Why America Creates Jobs

HENRY STIMSON, THE U.S. SECRETARY OF WAR IN WORLD War II, once observed that a capitalist country going to war had ""better let business make money out of the process or business won't work.'' America followed that advice and won the war. Stimson's insight still applies in its peacetime version: modern capitalism won't work if markets aren't left fairly free. America abides by that axiom and, as a result, is a powerful job machine. Europe doesn't -- and is a puny job machine. The mystery is that so many economists can't understand this.

The huge job gap between the United States and Europe is, of course, well known. From 1979 to 1995, Western Europe created less than one job for every two new workers: 10.3 million jobs for 21.5 million added workers. Unemployment jumped from 5.7 percent to 11 percent. Meanwhile, the United States created 26 million jobs, absorbing 95 percent of new workers. The unemployment rate -- though fluctuating over the business cycle -- hasn't drifted up. It was 5.8 percent in 1979 and 5.6 percent in 1995.

What's new (and interesting) is the professed puzzlement of many economists over the job gap. Understandably, it has inspired a lot of research. Less understandably, many studies can't explain it. Factors once rated as U.S. advantages (flexible wages, greater competition, less generous social programs) are now deemed, on closer inspection, not to matter. Gee, this research is hard to take seriously, because it seems determined to miss the larger picture. Which is this: America's economic culture favors growth; Europe's doesn't.

Job creation requires three things: (1) the economy must grow fast enough so that companies want more workers; (2) hiring must be profitable -- if labor costs are too high, firms won't hire even if demand is strong; and (3) people must be willing to work. On all counts, the U.S. economy outperforms the European:

Economic growth: Between 1979 and 1995, the U.S. economy grew at an annual average rate of 2.4 percent; the European Union's economy grew only 2.1 percent annually. (The EU includes most major Western European countries; the unemployment figures cited above are those of the EU.)

Labor costs: Europe's rise faster than America's despite higher unemployment. Between 1983 and 1993, compensation per worker (wages plus fringes) jumped 6.3 percent annually in the EU; the comparable U.S. increase was 4.2 percent.

Work effort: Americans work harder, because the alternative -- being supported by government -- isn't attractive. Interestingly, initial U.S. and European unemployment benefits are similar. They typically replace about 50 to 70 percent of an average worker's wages. But after some joblessness, U.S. benefits dwindle while European countries continue to provide support.

None of this means Europe's economy is dead. As NEWSWEEK'S Marc Levinson has reported, many European firms still create new jobs with superior products. But on balance, excessive government -- taxes, regulations, market controls -- hobbles overall growth. Markets don't match workers and jobs.

To conclude otherwise (as some studies do) defies common sense. One book from the National Bureau of Economic Research in Cambridge says Europe's generous social policies don't foster high joblessness. The book studied various welfare policies and found little ""trade-off'' between ""social protection and economic flexibility.'' A new study from the Organization for Economic Cooperation and Development in Paris also questions the ill effects of some European policies.

The trouble with these studies is that they try to explain too much from too little. To understand why, consider a sports analogy. Suppose basketball Team A has a tiny advantage over Team B in rebounds; it also has small advantages in steals and three-pointers. Separately, no single advantage seems decisive; together, they explain why Team A wins championships. The same is true of Europe and America. No single U.S. advantage (or European disadvantage) matters. What counts is the collective impact.

All Europe's disadvantages feed each other. Higher labor costs (not fully offset by higher productivity) deter hiring. Steep payroll taxes -- needed to pay generous social benefits -- do the same. European growth also suffers from a fixed exchange-rate system that forces most countries to follow German interest rates. Without that discipline, it's feared that inflation would accelerate. In turn, this fear stems from other features of Europe's system: stronger unions; more political determination of wages; less competition in product markets.

America's advantages are also reinforcing. The business climate is more favorable than in Europe. American corporations are consistently more profitable. In 1995, U.S. companies earned an 18.3 percent return on assets compared with 13.8 percent for German firms. In the United States, venture capital is more available for start-up companies. Government regulation has been lifted from more critical industries, such as telecommunications. All the added product and profit opportunities encourage expansion. Flexible wages favor hiring.

With apologies to James Carville, ""it's the system, stupid.'' America still embraces the market culture: its obsession with growth; its striving for wealth (and tolerance of inequality); its acceptance of change. Europe is less enthralled and more inclined to reshape market culture through government. The lesson is not that government is bad. It isn't. Government does much good, from environmental regulation to unemployment insurance. But too much government or misguided government can subvert economic growth.

What Europe teaches is that the corrosion is a slow, cumulative process. Europe's efforts to reverse it (by easing regulations and limiting social benefits) will be slow, precisely because no one policy does all the harm. In America, we ought to take heed. To work well, government needs to be used with restraint. To work well, capitalism needs to retain its central features -- including the freedoms to fail and to get rich.