Europe's Lagging Service Sector

At the same time that changing technology creates an economic force leading to greater hours worked in the service sector, Europe raises taxes, thus creating an opposing force that encourages services to be provided outside the market.

Europe's failure to develop the kind of thriving service sector that has transformed the U.S. economy, a deficiency for which high taxes are largely to blame, is the main culprit behind the fact that over the last fifty years, hours worked in Europe have declined by almost 45 percent compared to hours worked in the United States. That's the conclusion of NBER Research Associate Richard Rogerson in Structural Transformation and the Deterioration of European Labor Markets (NBER Working Paper No. 12889). He finds that over the last half a century, European economies have suffered from a form of arrested development.

Rogerson observes that, typically, as a modern economy develops, employment is concentrated first in agriculture, then it moves to manufacturing, and finally, to services. Europe seems to have made it through the first two phases but then fumbled the transition to the service sector. Rogerson believes that this lack of service sector maturation goes a long way toward explaining the deterioration of European labor markets where, for some time now, unemployment rates have far exceeded those for the United States.

From Rogerson's perspective, analysts seeking to understand why European unemployment rates in the 1970s abruptly increased relative to those of the United States have failed to take a longer view of the situation. While most have looked for economic shocks during the 1970s that might explain the problem, Rogerson believes it's necessary to broaden the lens and consider a period that starts in 1956 and runs through 2003. Also, Rogerson contends that a better way to understand the relative health of a labor market is to look at hours worked, not just unemployment. He finds that from 1956 to 2003, there is a steadily broadening chasm between hours worked in the United States versus Europe.

"Whereas the differences in unemployment rates emerge in the mid-1970s, the decline in hours of market work in Europe relative to the U.S. begins in the mid-1950s and continues at a fairly steady rate until the mid-1990s," he writes. "Hours of work in France, Italy, and Germany (Europe's largest economies) decline by more than 45 percent relative to the U.S."

The problem, according to Rogerson, is not with the lag one sees in the 1950s. Europe's economies in the mid-1950s were not as developed as the United States, as measured by labor productivity. Yet over the next 45 years, they seemed to be closing the productivity gap. So, why the lower amount of work? A closer look shows that while Europeans eventually matched U.S. employment rates in agriculture and industry, as of 2000 the employment rate in Europe's service sector was only 70 percent of the U.S. level. "In 2000, almost all of the difference in hours worked are accounted for by differences in the service sector," he writes. "As Europe catches up to the U.S. in terms of overall productivity, it does not develop a market service sector of the same magnitude."

Rogerson views Europe's relatively anemic service sector as a by-product of a European tax rate that is 15 to 20 percent higher than that of the United States. "The reason that Europe fails to develop a service sector similar to the U.S. is that at the same time that changing technology creates an economic force leading to greater hours worked in the service sector, Europe raises taxes, thus creating an opposing force that encourages services to be provided outside the market," he writes.

In other words, while in the United States it's now the norm for people to pay professional providers for services such as child care, elder care, cooking, cleaning, home repairs, and yard maintenance, Europeans -- with taxes taking more of their disposable income -- are more likely to do these things for themselves. Rogerson call this "home work" as opposed to "market work." And, he notes that there is evidence that if one adds up the hours Europeans spend doing "home work" (which in the United States is more likely to be handled by service providers), it significantly offsets the differences in market work.

Rogerson shows that if the United States were to adopt Europe's level of taxation and spending programs, time allocations would "change dramatically." They would look more like Europe's, in that a big chunk of "market work" hours would shift to "home work" hours with, presumably, a commensurate increase in unemployment.

-- Matthew Davis