The quarter-century that ended around 1973 was a `Golden Age' of economic growth in Western Europe, as real GDP grew nearly twice as fast as in any comparable period. In Discussion Paper No. 973, Research Fellow Barry Eichengreen notes that catch-up vis-à-vis the US or Europe's own historic trend certainly offered exceptional scope for growth, but it was nevertheless more than 50% higher during 1950-73 than subsequently, even after adjusting for these effects. This West European growth `miracle' also arose because net investment was nearly double its highest level before or since. Eichengreen attributes this to a favourable combination of wage moderation and growth of trade, reflecting policy-makers' determination to learn from their errors of the inter-war period and new post-war institutions' success in solving commitment and coordination problems. Domestic social and economic institutions monitored interest groups' compliance with a `social compact' to moderate wage claims, which stimulated the demand for and supply of investment, while new international institutions underpinned governments' commitment to trade liberalization. By encouraging restructuring along export-oriented lines, this enhanced the productivity and profitability of such investment and enabled countries to exploit their comparative advantage regardless of the structures of their domestic demand.

Institutions did not promote growth equally across Europe, however, as the UK and Ireland did not develop the necessary domestic institutions, France and Italy did so only with delay, and others failed to integrate their domestic economies into the evolving international framework. The exceptional circumstances of war and reconstruction provided remarkable opportunities to make major adjustments to institutional arrangements, but socio-economic inertia nevertheless made the achievement of radical change difficult in some cases. Eichengreen attributes the growth slow-down after 1971 to the rise in international capital mobility in the 1960s and early 1970s. By providing capitalists with an exit option, this reduced their incentives to maintain high levels of investment and hence reduced workers' incentives for wage restraint. The institutional mechanisms that had evolved to support the post-war settlement proved inadequate to meet the challenge posed by these new pressures.

Institutions and Economic Growth: Europe After World War II
Barry Eichengreen

Discussion Paper No. 973, June 1994 (HR/IM)