Monday, July 18, 2005
A wake-up call for Europe
Posted by David Smith at 09:12 AM
Category: David Smith' s magazine articles

A lot of ink has been used up, and airtime wasted in the past few weeks, analysing the decision by the people of France and the Netherlands to reject the proposed constitution for the European Union. The “no” votes from two of the EU’s six founder members, in late May and early June, which effectively killed off the constitution, were attributed variously to concern over the “Anglo Saxon” nature of the treaty to protest votes against national governments.

Such complicated explanations are, however, unnecessary. All elections are, in the end, “pocketbook” elections. People vote, in other words, according to the state of their wallets and purses. In France and the Netherlands they voted against the constitution because the EU, far from bringing the prosperity associated with its early decades, has become synonymous with economic failure.

Ask the man or woman in the street in Paris or Amsterdam, or for that matter London or New York, for a thumbnail sketch of the European economy and you can bet they will give you a description that includes high unemployment and slow growth. Not all of them will correctly diagnose the cause of this as the rigidities of the EU economy, and in particular its labour market, but they will know that Europe, once an economic success story, is now struggling.

A decade ago, there was little to choose between unemployment in Britain and the 12 countries that make up “euroland”. Both had jobless rates of around 10 per cent of the workforce. Since then, however, UK unemployment has more than halved and stands at 4.7 per cent on an internationally comparable basis, while the euroland rate is still close to 9 per cent. In a generally benign period for the global economy, Britain has created three million new jobs, overwhelmingly in the private sector. The “old” European economies – France, Germany, Italy – have created barely any.

Lord Layard of the Centre for Economic Performance at the London School of Economics has just published a new edition of his book Unemployment, co-written with Stephen Nickell and Richard Jackman. In it he looks at why unemployment has diverged so sharply in the past decade or so.

The difference, he says, is between those countries who reformed their labour markets, as Britain did in the 1980s (as a Labour peer he pays tribute to the Thatcher reforms) and those that did not. The three big economies of “old” Europe fall into the second category and are suffering for it.

It is not just, of course, in the unemployment figures that the damage is being done. The longer that people are unemployed the more they become distanced from the world of work and the harder it is to re-engage them with it. High unemployment breeds high unemployment.

It damages in another way. The big difference between the growth performance of the euroland economies and those of Britain and America is the behaviour of domestic demand. Anglo-Saxon consumers have been willing to spend; those in Europe have not. The fear and the reality of unemployment, and the reluctance in consequence to take on debt, explains much of this. In the past 10 years the UK economy has grown by an average of 2.7 per cent annually. Germany has expanded by barely more than a third of that rate, at just over 1 per cent. The difference is accounted for by the behaviour of domestic demand – strong in Britain, weak in Germany – in the two countries.

Euroland is caught in a vicious circle. The Paris-based Organisation for Economic Co-operation and Development recently revised down its growth forecast for the area for this year from 1.9 to 1.2 per cent, warning of depressed consumer and business confidence, and arguing for a cut in interest rates by the European Central Bank (ECB). The very credibility of monetary union was threatened by economic stagnation, the OECD warned.

This was what the people of France and the Netherlands were voting against. Like the character played by Peter Finch in the film Network, they were saying: “We’re not going to take it any more.” Europe was supposed to be about rising prosperity – as indeed it once was – not about becoming permanently becalmed in the economic doldrums.

What has happened to peg the EU economy back? A large explanation for the problem is that provided by Layard. The turning point came a decade or so ago. Instead of promoting reform and flexibility, EU leaders focused on the task of achieving monetary union and promoting closer integration. These aims were perfectly laudable on their own but, in the absence of flexibility, were doomed to difficulty.

Otmar Issing, chief economist at the ECB, has recently admitted something I have long argued; that Europe was not an “optimal currency area” when the euro came into being at the beginning of 1999. An optimal currency area, which was the focus of my book ‘Will Europe Work?’ was introduced by the Nobel prize-winning economist Robert Mundell. He said that for a currency area to work it had to have wage flexibility, geographical mobility of labour and a large enough central budget to offset economic shocks. The EU had none of those things.

According to Issing, perhaps only five of the original 11 (later 12) euroland economies were sufficiently converged for monetary union to work. It went ahead anyway, for political reasons, on the assumption that convergence would follow and an optimal currency area evolve. That has not happened.

Flexibility was not just an add-on for Europe, therefore, it was essential. It was essential for the euro to work and it was essential if the EU economy is ever going to be able to compete with America, let alone China and India.

Flexibility was the aim of the Lisbon agenda but at its halfway stage, as even a sympathetic high level committee of experts concluded, progress was dismal. Now the constitution is gone, the priority for Europe, and more particularly for national governments, has to be to urgently pursue economic reforms and achieve that necessary flexibility.

Will it happen? It would be unwise to bet on it. Europe has had a wake-up call. Experience would suggest it will not necessarily respond to it.

From Business Voice, July-August 2005

Comments

Nice one, I agree to the totasl extent of agreement possible.

Posted by: Walton at July 19, 2005 11:52 AM

OMFG LOL!!!11!

Posted by: Tiddles at July 19, 2005 11:53 AM