The Club of Competitors

If the reports are on target, Europe will grow faster than America in 2007—for the first time in six years. European Union countries created 2 million new jobs last year, cutting unemployment to its lowest since 1991. Better, growth is no longer confined to outliers like Britain, Spain or the Baltic mini-states. Europe's resurgence is driven by the behemoth at the continent's heart, Germany. After 15 years of malaise, the EU's traditional locomotive grew at almost 3 percent in 2006, roaring past such laggards as France and Italy. Years of restructuring and smart wage deals with the unions have made German manufacturers, especially exporters, über-competitive.

The jury is still out over how much of this faster growth is temporary. But the process by which the German economy has shaped up is Exhibit A for what's going right in the EU these days. It's not a matter of any single smart policy or innovative wage deal. The key to Germany's broader revival is the way the EU has boosted competition—both between companies for markets, and between member states for the best policies to create jobs and raise growth.

Since its enlargement in 2004, the EU has ceased to be a cozy club of select Western powers. It has become an increasingly integrated market of 27 countries, not to mention half a billion consumers. More important, the EU is also a beauty contest between 27 different social models, tax regimes and education systems, whose people and companies can ever more easily vote with their feet. Conventional wisdom has it that the European Union is all about communal protection: finding strength and safety in numbers, while pooling power to create the necessary economic and political clout to stand up to America. In truth, Europe owes its revival to precisely the opposite—competition within the EU itself.

Take Germany. Faced with low-cost competition from the EU's newest members in Eastern Europe, German manufacturers took a hard look at how much work should stay in Germany and made innovative pacts with their unions to slash costs. Politicians and bureaucrats saw countries like Slovakia and Estonia lure investors with radically simplified taxes and regulations—forcing them to rethink their own policies. Mikulas Dzurinda, the former prime minister of Slovakia whose 19 percent flat tax not only attracted foreign manufacturers but also helped create thousands of local businesses, is convinced his reforms benefited far more than just Slovaks. "Intra-EU competition on taxes and the social model," Dzurinda said last week at a confab in Brussels, "is the best way to make all of Europe more competitive." When German Chancellor Angela Merkel put a flat-taxer into her shadow cabinet in 2005, she was partly inspired by her friend Dzurinda. While she has backed off the flat tax, her plans to cut corporate levies are fast moving forward.

The revival also shows the euro zone's benefits. In another age, Germany might have used deficit spending to juice up the economy and avoid restructuring. Italy and France routinely devalued their currencies to push up exports. Now those loopholes are closed, and EU nations must compete on policies as well as products and prices. If Merkel gets her proposed "Transatlantic Marketplace"—a sharp reduction in the regulations and red tape that hinder trade and investment—it will heat up competition even more, says Richard Salt, who has examined the proposals for the German Marshall Fund. "The more you expose Europe's economies to the dynamism of the U.S. market, the more of a competitive stimulus these economies will get."

Brussels, too, deserves credit. If it weren't for the EU Commission pushing to open protected national markets, Germans might still be using rotary phones. European airlines wouldn't be the most profitable (and cheapest) in the world. If anything, today's competition among 27 EU members is a return to the historical strength that once made Europe great. As Jared Diamond argues in his best-selling "Guns, Germs, and Steel," Europe's rise to global pre-eminence was the product of intense competition of countless states on a small continent. If today's Europe is to be resurgent in a globalized world, it will be for much the same reason.