 13, Belgium Germany Netherlands 13, France France 12, Denmark Belgium 12, West Germany United 12, Norway Kingdom Norway 11, Italy Austria 11, United Kingdom Finland 11, Austria Italy 10, Finland Spain Portugal (continued)

5 The Golden Age of European Economic Growth 5 Table 1 (continued) Greece Spain Portugal Greece Ireland Ireland United 16, United States States (c) Y/P, 1995 Y/P Growth, Y/HW, 1995 Y/HW Growth, Norway 21, Belgium Switzerland 20, Norway Denmark 20, France Netherlands 18, Denmark France 18, Netherlands Belgium 18, Italy Austria 18, Germany United 17, Sweden Kingdom Sweden 17, United Kingdom Italy 17, Austria Germany 17, Finland Finland 16, Switzerland Spain 13, Spain Ireland 12, Ireland Portugal 11, Portugal Greece 10, Greece United States 24, United States Source: The Conference Board (2016) Note: post-1973 Ireland based on GNP Toniolo (2008). 1 The convergence rate was a little above 2% per year during the Golden Age but slowed to about 1.5% subsequently. Fourth, during the Golden Age, both the United Kingdom and Ireland underperformed in the sense that their growth was significantly slower than in countries with higher initial levels of income and productivity. For the UK, a prima facie verdict of growth failure in these years is reinforced by the evidence of being overtaken so that by 1973 levels of real GDP per person and of labor productivity were below those in many other European countries. Table 2 benchmarks the sources of growth in labor productivity using a standard neoclassical growth accounting framework implemented in identical fashion for each country and permitting comparisons not only between Western European countries but also between the latter part of the Golden Age and the subsequent 1 Their results show that this did not apply prior to 1950.

6 6 N. Crafts Table 2 Contributions to labor productivity growth, (% per year) H/L K/L TFP Y/L H/L K/L TFP Y/L Austria Belgium Denmark Finland France West Germany Greece Ireland Italy Netherlands Norway Portugal Spain Sweden Switzerland UK Source: Bosworth and Collins (2003) Note: Estimates are for the whole economy and labor productivity is measured on a per worker basis. Growth accounting is based on assuming a Cobb-Douglas production function in which Y = AK α (HL) 1 α where H is the average educational standard of the labor force, A is TFP, K is capital and L is labor. This allows the following expression for the sources of labor productivity growth to be derived: Δln(Y/L) = α[δln(k/l)] + (1 α)[δln(h/l)] + ΔlnA period of slowdown. The Golden Age era of rapid catch-up was indeed a period when both capital-deepening and TFP growth contributed greatly to labor productivity growth. Nevertheless, in most cases, TFP growth made the larger contribution and in countries with very rapid labor productivity growth the differential with the slower growing countries was much more due to TFP growth than capital deepening. When TFP growth is as rapid as it was for Europe during the Golden Age, it can be expected that there is a substantial component from reductions in inefficiency, both allocative and productive. Maddison (1987) in a somewhat speculative exercise concluded that much of the Solow residual was typically attributable to some combination of labor quality, improved allocation of resources, changes in the utilization of factors of production, reductions in technology gaps and economies of scale, leaving only a modest share unexplained and perhaps reflecting disembodied technical change. Maddison s list of the components of rapid TFP growth in the European Golden Age is broadly in line with conventional economic histories, but precise quantification is, of course, very difficult and there is no consensus on the details. 2 2 It should be noted that the results of a data envelopment analysis also give strong support to the claim that TFP growth during the European Golden Age was boosted considerably by improvements over time in the efficiency of factor use (Jerzmanowski 2007).

7 The Golden Age of European Economic Growth 7 Table 2 reveals that the slowdown in labor productivity growth in Western Europe after the Golden Age reflected declines in both capital deepening and TFP growth in every country but that the latter was generally more important. The unweighted average decrease between and was 1.00 percentage points per year for the capital-deepening contribution but 1.75 percentage points per year for TFP growth, which was largely the result of the evaporation of transitory components mentioned above. The dramatic decline of TFP growth in Southern European countries reflects this point. What Explains the Golden Age of European Growth? This section of the chapter considers attempts by cliometricians to explain why growth was so much faster in these earlier postwar years than either before or since. Much of this work has entailed testing hypotheses put forward in earlier vintages of economic history. The focus will be primarily on research with a cross-country perspective, but at the end its implications for understanding the UK growth failure will be reviewed. The Janossy Hypothesis The conventional idea of the so-called Janossy Hypothesis, which is based on an interpretation of Janossy (1969) proposed by Dumke (1990), is shown in Fig The basic idea is that after World War II the level of output in European economies was unusually low (at C) and that a period of super growth followed in which output first bounced back to its prewar level (CD) after which growth continued at a higher than normal rate (DE) until the normal growth rate resumed (at E). Obviously, countries varied in terms of how far the point C was below trend, and therefore in the scope for reconstruction and super growth, with West Germany often seen as an extreme observation and thus a good candidate for a wirtschaftswunder. This analysis raises two questions, which the cliometric literature has addressed: first, how much did reconstruction contribute to growth? and second, is it correct to see European countries returning to a pre-existing trend growth path? Since a pioneering paper by Dumke (1990), the issue of the reconstruction contribution has been tackled by running what might be called augmented unconditional convergence regressions. In this approach, growth of real GDP per person is regressed against the initial level of income per person, a measure of the shortfall of the actual output level compared with an estimate of the level of trend output in the late 1940s (typically called GAP ) to capture the potential for reconstruction effects 3 The graph embodies a trend-stationary view of the world. Arguably, Janossy himself believed in segmented trends where labour productivity growth in each period was underpinned by investment in human capital, see Vonyo (2008).

8 8 N. Crafts Log of output The Jánossy Hypothesis E F A B D C Time Fig. 1 AF, long run trend line; AB, pre-war output levels; BC, war induced shocks to output; CE, total length of the reconstruction period; CD, recovery of pre-war levels; DE, re-attaining the trend line; EF, output levels after reconstruction; Source: Dumke (1990) and the share of the labor force in agriculture for a sample of European or OECD economies. Dumke (1990) estimated an equation of this type to explain average growth rates in cross-section for He found that reconstruction was generally statistically but not economically significant and accounted for only about 5% of growth over the period. For West Germany, however, reconstruction did account for a large part of the difference between its growth and the average growth outcome and was complementary to conventional β-convergence. A subsequent paper by Eichengreen and Ritschl (2009) echoed these findings for West Germany but argued that the output gap at the end of the war and reconstruction effect in the 1950s was somewhat bigger than Dumke had thought. They emphasized that this explained much of the extremely rapid TFP growth of that decade. 4 Temin (2002) estimated a similar equation for European countries for decadal growth during the 1950s through the 1990s but focused only on average performance. He found that reconstruction had a statistically significant positive effect only for but not thereafter. Vonyo (2008) developed this approach further; his innovations included adding labor force growth as an independent variable and adopting a panel-data estimation setting. His results are summarized in Table 3. He found that reconstruction effects, which lingered through to the 1980s, were on average economically significant throughout the Golden Age with a very strong 4 Eichengreen and Ritschl (2009) estimate that TFP growth in West Germany was 5.39% per year during and it seems reasonable to infer from their discussion that as much as 3.5 percentage points per year may have been due to reconstruction.

9 The Golden Age of European Economic Growth 9 Table 3 Contribution of reconstruction to growth of real GDP per person (% per year) 1950s 1960s 1970s 1980s Austria Belgium Denmark Finland France Germany Italy Netherlands Norway Sweden Switzerland United Kingdom Unweighted Average Source: Vonyo (2008) Note: Derived from panel estimation of two equations in one of which growth is regressed on initial income, labor force growth, GAP*Time, and a country fixed effect and in the other the fixed effect is regressed on GAP. GAP is the proportional difference between potential and actual output in 1948 where potential output is extrapolated from the 1938 level using the average annual growth rate from 1920 to The reconstruction contribution is obtained by adding the estimated impact of GAP in the two equations impact in West Germany, but his results are notable also for underlining that in Sweden and Switzerland there was no reconstruction bonus. Clearly, there is some support among cliometricians for Janossy s emphasis on reconstruction as an important factor in early postwar growth in addition to regular catch-up growth. It is also apparent that its impact varied greatly across countries. An implication of this is that international comparisons of growth performance during the Golden Age should attempt to normalize for differential scope for reconstruction, especially if they involve West Germany. The claim that the effects of reconstruction on growth still mattered in the 1980s should be treated with caution given the different results presented by Temin and Vonyo. The second issue, relating to trend stationarity in long-run European growth, was investigated using time-series econometrics by Crafts and Mills (1996). They took the pure-janossy hypothesis to mean that the return to normal growth would entail going back to the pre-1914 trend growth rate for real GDP per person by the end of the Golden Age. They found that the growth process could be modelled as segmented trend-stationary for all the European countries in their sample. On this basis they were able to reject the pure-janossy hypothesis except in the case of Denmark. In the cases of Spain, Sweden, and Switzerland, a modified-janossy hypothesis that after the Golden Age they had returned to the pre-1914 trend growth rate (but on a path at a higher income level) could not be rejected. This implies that all European countries except Denmark had higher real GDP per person at the end of the Golden Age than would have been predicted by extrapolating the pre-1914 trend.

10 10 N. Crafts This is very much what a reader of Abramovitz (1986) or Maddison (1982) would have expected given their emphasis on the unprecedented nature of rapid catch-up growth after Macroeconomic Stability It is widely recognized that the Bretton Woods era, which coincided with the Golden Age, was a period when macroeconomic fluctuations were relatively gentle (cf. Table 4), and it has been argued that this provided a highly favorable context for rapid postwar growth (Boltho 1982). Clearly, it was important that there was no repeat of the disastrous policy errors associated with the interwar gold standard which led to a lost decade for the gold bloc countries in the 1930s. The absence of banking crises in an era of capital controls and tight regulation of banks would also appear to be a positive feature of these years, as has been underlined by recent experience. Finally, the OPEC oil-price shocks only materialized in the 1970s. That said, some important caveats should be noted. First, the hypothesis that volatility can harm growth has been somewhat controversial. One reason for this is that models were produced that had the opposite prediction, namely, that larger and more frequent business-cycle fluctuations can raise growth, for example, since the opportunity cost of productivity enhancing activities falls in recessions (Aghion and Saint-Paul 1998) and conflicting results have been found in empirical work. Nevertheless, the preponderance of evidence points fairly clearly to a negative effect on investment and growth of unexpected volatility, uncertainty, or the variance of innovations to a forecasting equation for growth (Bloom 2014; Rafferty 2005; Ramey and Ramey 1995), and this implies that a benign macroeconomic environment could have been beneficial for long-run growth outcomes in the Golden Age. Second, the reconstruction of the world economy after World War II was based on the Bretton Woods Compromise (Rodrik 2000), which severely restricted international capital mobility while seeking to liberalize trade. This implied a new macroeconomic trilemma choice in which priority was given to scope for independent monetary policy to manage the domestic economy rather than the efficient allocation of capital. In the1950s and 1960s, average current account positions as a fraction of GDP were at an all-time low (1.3% in ), and in cross-sectional Feldstein- Horioka regressions to predict investment/gdp the coefficient on savings/gdp is Table 4 Real GDP growth: average for G7 countries in four macroeconomic eras (% per year) G7 Mean G7 Standard deviation (Gold Standard) (Bretton Woods) Source: Bordo (1993)

11 The Golden Age of European Economic Growth during (Obstfeld and Taylor 2004). This imposed a domestic savings constraint on growth. Third, the successful prevention of banking crises surely entailed lower growth in normal years. Financial regulation reduced leverage in bank balance sheets and surely implied a higher cost of capital since Modigliani-Miller offsets are known to be imperfect (Miles et al. 2013). Capital controls also raised the cost of capital and adversely affected growth (Voth 2003). The period was characterized by high costs of adjusting capital stocks to the optimal level and also by high values of Tobin s Q in both West Germany and the United Kingdom (Crafts and Mills 2005). Overall, this suggests that investment and growth were constrained by the regulatory environment, but at present there is no study that quantifies the overall impact. Structural Change Some, but not all, European economies had substantial low-productivity agricultural sectors at the start of the Golden Age; for example, in 1950, 49% and 42% of employment was in agriculture in Spain and Italy, respectively, but only 5% in the UK. Kindleberger (1967) argued that in some cases fast growth could be understood in terms of a Lewis dual-economy model with elastic supplies of labor available to the industrial sector. Temin (2002) found that a statistically significant effect from adding the initial share of the labor force in agriculture to unconditional-convergence growth regressions for the 1960s and 1970s but not thereafter. He argued simply that this reflected the productivity gain from correcting a misallocation of resources. The orthodox shift-share way to measure the contribution of structural change in employment to labor productivity growth is to calculate it as aggregate labor productivity growth minus a weighted average of intra-sectoral productivity growth rates based on initial employment shares, as, for example, in Maddison (1987). This assumes, however, that the intrasectoral productivity growth rates are unaffected by the labor transfer. This will not be the case, however, if there was surplus labor in agriculture (Kindleberger 1967) and/or the increased size of the manufacturing sector allowed economies of scale to be realized (Kaldor 1966) since one or both of the intrasectoral productivity growth rates will be increased. The problem facing cliometricians has been to evaluate this additional contribution. Broadberry (1998) proposed a way to address the first of these issues. He suggested that in a declining sector, such as agriculture, a modified shift-share calculation should be used in which the actual should be replaced by a counterfactual labor productivity growth rate obtained by actual output growth minus national labor force growth. Table 5 reports the results of this method and compares them with those obtained using the orthodox method for a number of European economies. Not surprisingly, the contribution of structural change is much larger using Broadberry s method and is indeed quite large for Italy and Spain. Nevertheless, it must be accepted that although some correction for surplus labor probably is justified, this is no more than a rough and ready approach.

12 12 N. Crafts Table 5 Contribution of structural change to labor productivity growth, (% per year) Orthodox measure Broadberry measure Denmark UK Sweden Netherlands France West Germany Italy Spain Source: Crafts and Toniolo (2008) who derived the estimates from data in van Ark (1996) based on Broadberry s methodology using a three sector (agriculture, industry, services) de-composition where agriculture is deemed to be the declining sector Note: The orthodox approach considers the contribution of structural change equals ΔA O /A O ΣΔA i /A i *A i /A O *S i where A is labor productivity, S is share of employment, and subscripts o and i stand for the whole economy and sector i, respectively (Nordhaus, 1972). Broadberry (1998) modified this so that labor productivity growth in the case of declining sectors was measured using the overall national rate of labor force growth not the sectoral rate The evidence on economies of scale in manufacturing is also far from satisfactory. Kaldor based his views on a belief in Verdoorn s Law which he interpreted as implying a positive relationship in manufacturing between the rate of growth of labor productivity and the rate of growth of employment. This could reflect various sources of economies of scale including learning by doing. On the whole, the literature has been rather skeptical of the validity of Verdoorn s Law and, in any case, most economists would look to better-specified estimating equations to try to infer the presence of scale economies. 5 The evidence from econometric investigations for European industries in the 1970s and 1980s is in fact somewhat mixed (Caballero and Lyons 1990; Henriksen et al. 2001) and might suggest that experience varies. The best developed example of a structural change account of the Golden Age relates to Italy which experienced a major shift of labor from agriculture to industry and was able to expand internationally tradable manufacturing by sustaining a substantially undervalued exchange rate for about two decades. Rossi and Toniolo (1996) using a modified growth accounting technique pioneered by Morrison (1988) found evidence of significant economies of scale during the postwar period. Based on an approach suggested by Rodrik (2008), Di Nino et al. (2013) estimated that undervaluation contributed % per year to GDP growth in an economy where wage growth was lower than labor productivity growth in tradables in the context of a strong domestic flow of migrant labor. Putting these components together gives an 5 Magacho and McCombie (2017) is a recent review which suggests that the proposition will be rejected by mainstream growth economists. Maddison (1987) attributed only a small part of the Solow residual during the Golden Age to scale economies, which he assumed amounted to 3% of GDP growth, but this was no more than a guess.

13 The Golden Age of European Economic Growth 13 account of Italian growth quite similar to that which a reader of Kaldor and Kindleberger might expect. The Marshall Plan and the European Economic Community The reconstruction of the European economy entailed not only investment but policy reforms. The Golden Age was notable not only for the Bretton Woods agreement but also for the Marshall Plan and the European Common Market. Both of the latter promoted European economic integration and it is this aspect which is the main focus of this section. In terms of short-run static effects, trade liberalization can improve allocative efficiency and/or productive efficiency, i.e., given existing costs, factors of production are deployed more efficiently or production costs are lowered. Insofar as freer trade increases competition in product markets (through actual or potential entry), it may have both effects as market power is reduced and price-cost margins fall, while managers of firms are pressured to reduce costs to the minimum feasible (principalagent problems are reduced). In terms of long-run dynamic effects, according to endogenous growth models, it is possible that the growth rate will rise as a result of economic integration. In a basic AK model, if investment (or more generally the rate of growth of the capital stock) responds positively, there is no tendency for diminishing returns to erode this initial effect so there is a permanent impact on growth. Perhaps more plausibly, if a larger market and/or more competition in product markets ensues from economic integration, this may raise the rate of innovation and total factor productivity (TFP) growth. Even so, in a perhaps more realistic (semi-endogenous) growth model, the trade-liberalization impact on the growth rate would be a transitory phenomenon reflecting a move to a higher level of output rather than faster trend growth. Growth regressions can be used to estimate the effect of European economic integration on income growth. Here the most useful paper is Badinger (2005), which made an index of the level of integration for each EU15 country from 1950 to 2000, and in a panel-regression setting with suitable controls examined its relationship with growth and with investment. The integration index, which took account both of GATT liberalization and European trade agreements, shows that 55% of the protectionism of 1950 was eliminated between 1958 and 1975, a figure which then rose steadily to 87% by The results of the regressions were that changes in integration were positive for growth but that the level of integration had no effect and that changes in integration had somewhere between half and three quarters of their impact through investment with the remainder coming from changes in TFP. Across the EU15 as a whole, GDP was estimated to be 26% higher than if there had been no economic integration after 1950, with a narrow range from 21.6% for Sweden to 28.9% for Portugal. The peak effect on the level of income resulting from the rapid liberalization prior to 1975 would have raised the growth rate over the period by about 1% per year impressive, but only about a quarter of the western European growth rate in a period of rapid catch-up growth (Crafts and Toniolo

14 14 N. Crafts 2008). The implication of the results in Badinger (2005) is that European economic integration has had a sizeable impact on the level of income but has not had a permanent effect on the rate of growth. This amounts to rejecting the endogenous growth hypothesis and is line with investigations of the impact of recent trade liberalizations using difference-in-difference approaches (Estevadeordal and Taylor 2013). 6 The Marshall Plan was a major program of aid which transferred $12.5 billion from the United States to Western Europe during the years and provided inflows to recipient countries which typically averaged about 2% of GDP per year. 7 It helped reduce the costs of the Bretton-Woods Compromise by speeding up European integration via trade liberalization and the conditionality that it entailed also promoted pro-market reforms that were conducive to growth. As De Long and Eichengreen (1993) stressed, rather than being a handout, the Marshall Plan was a structural adjustment program along the lines of the Washington Consensus the most successful ever which succeeded by raising productivity growth and steered Europe away from becoming Argentina, i.e., away from an inward-looking development strategy based on protectionism. In particular, each country signed a bilateral treaty with the United States, which committed them to follow policies of financial stability and trade liberalization while the Organization for European Economic Co-operation (OEEC) provided conditional aid to back an intra-west European multilateral payments agreement; in 1950, recipients had to become members of the European Payments Union (EPU). This lasted until 1958 by which time intra-european trade was 2.3 times that of 1950 and a gravity-model analysis confirms that the EPU had a large positive effect on trade levels. 8 The Marshall Plan worked by tipping the balance in favor of pro-market structural reforms that raised productivity growth rather than through a direct stimulus. 9 This analysis can be developed by thinking in terms of a 3-gap model (Bacha 1990). This takes into account that aid can have positive growth effects through relaxing savings, foreign-exchange, or fiscal constraints. Eichengreen and Uzan (1992) provided an analysis of this type. The bottom line is that the direct effect of an average inflow of 2% of GDP would have raised the growth rate by 0.3 percentage points during the years The establishment of the European Economic Community increased trade considerably. In 1958 the EEC was formed by the original six countries following the 6 Estevadeordal and Taylor point to reductions in tariffs on capital goods with consequent increases in the capital to labor ratio as central to the positive levels effect of trade liberalization; for a similar argument applied to Golden Age Europe, see Cubel and Sanchis (2009). 7 More details of how it worked can be found in Crafts (2013). 8 See Eichengreen (1993) which also contains a detailed description of the logic and mechanics of EPU. 9 Exclusion from the Marshall Plan and EPU postponed but did not necessarily preclude liberalization, as is shown by the 1959 reform in Spain which raised the growth rate by 1 percentage point per year for the next decade and a half (Prados de la Escosura et al. 2011).

15 The Golden Age of European Economic Growth 15 Table 6 Trade costs Germany- France Germany- Italy Spain- France UK- France UK- Italy UK- Norway Source: Data underlying Jacks et al. (2011) generously provided by Dennis Novy Note: Trade costs are inferred using a gravity model and comprise both policy and non-policy barriers to trade; estimates are not strictly comparable with those for ; estimates that include Spain are for 1939 not 1938 signing of the Treaty of Rome in The signatories pledged to lay the foundations of ever closer union among the peoples of Europe and Article 2 committed members to form a customs union, to establish a common market and to harmonize policies. The EEC customs union was achieved in 1968, but the common market took much longer and awaited the Single European Act, which addressed nontariff barriers to trade, liberalized trade in services and ended capital controls and was (less than fully) implemented from Even so, trade costs between the six countries fell relatively rapidly (cf. Table 6). Using a gravity model, Bayoumi and Eichengreen (1995) estimated that intra-eec trade among the original six members was increased by 3.2% per year between 1956 and 1973 implying that EEC membership may have raised income levels by 4 8% by 1970 (Eichengreen and Boltho 2008) based on the elasticity between trade volumes and income estimated by Frankel and Romer (1999). Social Capability and Technological Congruence These concepts are central to the explanation given by Abramovitz and David (1996) for the Golden Age. They emphasize that catch-up growth is not automatic but depends on Social capability and technological congruence. Their approach is one of conditional convergence and their argument is that lack of social capability and technological congruence had held Europe back prior to World War II, but these constraints on growth were much reduced by the 1950s and 1960s (Nelson and Wright 1992). Technological congruence refers to the cost effectiveness of the leader s technology in the follower countries which can be undermined by differences in factor prices or market size. Social capability refers to the ability to 10 The six founder members were Belgium, France, Germany, Italy, Luxembourg and Netherlands.

16 16 N. Crafts assimilate new technology. Absorptive capacity is underpinned by education, skills, and economic competences including organizational effectiveness, appropriate business models, and training. Beyond this, however, social capability turns on institutions, economic policies, and the incentive structures that they imply, which affect the profitability of innovation and investment. There is strong evidence of a significant increase in the rate of technology transfer into Europe after World War II. Madsen (2007) estimated a model in which TFP is impacted by imports of knowledge embodied in high technology goods and concluded that this played a major part in the reduction of TFP gaps. Comin and Hobijn (2010) investigated diffusion processes and showed that adoption lags for new technologies became much shorter. These studies do not, however, account for the relative importance of increased social capability and technological congruence. The best evidence on technological congruence was provided by Jerzmanowski (2007). He devised a method to decompose TFP gaps into a part due to inefficiency (distance from the production function) and a part due to technology (inferior production function due to inappropriateness of American technology). His results (Table 7) show that TFP gaps were still quite large in 1960 but that they were primarily due to shortfalls in efficiency rather than technology gaps. Subsequently, big reductions in these efficiency gaps by 1985 accounted for a good part of European catch-up. This tends to confirm both the importance of improvements in resource allocation and that American technology was congruent for early post-war Western Europe. When he proposed the concept of social capability, Abramovitz (1986) stated that the problem was that no-one knew just what it meant or how to measure it. Since then, a good deal of progress has been made. Giorcelli (2017) provides an important Table 7 Decomposition of 1960 level of TFP into efficiency and technology components (USA = 1.00) TFP Efficiency Technology Austria Belgium Denmark Finland France Greece Ireland Italy Netherlands Norway Portugal Spain Sweden Switzerland Source: Jerzmanowski (2007) Note: TFP = Efficiency*Technology

17 The Golden Age of European Economic Growth 17 example of improved absorptive capacity in Italy as a result of managerial training under the auspices of the Marshall Plan. She is able to compare firm performance where managers participated in sponsored visits to learn about American management practices with a control group that was excluded from the program. Productivity in the former grew by 52.3% relative to the latter over 15 years. This paper indicates that management quality was important to realizing the potential of new technology and, especially in the context of research by Bloom and Van Reenen (2007), suggests that improvements in management might have contributed to enhanced social capability in postwar Europe. This is a promising area for more research. Turning to institutions and incentive structures, when Abramovitz first put forward the idea of social capability, the fashionable thesis was that of institutional sclerosis as set out by Olson (1982). Put simply, this proposed that in the absence of shocks such as wars and invasions over time democracies tend to experience a proliferation of rent-seeking interest groups, which act as a constraint on growth. The logic of this argument would be that World War II and its aftermath significantly relaxed this constraint for some countries, notably, West Germany. This hypothesis has generated a large literature by economists and political scientists exploring crosscountry evidence which has, on balance, been supportive of Olson (Heckelman 2007). European economic historians have, however, been distinctly skeptical. In the case of the prime example, Eichengreen and Ritschl (2009) summarized a literature emphasizing institutional continuity rather than change. Comin and Hobijn (2011) developed a neat test based on changes in the adoption lags for new technologies after World War II for technologies with and without a competing predecessor. They found that for the latter these fell by 13 years, whereas for the former they increased by 5 years. The Olson hypothesis predicts the opposite. Another approach to assessing the impact of institutional and policy settings on growth has been to use indices of economic freedom. Countries that are economically free have secure property rights and effective enforcement of contracts, stable prices, low barriers to trade, and resources mainly allocated through the market. Because of data limitations, analyses incorporating an economic freedom variable in a growth-regression specification have examined post-1975 experience. On balance, papers that pay attention to issues of endogeneity (De Haan and Sturm 2000; Kacprzyk 2016) give some support to the hypothesis that either the level of or increases in economic freedom promote growth. Recently, Prados de la Escosura (2016) has developed a Historical Index of Economic Liberty that will allow the hypothesis to be tested for earlier periods. Table 8 shows a general tendency to increased economic liberty in Western Europe; this was the case comparing with for all countries except Greece and Norway. It seems possible that these data can be used to provide some further support for the Abramovitz and David (1996) claim that improved social capability was an important ingredient in the recipe for the Golden Age.

18 18 N. Crafts Table 8 Economic liberty (0 10) Austria Belgium Denmark Finland France Germany Greece Ireland Italy Netherlands Norway Portugal Spain Sweden Switzerland United Kingdom Source: Prados de la Escosura (2016) High Investment/Wage Restraint Cooperative equilibrium The most striking hypothesis to explain enhanced social capability in post-war Western Europe is that of Eichengreen (1996) who argued that high investment rates which allowed successful exploitation of catch-up opportunities were facilitated by successful social contracts which sustained wage moderation by workers in return for high investment by firms. To achieve a cooperative equilibrium of this kind, it is necessary to solve a time inconsistency problem. In the event of wage restraint, capitalists can go back on their promise to invest and raise dividends instead. On the other hand, if investment is increased, then workers can abandon wage restraint and seek to appropriate the profits. Corporatist arrangements provided institutions to monitor capitalists compliance and centralized wage bargaining that protected high-investment firms and prevented free-riding by subsets of workers. A game theoretic analysis suggests that the central foundation of a cooperative equilibrium with high investment and wage moderation is that both sides are patient take a long-term view of the payoffs to their decisions and have reason to expect those payoffs to be substantial (Cameron and Wallace 2002). Table 9 records the evolution of systems of industrial relations. Compared with 1925, in 1950 there were more countries classified as corporatist or neo-corporatist, characterized by coordination in wage bargaining, and fewer with decentralized collective bargaining. In a growth-regression study, Gilmore (2009) found that coordinated wage bargaining may have had quite strong positive effects on investment and growth prior to 1975, but these were not found in subsequent periods. These results are supportive of Eichengreen s hypothesis. But this was not

19 The Golden Age of European Economic Growth 19 Table 9 A classification of industrial relations systems Corporatism A,D,E A,B,DK,N, NL,S A,B,DK,N, NL,S A,B,CH,D,DK,N, NL,S Collective bargaining Neo-corporatist CH CH,D CH,D FIN Decentralized B,DK,N,NL,S, IRL,UK IRL,UK IRL,IT,UK UK Contestation F, FIN, IRL FIN,F,IT FIN,F,IT E,F,P Authoritarian IT,P E,P E,P Source: Crouch (1993) Note: A= Austria, B = Belgium, D = Germany, DK = Denmark, E = Spain, FIN = Finland, F = France, IRL = Ireland, IT = Italy, N = Norway, NL = Netherlands, P = Portugal, S = Sweden the only route to rapid catch-up growth as was apparent in the earlier discussion of the Lewis dual-economy model favored by Kindleberger. In Italy, for example, elastic supplies of labor to the industrial sector restrained wage increases and underpinned high investment at least until the late 1960s (Crafts and Magnani 2013). If patience and optimism about large future rewards, rather than coordinated bargaining alone, are required to achieve the high investment with wage restraint cooperative equilibrium, then it may be quite fragile. As Cameron and Wallace (2002) point out, the economic environment of the Golden Age was conducive to this outcome, whereas the turbulence of the 1970s was not. The cooperative equilibrium is more likely in a world of restricted capital mobility, fixed exchange rates, weak bargaining power for workers, and lots of scope for productivity growth. This describes the 1950s much better than the 1970s. Relative Economic Decline in the UK A brief look at the UK during the Golden Age is instructive. As was noted earlier, growth was relatively slow compared with other European countries. Some of this reflects less scope for catch-up including having an already small agricultural sector in But there was more to it than that notwithstanding the claim to the contrary by Temin (2002). So, while the Janossy and Kindleberger hypotheses are relevant to the British case and would, of course, predict that economic growth would be slower than West Germany and Italy, for example (cf. Tables 3 and 5), there is nothing in these models that would predict the UK s slide down the European ranking of labor productivity from 2nd in 1950 to 10th in In this context, being overtaken connotes avoidable failure even though simplistic growth regressions might seem to say otherwise. A case-study approach allows the cliometrician further insights, especially with regard to the role played by social capability. Britain did not achieve the transformation of industrial relations that happened elsewhere in Europe which implied a considerable growth penalty. When it is not