Europe is home to competitive and globally successful companies; it enjoys comparably efficient and effective public services; it boasts world-class infrastructure; it maintains advanced education systems and generates internationally competitive top technology. And, at the same time, the contours of what may be called the European Social Model have remained intact: a well-developed welfare system provides a safety net for the needy; income inequality is relatively contained, especially when compared to other parts of the world. Nevertheless, in a comparative perspective, in the light of the economic growth rates registered in the United States – not to speak of the spectacular growth dynamics in some emerging market economies – the performance of the euro area economy has been rather disappointing. What are the reasons? Taking a long-term perspective, and looking beyond the short-term fluctuations of the business cycle, we must examine the fundamental determinants of its potential or long-term economic growth: demographic trends, developments in labour utilisation and productivity and the variety of underlying factors that affect the ability of the European economy to achieve increased efficiency and to create more employment. In order to better understand and assess the relative contribution of these determining factors, it is useful to express, by employing a growth accounting framework, GDP growth in terms of the rates of change in productivity, labour utilisation and population. Table 1 shows the extent to which the rates of change in these three variables have contributed to real GDP growth in the euro area and in the United States over the period 1996-2005.

In fact, the dispersion of growth and inflation rates within the euro area since the  4  6  See Blanchard (2004) and Alesina and Giavazzi (2006). BIS Review 43/2007  introduction of the euro is very similar to that observed across regions and states in the US. What is characteristic of Europe, however, is the persistence of the observed dispersion in growth rates. This persistence may be attributed to a number of factors, such as the stimulative effects of historically low interest rates, which sustained dynamic growth over recent years, especially in Spain, Ireland and Greece. Another important factor, which has received increasing attention, is the potential longerlasting influence of differences in economic institutions and social values, encapsulated in the socalled social models, of different European countries on their economic performance. As Sapir (2005) has observed, “the notion of a single “European Social Model” is largely misleading.” The prevailing social models in European countries can be meaningfully grouped into four types, as shown in Chart 8: First, there is what could be called the Nordic model, which applies to Scandinavia, Finland and also includes the Netherlands: in this model, social protection benefits, universal welfare provision and active labour market policies are highly developed. Public sector employment is significant by any standards. The associated fiscal expenditures are large, necessitating comparatively high tax rates. Powerful labour unions ensure that wage disparities remain limited. This model has contributed to generating high employment rates, in combination of with a low risk of poverty and relative income equality.