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Based on Barry Eichengreen’s article
“Innovation and Integration:
Europe’s Economy Since 1945”
EUROPE’S ECONOMY SINCE 1945
INTRODUCTION
 2nd half of the 20th century was a period of
unparalleled growth in Europe:


Real GDP per capita more than tripled in the
Western countries and more than doubled in the
Eastern countries
Quality of life improved – hours worked per year
declined by more than one-third giving way to
leisure time and lengthening life expectantcy
 However – unemployment rose over the period and taxes
also soared
 BUT, by any standard, Europeans are better off today
than their parents and grandparents
Introduction (cont.)
 Southern Europe grew faster than Northern Europe
 Western Europe grew faster than Eastern Europe
 Growth was faster in the 2 decades before 1973 than
the 2 decades after
 HOWEVER, the postwar period is regarded as the
golden age of economic growth
Introduction (cont.)

2 exogenous conditions stimulated growth in the
second half of the 20th century:
1.
Backlog of unexploited technological and organizational
knowledge with which Europe entered the period

2.
Military had to innovate to survive the world wars (for ex. İt had to
invent jet engines, radar and computing)
The great power conflict between the USA and Soviet Union
forcing countries to conform to the form of economic
organization as their dominant partner

Their choice determined their subsequent economic performance
●
●
Western Europe – Market Capitalism
Eastern Europe – State Socialism
Introduction (cont.)
 Principal Features of the International Economic
Environment of the Postwar Period:
 Marshall Plan
 Bretton Woods International Monetary System
 General Agreement on Tariffs and Trade
 These were all molded by the US – Soviet conflict
Exogenous Actions –
Endogenous Processes

To the 2 exogenous actions there were 2 reactions – 2
endogenous processes
1.
Transition from extensive to intensive growth
●
Extensive growth: growing on the basis of known
technologies – raising output by putting more people to
work at familiar tasks and raising labor productivity by
building more factories along the lines of existing ones
Rising capital/labor ration = extensive growth
Intensive growth: growth through innovation
Europe relied more on extensive growth before 1973 and
more on intensive growth thereafter
●
●
●
Extensive Growth
 Facilitated by the backlog of technology
 Less important to innovate so long as there were
known technologies still to be acquired and
commercialized
 Easy as long as there were elastic supplies of labor
(refugees from the east; repatriates from the colonies;
underemployed workers from the agricultural
perihery) who could be added to the industrial labor
force without putting upward pressure on wages
Extensive Growth (cont.)
 Extensive growth was what planned economies
organized on Soviet lines did best
 Government decides how many factories to build; directs
state banks to mobilize the resources; limits consumption
to what is left; decides what foreign technologies to
acquire...
 This was a successful strategy for Eastern European
countries for a while
 The more successfully European countries pursued
this model, the more quickly they exhausted the
backlog of technological and organizational
knowledge
Extensive Growth (cont.)
 As European countries depleted backlog of
technology and organizational knowledge – they were
forced to switch to intensive growth
 The centrally-planned economies were the least good
at innovation because new knowledge bubbled up
from below instead of raining from above
 This became a problem for the centrally planned
economies once the technology was used and the
labor force was fully employed
Exogenous Actions –
Endogenous Processes (cont.)
2.
European Integration

Globalization for Europe meant regional integration

European integration was encouraged by the U.S. To
fight off the Soviet influence

The Soviet Union prohibited the participation of
Eastern European countries to integrate with Western
Europe
How Can Europe Avoid Another War? – The
Question and Ideologies
 The solution to this problem differed on beliefs about
the cause of WWII and the three schools of thought in
existence were:
 Germany was to blame: The so-called Morgenthau plan of
1944 proposed to avoid future war by turning Germany into a
country primarily agricultural and pastoral in nature. The
same thinking existed after WWI where the victors were
rewarded with German territories and financial reparations –
this led to the German cycle of resentment and economic
downturn that led to WWII
 Capitalism was to blame: Marxism-Leninism blamed
capitalism for WWI and II and offered communism as a
solution
 Nationalism was to blame: Excesses of destructive nationalism
was blamed for the war and European integration was offered
as a solution
 The 3rd view ultimately prevailed but this was far from
clear in the 1940s
European Integration (cont.)
 Before 1913 – Western Europe was at the heart of the
global trade and financial system
 World War I (1914-1918) – disrupted this
 The Bolshevik Revolution (1917) and the Treaty of
Versailles (1919) also disrupted trade and finance
 World War II (1939-1945) – also had negative effects
 Europe had to rebuild its international economic
position from a very unfavorable starting point
PHASES OF GROWTH, 1820-1992
Europe’s Economic Growth
 Western Europe (Austria, Belgium, Denmark,
Finland, France, Germany, Italy, Netherlands, Norway,
Sweden, Switzerland and the UK)– during 1950-1975
grew twice as fast as 1820-1970
 Southern Europe (Greece, Portugal, Spain, Turkey and
Ireland) – acceleration and decelaration is more
dramatic
 Eastern Europe (Bulgaria, Czechoslovakia, Hungary,
Poland, Romania, Yugoslavia and the USSR) – grew
faster than Western Europe before 1973 because this
region lagged behind the West in the 19th century
 Growth halts after 1973 – not evident in any other region
Per Capital Real GDP Growth in 56 Countries, 1820-1992
European Growth (cont.)
 Per Capita GDP Growth = (Rate of Growth of Output)
– (Rate of Growth of Population)
 Per Capita GDP Growth is a better measure of the change
in living standards
 Western Europe fares better due to lower rates of
population growth
 Out of the 12 Western European countries extensive
growth was fastest in Germany, Austria and Italy
 The slowest in the UK – after 1973 the UK continued to
underperform the W. European average
 1973-1992 : period of intensive growth
 Switzerland, Sweden and the Netherlands performed
even worse
European Growth (cont.)
 Southern Europe: Greece and Iberia (Spain and
Portugal) performed better than Turkey and Ireland
 But the post-1973 slowdown was the least dramatic in
Turkey and Ireland (best performers in S. Europe in the
years of intensive growth)
 Eastern Europe: Growth of output per capita was
relatively uniform – reflects the heavy hand of
planning
 In the extensive growth years it was the slowest in those
countries that started out with high levels of output per
person (Czechoslovakia and the USSR)
 Central planning and state trading were important in this
convergence
 Intensive growth years led to stagnation in the region
Economic Impact of WWII
 WWII – destroyed economic capacity (persons,
factories, farms, roads, bridges, ...) and economic
relations
 Roads and etc. could still be fixed but economic
organization was interrupted
 During and after the war:
 There was rationing and controls
 Labor and raw materials were directed to production of




critical commodities
Wages were frozen
Government froze the prices of consumer goods like food,
fuel and clothing and rationed purchases
Banks were regulated
Commodity imports and capital exports were controlled
Effects of Rationing...
Early Post-War Period
 In 1945 a family almost anywhere in Europe found
themselves in a nation which was or had recently been:
 Ruled by a brutal fascist dictator
 Occupied by a foreign army OR
 Both
 As a result of these governmental failures thens of
millions of Europeans were dead and Europe’s economy
lay in ruins
 The 2nd WW was the fourth time in 130 years that France
and Germany were at the core of increasingly horrifying
wars
Aftermath of WWII
(Germany 1945)
Aftermath of WWII
(London 1944)
Death and Destruction in WWII
Death Toll
Austria
Belgium
Denmark
Finland
France
Germany
Italy
Netherlands
Norway
Sweden
Switzerland
UK
525.000
82.750
4.250
79.000
505.750
6.363.000
355.500
250.000
10.250
0
0
325.000
Source: Baldwin & Wyplosz, p. 5)
Pre-war year when
GDP equalled that
of 1945
1886
1924
1936
1938
1891
1908
1909
1912
1937
GDP grew during WWII
GDP grew during WWII
GDP grew during WWII
Europe,
Post-WWII
Economic Effects of WWII (cont.)
 At the conclusion of hostilities, industrial production
was no more than 40% of prewar levels in Belgium,
France and the Netherlands and less than 20% in
Germany and Italy
 From this position it was possible to boost output
quickly by restoring essential infrastructure and
freeing resources for peacetime use
Production in Western Europe
Rebuilding Europe

Building infrastructure was the easy part


Making growth self-sustaining was a difficult task
3 obstacles to self-sustaining growth:
Resource bottlenecks
2. Price controls
3. Political uncertainty
1.
1. Resource Bottlenecks
 Europe tried to increase its “industrial capacity”
 Due to national security issues industries like steel
and iron were given priority
 Governments wanted to increase output and capacity
 Problem was that Europe produced limited inputs of
capital goods in this process
1. Resource Bottlenecks (cont.)
 Germany was the traditional producer and exporter of
capital goods and its production was now limited by
the occupying powers
 Inputs could still be purchased from the U.S. – but
only for dollars
 By 1947 – Europe had no dollar reserves
 Since inputs need to come before outputs Europe
could not use its exports to finance inputs
 Borrowing abroad was not possible due to the
uncertain political situation
2. Price Controls
 So long as prices of goods were frozen below free-
market levels, producers had little incentive to bring
their goods to market
 For ex. They fattened their cows instead of slaughtering
them
 Workers were not able to purchase goods so they
spent their time not at work but with other activities
 Black market took off as governments ran deficits and
printed money
 If governments left their control, then inflation would
come about
3. Political Uncertainty
 Communists had key positions in French and Italian
governments in 1947
 Denmark had a weak minority government
 UK had embarked upon industrial nationalization
 It was not clear that governments in these countries
would respect private property, resist to temptation
impose taxes and let markets work
Nationalization in Britain...
Rebuilding Europe (cont.)
 Because of resource bottlenecks, price controls and
political uncertainty, there were no individual
investments, bank lending was minimal and
companies did not invest in training their employees
Marshall Plan
 Aid initiative launched by the US in 1947 – removed all of
these obstacles
 U.S. Provided $13 billion of U.S. Government grants over a
period of 4 years
 This solved the problem of having to export to import but
unable to import without first exporting
 Countries accepting Marshall Plan aid had t osign
bilateral pacts with the U.S. Agreeing to:
 Decontrol prices
 Stabilize exchange rates
 Balance their budgets
This prepared them for the market economy
Marshall Plan
Map of ColdWar era
Europe and
the Near East
showing
countries that
received
Marshall Plan
aid. The red
columns show
the relative
amount of total
aid per nation.
Marshall Plan (cont.)
 Helped to resolve political uncertainty by tipping the
balance of political power toward centrist parties
 The US did not want to give aid to socialist governments
so countries with communist and socialist governments
saw the exit of these politicians
 Marshall Plan was the choice between plan and
market
 The Plan’s effects on price decontrol were immediate:
 Stores empty one day were fully stocked the next day
 Absenteeism among workers fell
 Import restrictions were slowly lifted
Marshall Plan (cont.)
The Plan became the
choice between plan and
market – USSR refused
to allow its satellites to
take any aid
Marshall Plan (cont.)
Those nations
accepting
Marshall Plan
aid saw the exit
of socialist and
communist
politicians and
policies ...
Marshall Plan (cont.)
 Also encouraged European integration
 U.S. Aid was given on the basis of a collective strategy for
using the funds
 Marshall planners envisioned a United States of
Europe where war would be inconceivable
 European integration was a way of reconciling other
countries, France in particular to higher levels of
German industrial production and
 Of disarming those who insisted on “pastoralizing” the
German economy
 Marshall Plan helped to eliminate ceilings on German
industrial production and cancelling its debt due to
reparations
 Germany could now go back to being the heart of the
European economy
Marshall Plan (cont.)
As seen vividly in this
poster for Marshall
Plan aid, the aim was
European integration...
Marshall Plan (cont.)
 Marshall planners also wanted to stimulate Europe’s trade
 In the immediate postwar years, there was bilateral trade
 But bilateral trade agreements made it hard to move towards
the free-market (multilateralism)
 However, liberalization needed to be taken by all of the
European countries at once.

If one liberalized and others did not, that one country would be
flooded with imports
 THIS PUT THE MARSHALL PLAN IN JEOPARDY!
European Payments Union (EPU)
 Each country’s net balances with each other country were
reported at the end of each month to the Bank for
International Settlements – the EPU’s fiscal agent – which
cancelled ofsetting claims
 Country’s now had liabilities/claims not on other
countries but on the EPU as a whole
 Countries no longer cared who they did trade with
 Countries could also run temporary deficits
European Payments Union (cont.)
 U.S. Contributed $350 million of Marshall Plan funds to




the EPU
This helped to stimulate trade (from $10 billion in 1950 to
$23 billion in 1959)
Also made sure that Germany committed to free and open
trade
EPU was a stepping stone toward collective governance
The next move towards collective governance was the
European Coal and Steel Community (ECSC)
 Laid the seeds for the European Economic Community
European Payments Union
(cont.)
100
20
A
A
B
B
120
290
30
40
520
320
C
470
Bilateral Settlements
Total payments: 90
C
A
Exports
Total Payments: 1820
B
10
EPU
20
10
C
Clearing
Total Payments: 40
Investment and the Labor Market
 If trade was needed for European growth, the second
thing that was needed was investment
 Plant and equipment were needed to implement new
technology – requires investment
 Countries used their money differently, for ex.:
 Norway used its money to rebuild its infrastructure
 Belgium used its money to keep declining industries alive
 Countries with high returns on investment
experienced high rates of growth of the labor force
Investment and the Labor Market
(cont.)
 Payoff on investment high where ther is expanding
labor force with which additional capital could be put
to work
 Growing labor force also helped curb wage increases
 Firms could put the money saved back into the
company as investment
Investment and the Labor Market
(cont.)
 Germany had expanding labor force due to East
Germany until the erection of the Berlin Wall
 Netherlands had expanding labor force due to the
return of Dutch settlers from the East Indies colonies
 France and Italy – underemployed agricultural
workers had the same effect as they shifted to
manufacturing and services
Postwar Social Contract
 European societies also developed corporatist
structures to restrain wage growth and see that profits
were put back into investment
 Governments wanted to guarantee that the union
strikes over wages and work conditions would not
happen again
 They needed to guarantee to the unions that in
exchange for a limit on their wage demands, the
industrialists would put the profit they received back
into the firm
 Governments were concerned that if unions pursued
wage increases and management paid out profits,
investment and growth would suffer
Postwar Social Contract (cont.)

Government implemented a series of negotiations
with capital and labor resulting in a few different
institutions:
1.
Firms agreed (by law) to put profits back into the
firm and workers had more say (both in
supervisory boarda dn investment policies of firms)
●
This was the set of institutions that monitored the
compliance of the parties to their agreement to
exchange wage moderation for the reinvestment of
profits
Postwar Social Contract (cont.)
2.
The second set of institutions created “bonds” that
would be lost in the event that either party reneged on
its agreement

Firms received industrial input from government at
submarket prices, investment-friendly monetary policies
were implemented by the central banks to encourage more
investment

Labor was also bonded by a parallel set of government
programs: paid vacations, limited work hours and social
security structures were adopted in exchange for wage
restraint – sick pay, retirement incomes, tax and social
insurance concessions...
Postwar Social Contract (cont.)
3.
Third set of institutions coordinated bargains
across firms and sectors

Bargaining was centralized in the hands of a trade
union federation and national employers association
and governments intervened to harmonize the terms
of the bargains reached by different unions and
employers

•
Departure from laissez-faire
There was a shift from low-production agriculture
to high-productivity manufacturing and services in
the Western European countries
Eastern Europe and
the Planned Economy
 Eastern Europe was more heavily agricultural than the
West
 Eastern European State Planning Offices saw the
expansion of the industry as the most direct way of
raising labor productivity
 Government did not support agriculture like the West
did
 In fact, Eastern European planners set lower prices for
agriculture and high prices for manufacturing to shift
labor
Eastern Europe and
the Planned Economy (cont.)
 During the 1950s Eastern Europe started to report
impressive rates of growth
 However, those produced were not always of good quality
 By 1949 most major branches of industry and finance
were owned and operated by the state – they allocated
a majority of their investment to industry
 However, they built along the lines of existing
factories (extensive growth) – innovation was not
rewarded
Achievements and Limitations
of Central Planning
 The Cold War and Stalinist ideology led planners to
push the industrialization process too far
 Traditionally Central and Eastern Europe had been
the continent’s agricultural resource – Planners
starved these regions of these resources
 Light crafts (like cobblers, masons, balcksmiths, tailors...)
also began to dissapear
 In the West, increases in output also meant increases
in living standards – this was less so in Eastern Europe
Achievements and Limitations
of Central Planning (cont.)
 Resources were wasted in central planning since
managers protected themselves against the risk of
missing production by over-ordering raw materials
and employing too many people
 This over-production did not improve the quality of
the goods produced or the variety (ex. The Hungarian
footwear industry in the 1950s produced just 16
different types of shoes)
Achievements and Limitations
of Central Planning (cont.)
 Public dissatisfaction, Stalin’s death and a slow-down of
growth led planners to experiment with decentralizing
the planning mechanism
 Managers were given more freedom and given rewards on
economizing resources
 However, this did not increase innovation
 Also, prices at home and abroad where free-market
principles dominated made free trade with the rest of the
world difficult if not impossible
Achievements and Limitations
of Central Planning (cont.)
 Self-sufficiency was also not desirable since each
country had different resources
 The solution was to encourage trade within the
Eastern Bloc
 The Council for Mutual Economic Assistance (CMEA)
or Comecon was established in reaction to Western
European integration under the Marshall Plan
CMEA / Comecon
CMEA / Comecon (cont.)
 CMEA’s founding members:
 Bulgaria, Czechoslovakia, Hungary, Poland, Romania and the
Soviet Union (in 1949)
 East Germany joined in 1950
 Moscows idea:
 Czechoslovakia and E. Germany: concentrate on the
production and export of industrial goods
 Romania and countries like it: concentrate on agriculture in
“international socialist division of labor”
 Romanian leadership was not pleased
 Relations within the CMEA were strained
 However, intra-bloc trade expanded under the CMEA
CMEA / Comecon (cont.)
A Soviet poster reading "COMECON: Unity of Goals, Unity of Action"
Regional Integration
in Western Europe
 Eastern Bloc’s commitment to Comecon was
strengthened by regional integration in the West
 Western European Integration: European Economic
Community, established in 1958 allowing free trade
among France, Germany, Italy and the Benelux
countries in less than 10 years
 Free trade allowed these countries to specialize in
goods they had a comparative advantage in and to
better exploit economies of scale and scope
 It eroded the power of monopolies and cartels forcing
sheltered producers to shape up or ship out
Regional Integration
in Western Europe (cont.)
 U.K. Declined to join the EEC rejecting the Franco-
German call for deeper integration
 Yet, attraction of a Common Market, proved irresistable
and Britain and 6 smaller European countries (Austria,
Denmark, Norway, Portugal, Sweden and Switzerland)
established the European Free Trade Area (EFTA) in 1959
– a more limited entity
 Finalnd joined in 1961, Portugal also joined at a later date
 Spain and Greece negotiated with the EEC and the
EEC chose to open itself to these 2 countries
 Growth accelerated in both the EEC and EFTA
Regional Integration
in Western Europe (cont.)
 Britain remained the sick man of Europe
 The corporatist system of wage restraint never took hold in Britain
 This was due to early industrialization which had left behind a
fragmented system of industrial relations
 Many small trade unions fought the efforts to coordinate an
economy-wide wage bargain
 Poor wage constraint, resistance to the introduction of new
technologies and forms of work organization produced poor
results for Britain
 Britain had the lowest investment rates in Western Europe
 Government tried to get additional output but it led to
inflation and balance-of-payments deficit – so the
authorities raised interest rates
Economics of Intensive Growth
 As the backlog of technology inherited from WWII
dissapeared, the challenge became to innovate new
products and processes
 The U.S. Had a leg up on this process. In 1963 it
devoted 3.5% of its GDP to R&D spending.
 By the mid-1960s the U.S. Was spending 5 times as much
as all of Western Europe on R&D in the computer
industry
 European governments took steps to close the gap
 With increased spending the countries of Western
Europe increased their share of global exports of
research-intensive goods