Sunday, March 27, 2005
Sad to say, Europe's big boys are still stuck in the mire
Posted by David Smith at 11:00 AM
Category: David Smith's other articles

Europe, for once, is getting interesting. In the past few days we have had a rewriting of the fiscal-policy rules underpinning the euro, the beginning of the end of France’s economically damaging 35-hour week, and a debate on economic reform at a Brussels summit of EU leaders.

We even have polls raising the prospect of a French referendum rejection of the EU constitution (France came close to saying no to the Maastricht treaty 13 years ago). The constitution debate is hotting up. Last week Professor Roland Vaubel and 100 other notables from European think-tanks and universities published a round-robin letter calling for it to be rejected.

Before getting on to that, let me make a small point. I have often referred to the disappointing performance of the euro area — “euroland” — and the EU economy as a whole. That implies Europe has converged, and that all are affected by eurosclerosis to the same degree.

But it is plainly not true of Ireland, which has averaged 7% growth over the past seven years, or Luxembourg, 4%-plus, Greece, 4%, Spain, with an average growth rate approaching 4%, or Finland, 3%-plus. The older, bigger, continental EU economies — Germany, France and Italy — have done badly. The smaller, agile members have done rather better.

This is also true of economic reform. Five years ago in Portugal EU leaders signed up to an ambitious programme to make Europe’s economy flexible and competitive. At the halfway stage, as a recent high-level group headed by former Dutch prime minister Wim Kok pointed out, progress can be described at best as patchy.

That overall conclusion disguises some big differences. Denmark, Finland and Sweden have led a Scandinavian drive towards flexibility, and Ireland, Spain and Britain have also done well. They are the heroes of the Lisbon process, according to a Centre for European Reform (CER) assessment.

But others, notably France, Germany, Italy, Belgium and Greece, come out as villains. Of the 17 targets set out for reform, Greece has achieved precisely none. But Italy, the CER says, scores even worse than Greece for overall progress.

On the face of it, France’s dismantling of its 35-hour week is a welcome development for those interested in a more flexible EU economy, essential for Europe’s long-term survival.

Last week’s dismantling comes with strings attached. Firms can buy an extra 220 hours a year of work from their employees (up from 180 allowed until now), with the option of additional overtime on top of that. The effect on actual hours worked, however, may not be that large.

And even if this is a step forward, Europe took a big step back last week. The Brussels summit, intended to spur economic reform, ended up caving in to French demands and sent plans to liberalise Europe’s service sector back to the drawing board.

The plans, proposed by Frits Bolkestein when he was EU internal market commissioner, would have brought competition to the 70% of the European economy accounted for by services. It would have allowed competitors from lower-cost (and less regulated) EU states to undercut everybody from plumbers and electricians to architects and surgeons. The unions, particularly in France, said this would destroy life as they knew it. The summit agreed, to Tony Blair’s discredit, and the commission was sent away to redraft the directive in a way that preserves “the European social model”.

That tells you most of what you want to know about the way the EU operates. Special interests, whether they be French farmers or service-sector workers and urban professionals, put up a barrier to progress. Politicians are too craven to face up to them. Progress is halted.

On this occasion the imminence of France’s May 29 constitution referendum put sand in the wheels. Optimists would say that once the vote is out of the way, things will be back on track. I would not bet on it.

The same malign influence can be seen in the relaxation of the rules on the stability and growth pact (SGP), insisted on by Germany in the 1990s as a condition for signing up to the euro. The rule was simple enough: countries should normally keep their budget deficits below 3% of gross domestic product (GDP). Once France and Germany itself exceeded that limit, however, its days were numbered. The new pact, condem-ned by the European Central Bank, allows excessive-deficit countries to correct imbalances at their leisure.

Again, everybody should not be tarred with the same brush. Some countries, for example Spain, Belgium, Austria, Ireland and Luxembourg, have low budget deficits. Finland has a surplus. But there are no prizes for sticking to the rules.

The new pact, in fact, achieves the worst of all worlds. Unlike Gordon Brown’s fiscal rules, it takes no account of capital spending. All countries, it says, should aim for a long-run budget deficit of 1% of GDP. Britain’s long-run budget deficit, according to the Treasury, will be 1.5% of GDP, reflecting a big programme of public investment. Whether or not the chancellor breaks his own rules, he is on course to break those of the EU.

That’s not the only problem. Britain’s budget rebate, won with heroic use of the handbag by Margaret Thatcher, is again under threat. The rebate’s status is almost akin to the Queen’s head on British banknotes. And this with our own constitution referendum looming.

I’d like to say something nice about Europe, I really would. But it is hard.

PS Where is this general election going? Not very far for the Tories where the economic debate is concerned. Last Sunday we reported Treasury figures showing the tax burden would rise by nearly 3% of GDP between 2003-4, the latest full fiscal year, and 2008-9, the likely final year of the next parliament. That is equivalent to £35 billion in today’s prices.

Meat and drink, one would have thought, to an opposition party wanting to prove Labour will tax us much more. Independent economists suggest that at least £10 billion of the £35 billion will have to be found by imposing new taxes, and will not be achieved by fiscal drag (rising incomes increasing people’s effective tax rates) or other “natural” means.

The Conservatives seem unwilling to take Labour on, however, partly because of a reluctance to admit that the tax burden would also rise if they were in power, and partly because any talk of tax cuts going beyond the £4 billion they have put their names to might smack of ill- discipline, hence Howard Flight’s resignation. In fact, as new projections from Price Waterhouse Coopers show, the tax gap between the two main parties is bigger than that. It projects that the Tories would be raising £11 billion less in taxes by 2007-8 than Labour, with this difference growing over time.

Perhaps, too, the Tories recognise a dead horse when they see it, and have decided it isn’t worth flogging. YouGov polling for this newspaper shows Labour is streets ahead when it comes to the key question of economic competence, even if Labour’s overall poll lead has slipped. People trust Labour by 50% to 43% to take the right decisions on the economy, while they distrust the Tories by 58% to 31%, even before the Flight effect. No party has ever won when so far behind on this issue. Unless Oliver Letwin and his Treasury team have been keeping their heavy armour in reserve, they are sunk.

On a different note, I promised to return to the question: “If Britain is doing so well, how come it doesn’t feel like it?” This is a last chance to influence the debate. All will be revealed next week.

From The Sunday Times, March 27 2005

Comments

“If Britain is doing so well, how come it doesn’t feel like it?”

Data released this week gives a clue. There was the ONS household income survey and the analysis by the Institute for Fiscal Studies showing that average household incomes after tax and benefits fell in 2003/4.

Then there was the BoE data showing that Mortgage Equity Withdrawal in 2004 Q4 accounted for only 3.4% of post-tax income - compared to 8.4% at the end of 2003.

I've posted MEW graphs here:
http://www.graphicinvestor.com/econo/UK/MORTGAGES/Mortgages.htm

There can be only one conclusion - income drying up, costs going up, result misery.

Posted by: David Sandiford at March 31, 2005 10:57 AM

I think it is rather disingenious to point to many of the smaller economies and look at thier rates of growth as some form of sucess.
I know this because I have been enjoying myself at others expense for a long while also.
In am sitting here with a fat belly and a warm glow because while staying at my brothers place, unbeknowst to him, I have just taken advantage of both his wife and his larder.

In rather the same way, the availablity of other peoples savings is so cheap its free in small countries like Ireland - just like my unwitting brother, who trusted me with access to his resources, by giving me the keys to his house, Ireland's tiny couple of million in population has the keys to a pool of 200 million EU savers to plunder, and interest rates which pay you money in real terms
.
If Ireland had to rely on its own savings to fund what can be laughingly called 'investment' in its many corpulances in both the property and banking sector and increasing public wages, and many other unproductive arenas, it would have ended its boom within 12 months as its currency became worthless due to reduced real purchasing power and a banking crisis.
As it is peoples average incomes are greater than in the UK.

When the crunch time comes I do not expect it to be pretty for me or Ireland.

(My brother is 18 stone and covered in tatoos, while I am a bird chested 9 stone minnow).

Posted by: Tony Hammond at April 2, 2005 11:09 AM

I think the point about small economies is that there is an element of aggregate illusion:- if Germany or France's growth are disaggregated into state/regional growth rates, then you're likely to find a few regions that do much better than average and compare favorably with the "small economies" ( as well, of course, as some other regions that do worse)

Posted by: Giles at April 2, 2005 11:02 PM