European Economic Growth & 1973 Oil Crisis

Posted on Mar 1, 2025 in Economy

European Union: Period of High Growth (1950-1973)

The period of high growth (1950-1973) in Europe is known as the Golden Age of European Growth. There was a convergence (catching up) in GDP levels (income levels). Countries that started in 1950 with lower levels of income grew faster than countries that had higher levels of income.

Reasons for High TFP Growth

  • Classical Growth Model (Solow model): Explains economic growth by investing in capital, specifically physical capital, with TFP being exogenous.
  • Technological Change: Emphasis on physical capital (increase in investment) because of two reasons:
    1. Capital destruction during WWII facilitated the increase in investment in the 1950s.
    2. The adoption of American technology by the European industrial sector (e.g., the assembly line and many other new technologies).
  • Elastic Supply of Labor (Lewis model): Based on the idea of the elastic supply of labor and the relationship between agriculture (the low-productivity sector) and industry (the high-productivity sector). It is related to the structural change, the increase in the labor force employed in industry in Europe. This created a positive dynamic: industries could enjoy moderate wages, increasing corporate profits, which translated into increasing investment (K). This structural change happened at a continental scale, from Southern European countries to the most advanced economies.
  • The New Growth Theory (Endogenous Growth Model): Considered the most satisfactory explanation of economic growth after 1950.
  • Endogenous Growth Models
    • Concept of “broad capital”: Physical capital + human capital (an extraordinary increase in the stock of human capital because of an increase in investment in human capital). Decreasing returns to capital are much lower than in Solow’s model: Augmented Solow model (Lucas) + externalities of investment in capital.
    • Emphasis on Convergence: Conditional convergence depends on:
      1. “Social capability” (difficult to quantify and define; it is the capacity of the institutions created to take advantage of a growth era).
      2. Technological gap (related to the adoption of new technology; the higher the gap, the more possibilities there are to incorporate new technology).

Conclusions: European Golden Age of Growth

  • The acceleration of growth rate came from greater investment in both physical and human capital.
  • The speed-up in growth has a significant unexplained component that seems to reflect an enhanced catch-up capability in the post-war world.
  • The slowdown in growth after 1973 is quite well explained by lower scope for catch-up (high initial income gap).
  • High investment rates were crucial to the transfer of technology.
  • Exports provided the necessary scale economies through rapidly expanding markets.
  • Abundant labor eased both the swift reallocation of manpower to technologically advanced industries and moderation in wage setting.
  • Demand management stabilized expectations and thus reinforced the investment drive.
  • An adequate stock of human capital and institutions (the post-war settlement).

The 1973 Crisis

This Golden Age of growth ended abruptly. What happened in 1973 was an unexpected shock in a world economy that had been growing at a very fast rate with stability. The OECD countries decided to increase the price of oil. This was due to a political reason: a war between the Israeli government and Arab countries. Since the foundation of Israel after WWII, there had been constant conflicts between them. The USA, Britain, and France supported the Israeli government, and the Arab countries decided to punish the Western support of the Israeli government by raising the price of oil.

Consequences

  • Petroleum Prices (Energy): Between 1972 and 1974, petroleum prices increased by 300%. There was a second crisis at the end of the 1970s (1979).
  • OPEC’s decision was equivalent to a tax on world petroleum consumers, representing around 2% of the GDP of industrialized countries.
  • Generalized increase in the price of raw materials.
  • Slackening of growth rate in all OECD countries.
  • Approximately 7% drop in industrial production in Europe (9% in Japan and the USA).
  • Growing unemployment, not seen since the inter-war period.
  • Sharp inflationary pressures (prices more than doubled compared to the 1970s): 2.8% to 6.6% in the USA; 3.7% to 9.3% in Europe.
  • Stagflation: A combination of low growth rates and high levels of inflation.
  • End to the Bretton Woods monetary system (1971): Suspension of the convertibility of the dollar into gold.
  • Bretton Woods failed for two reasons (a consequence of its own success):
    1. Boom of world financial markets, especially short-term investors that moved money around easily.
    2. Relative loss of weight of the US economy and the rise of Europe and Japan: Investors’ fears about the dollar and its compromise to keep the value of the dollar against gold.
  • Cheap energy during the 1960s had encouraged the expansion of energy-intensive sectors and of petroleum as an industrial energy source. Now, there were higher costs for industries, lower profits, and a rise in inflation and unemployment.
  • It was the deepest recession since the 1930s.
  • Between 1974 and 1975, industrial production dropped by 10% in industrialized countries.
  • Sharp deficit in the external sector: Oil was an imported good.
  • The crisis also hit hard the less developed countries that, during the 1950s and 1960s, had adopted ISI strategies.