Sunday, May 29, 2005
Europe grinds to a standstill
Posted by David Smith at 11:00 AM
Category: David Smith's other articles

By Wednesday we could have a triple no in Europe, or rather nein, non and nee. Last Sunday voters in North Rhine-Westphalia said no to Chancellor Gerhard Schröder. Today they seem likely to say no to the European Union constitution in France, and again on Wednesday, in another constitution vote in the Netherlands.

We cannot take all these votes for granted. The polls point clearly to referendum rejections of the constitution in today’s French vote and — even more emphatically — in the June 1 Dutch poll, but these things do not always follow the script.

There is, however, a common theme to all three elections — disappointment with slow growth and high unemployment. In Germany a decade of weak economic growth — partly blamed on the legacy of the unification of east and west Germany in 1990 — has sapped confidence and led to widespread angst. A weak opposition and deft politics allowed Schröder to hold on to office three years ago, but now his days are numbered.

In France the constitution looks set to be rejected for straightforward economic reasons, most notably high unemployment. But built on that is a fear that the old economic order is changing and that France’s place in it is under threat from the new entrants into the EU, and from prospective new entrants such as Turkey.

Similar fears abound in the Netherlands. Until recently the Dutch experience was atypical, an example of a successful adaptation of the European social model into a high-growth, low-unemployment economy. But the last three to four years have been pretty grim. Growth has been weak and unemployment has virtually doubled, admittedly from a rate of less than 3% of the workforce. The Netherlands has picked up the malaise that has long been affecting its larger neighbours.

What’s ailing the old core economies of Europe, and to what extent is the euro to blame? It is striking that the European economies doing worst at present are the original six members of the European Economic Community; Italy is in an even poorer state than France or Germany. These countries should have been better placed to adjust to the regime of the single currency than other, newer members.

There is no simple explanation for the malaise. Some would put it down to the European Central Bank (ECB). Since taking charge of European monetary policy on January 1, 1999 it has been too cautious and inflexible, worrying too much about inflation and not enough about growth.

My story would be slightly more complicated. Since 1992, when France narrowly approved the Maastricht treaty in a referendum and the European exchange-rate mechanism almost collapsed, the priority for the EU establishment became achieving the single currency.

That meant reining back budget deficits and, for high-inflation countries, taking tough action to converge with Europe’s low-inflation economies. It also meant, crucially, giving a low priority to making the EU economy more flexible and adaptable, notably by making labour markets work better and cutting red tape and regulations.

That reform, however, was vital. Lord Layard of the London School of Economics has demonstrated clearly the difference in the unemployment record since the early 1990s between those countries that did reform their labour markets and those, such as France, Germany and Italy, that did not.

By the time the euro came into being in 1999, Europe had suffered a big economic disadvantage. America’s productivity revival of the 1990s, built on information technology, passed Europe by. Since then, and following the switch to euro notes and coins in 2002, that disadvantage has been compounded. Euroland’s sustainable economic growth rate is now 1%-1.5%, half the rate in America and Britain and a fraction of China’s 9%-a-year expansion.

Euroland and its politicians are caught in a catch-22. Sustainable improvements in economic and job-market performance require far-reaching reforms. But voters will reject those reforms as long as economic performance is disappointing.

Thus Schröder’s political woes are a rejection of his so-called Agenda 2010 reforms. France’s likely “no” vote comes in spite of President Jacques Chirac’s successful kicking into touch of the EU services directive, which was seen as a threat to jobs.

Does this mean we can write off economic reform in Europe? Julian Callow, European economist at Barclays Capital, rightly points to the experience of Germany, where the corporate sector is introducing its own flexibilities, using the threat of transferring jobs to eastern Europe. But reform also requires political momentum. Schröder has lost it and Angela Merkel’s Christian Democrats are unlikely to provide it. I knew Margaret Thatcher, vaguely, and Merkel is no Thatcher.

The other possibility is that instead of EU-wide reforms such as the services directive, the emphasis will switch to national efforts. The EU’s Lisbon agenda has been a failure so far. Perhaps, when looking down the barrel of a gun, countries will see the need for reform or face prolonged economic stagnation. That is what happened in Britain a quarter of a century ago. There is not much sign of it yet in core Europe.

What about the euro, one of the sources of the malaise? It will struggle, except in the unlikely event of a yes vote in France or the Netherlands. Will it break up? A few years ago I wrote a book called Eurofutures, in which I said that an unsuccessful single currency would not last beyond the generation of politicians committed to EU integration and monetary union.

The euro will still be around, in its present form, in a year’s time. In 10 years, barring an improvement in Europe’s economic fortunes, I’m not so sure.

PS: Is Gordon Brown turning the Treasury into the ministry of silly ideas? The chancellor’s mortgage wheeze has drawn a cool response, with good reason. His scheme for joint equity loans, in which eligible borrowers will raise 75% of the value of a property and the remaining 25% of the equity is split between the government and mortgage lenders, will help between 20,000 and 30,000 first-time buyers over the next five years.

To put that in perspective, it compares with 361,000 loans to first-time buyers last year, when their number was depressed. Even on a generous estimate, fewer than 2% of first-timers will be helped, a small gain in return for this piece of social engineering.

The Treasury, in conjunction with John Prescott’s Office of the Deputy Prime Minister, insists that it is also acting on housing supply by releasing surplus public-sector land that was formerly owned by the National Health Service and the Ministry of Defence. Builders will put up the £60,000 bargain-basement starter homes demanded by Prescott of the industry.

Apart from the fact that starter homes have a chequered past, there is a serious question about whether this is proper use of public assets. The value of a house is determined not by building costs, whether they are £60,000 or £600,000, but by land values.

Giving the land away free means that those who buy, particularly on sites in southeast England, will either be subject to restrictions on selling or will be able to make spectacular capital gains.

The government seems determined to “do something” about the shortage of housing, whether it makes economic sense or not. Desperate measures don’t usually work.

From The Sunday Times, May 29 2005


What future for the Euro in 5~10 years?
Do you see a return to national currencies, or a split into (say) NorthEuro (FR+DE+AT+NL+...) and SouthEuro (ES+PT+maybe IT) with GR going alone - multinational currency blocs also with some currencies being uninational?

My non-economist's guess is perhaps 10 currencies for the whole EU-25 plus nonmember countries; with GBP and CHF being as now, and Franco-germany and its satellites in another, and maybe East-European & Scandinavian blocs.

Posted by: Rog at May 31, 2005 02:14 PM