Either the EU must liberalize its economy to compete in a globalized world, knowing its workers will have to retrain faster — and become more highly educated — than ever before.

This raises an interesting question. If more competitive economic policies enabled the United States to outperform Europe in the 1980s and 1990s why didn’t they also enable us to outperform Europe before then? The answer boils down to one word — globalization.

In earlier decades, the world simply wasn’t as global as it is today. The consequences of high taxes and inflexible labor markets weren’t especially severe in the low-tech, low-mobility 1960s and 1970s.

Globalizing struggles

As globalization heated up in the 1980s and 1990s, the cost of these policy decisions — in lost output, slower job creation and foregone productivity — became plain for all to see.

Empirical evidence supports this globalization story. The United States leads all 25 EU members in the Harvard Business School rankings of national policies that foster innovation.

A restrictive environment

The entire EU, on the other hand, does worse than the United States on the World Bank’s measure of labor-market policies that inhibit growth.

Or EU nations can band together to resist further liberalization, knowing that unemployment will become more prevalent and economic growth will remain slow.

Business-climate indicators paint a similar picture.

For example, an entrepreneur can create a new U.S. firm in five days, but it requires an average of 37 days to start one in the EU. Such data indicate the United States should participate more fully in the global economy, and a globalization index devised by A.T. Kearney and Foreign Policy magazine does indeed show the United States ahead of all but one EU member.

The underlying message is as simple as it is accurate. Nations that offer more competitive economic environments will reap greater benefits from a more open world economy.

Competition worries

Globalization places a premium on economic freedom and gives nations greater incentive to engage in policy competition aimed at liberalizing their economies.

But some worry that policy competition has gone too far. A recent report from the Organization for Economic Cooperation and Development, for example, concludes that the developed world should eliminate the “harmful tax competition” that tempts firms to move in search of better business climates.

A few months ago, the finance minister of Germany’s new coalition government echoed this concern when he urged the 10 newest EU members to raise taxes in the name of fairness.

Policy approaches

Can economics contemplate a means to thwart cross-border policy competition? Yes. A federation could impose minimum tax rates and labor standards — or even mandate a single set of tax rates and labor standards — so no nation could “unfairly” undercut another and “poach” workers and businesses.

An entrepreneur can create a new U.S. firm in five days — but it requires an average of 37 days to start one in the EU.

Under this view, Europe would need an integration that discourages — rather than encourages — further liberalization.

At times, the EU has done exactly that. In the mid-1990s, Sweden had to raise its farm subsidies as a condition for EU entry. In early 2004, the EU forced the Czech Republic to adopt labor-market regulations the country deemed onerous.

And in January 2006, Poland fought a pitched battle with European leaders to keep its tax rates below what EU leaders wanted. In each case, countries shared the goal of binding economies together but diverged over the terms.

Europhiles and Euroskeptics

Some analysts have cast the great continental debate as a contest between Europhiles desperate to bind EU countries together and Euroskeptics determined to maintain national sovereignty. But integration per se need not be the issue.

After all, a uniformly low-tax Europe with flexible labor markets would be just as integrated as a Europe with uniformly high tax rates and inflexible labor markets.

Integration paths

The key question centers on the kind of integration Europe ought to undertake.

Globalization places a premium on economic freedom and gives nations greater incentive to engage in policy competition aimed at liberalizing their economies.

Should it pursue an integration that fosters free markets and the economic growth they bring, or should it pursue an integration in which member states band together to resist the economic consequences of high taxes and heavily regulated labor markets in a global era?

What are the prospects for further liberalization? In 2005, the EU considered a proposal for free trade in services.

With goods now accounting for a dwindling portion of the EU economy, free trade in services would seem a logical step for a federation dedicated to providing a common market across Europe.

Internal resistance

Yet, the specter of increased competition from Eastern Europe’s cheap labor undermined public support. Bowing to opposition in several countries, the EU adopted only minimal changes in its services trade policies.

More recently, a months-long drama featuring massive street protests forced the French government to withdraw a proposal to increase labor market flexibility with a probationary employment period during which young workers would enjoy fewer benefits and less job security.

Becoming globally competitive

These incidents are balanced by signs favorable to reform. Current European Commission President José Manuel Barroso has spoken

Nations that offer more competitive economic environments will reap greater benefits from a more open world economy.

movingly of the need for Europe to further liberalize its economy to better compete in the global marketplace.

And to give just one example where this is happening, Germany has renegotiated labor contracts in a few high-cost sectors and has discussed limiting labor’s historic influence over corporate strategy.

These and other events within the EU suggest Europe’s future policy direction is far from decided.

At a crossroads

The EU stands at a crossroads as it debates further economic liberalization. Some EU members wish to preserve and even expand Europe’s social protections, so that workers can have much-needed security in an era of ever-more-rapid change.

Other EU members want Europe’s economy to become more flexible, so that economic growth can equal and perhaps even exceed that of the United States. Europe can’t simultaneously satisfy these competing visions.

Choosing a path

Either the EU must liberalize its economy

A uniformly low-tax Europe with flexible labor markets would be as integrated as a Europe with uniformly high tax rates and inflexible labor markets.

to compete in a globalized world, knowing its workers will have to retrain faster — and become more highly educated — than ever before.

Or EU nations can band together to resist further liberalization, knowing that unemployment will become more prevalent — and economic growth will remain slow.

The European Union has a clear choice, but the challenge of globalization is an issue for every economic entity on every continent, including the United States.

A path still undecided

U.S. labor markets may be somewhat more flexible than Europe’s, and the U.S. economy somewhat more open. But make no mistake, in areas ranging from steel to softwood lumber to clothing to autos, the United States faces pressure to ward off globalization rather than embrace it.

With technologies knitting economies closer and policies aligned toward openness, globalization has advanced steadily in the postwar era. Future policy choices in the European Union, United States and other entities will determine whether the world continues its progress toward increasing economic integration.