ZEW President Franz on the EU Lisbon Strategy

This article appeared in the January/February edition of the ZEWnews.

Lisbon Strategy

In last year’s discussions about the extension of working hours, there was one aspect that received little or no attention: the growth perspective.  This is rather surprising, not only because the European Union (EU) declared in the Lisbon Strategy of 2000 that its aim was to "make Europe, by 2010, the most competitive and dynamic knowledge-based economy in the world".

But what does this have to do with longer working hours? Between 1991 and 2003, annual average growth in labour productivity amounted to 1.8 per cent in the US and to 2.1 per cent in Germany. However, those countries used their productivity gains in quite different ways: In the US, real income per capita has increased by more than 2 per cent per year (Germany: less than 1 per cent), whereas in Germany, working hours per person have decreased by 0.6 per cent. In other words, with productivity growing at a similar rate, the United States has used productivity gains to generate additional income, while Germany channelled it towards more leisure time. The latter applies to a great number of EU countries.

This comparison requires some perspective, however. The critical question is, therefore, whether the statistically proven reduction in working time does in fact correspond to a deliberate decision to increase leisure time. If this proves to be true, the Lisbon Strategy is not off to a good start. Based on the current rate of productivity growth, increasing leisure time will not lead to growth. There is no question that if additional leisure time reflects individual preferences, this increase is in fact justified. However, there is no way that we can become “the most competitive and dynamic knowledge-based economy in the world” if we only indulge in leisure pursuits.

There are a number of plausible reasons why the reduction in working hours does not correspond to a deliberate increase in leisure time. Firstly, a proportion of all work activity takes place in the shadow economy, which – with a share of 16 per cent of GDP – is almost twice the size of the informal sector in the US based on its contribution to the GDP. Furthermore, the considerable tax cost associated with higher earned income makes the prospect of spending more time on leisure activities all the more attractive. In a recent study, Nobel laureate Edward Prescott came to the rather surprising conclusion that the United States’ much higher labour supply compared to Germany could be attributed almost solely to differences between the two tax systems. This might be an extreme position. But the opposing position, which has lately become popular in Germany, that labour supply has nothing whatsoever to do with the tax burden, is just as questionable.

Does this mean that we can forget the Lisbon Strategy? There is no need to resort to drastic measures. Rates of productivity development are not fixed or static values; productivity can grow. Economic policy measures aimed at lowering tax burdens as well as measures in policy areas such as education, innovation or competition policy could help achieve these goals. One option would be to reduce market entry barriers for start-up companies.

In its latest annual report, the German Council of Economic Experts also emphasised the need for action in these policy areas. Increasing labour productivity could solve the trade-off between economic growth and leisure time – and there is a lot to be gained from reducing unemployment in Germany.