Making Europe work

Some economists believe this summer could mark the moment when some of the eurozone’s peripheral members may begin to be forced out. Others think that such a scenario is inconceivable. All agree that, at least in the short term, a eurozone breakup would be disastrous for jobs and growth.

Europeans work significantly fewer hours per week- Howard Davies

But, because the outcome is unknowable, and depends on politics as much as on economics, let us leave that frightening prospect to one side and look instead at what we know about the underlying performance of the European Union economy. How competitive is Europe in the summer of 2012?

If we compare the EU15 (the membership before the enlargements of 2004 and 2007) with the US, the most obvious point is that GDP per capita in Europe is almost 25 per cent lower, a difference of around $11,000 a year. Furthermore, per capita EU productivity, which had been converging on the US level for 20 years up to 1995, when Europe was only about five per cent below the US, lost 10 percentage points in relative terms in the decade preceding the eurozone crisis. Europe was unable to match America’s significant productivity boost from the information-technology revolution.

But Europe managed to hold its share of global exports during that period more effectively than did the US. European companies have been more successful, on average, at maintaining their share of emerging-market demand than have US companies.

Moreover, European job creation has not been as bad as many think. An analysis by McKinsey & Company of new jobs in the US and the EU from 1995 to 2008 suggests that, while the US created 20 million new jobs, 19 million of them were attributable to population growth. The EU15 created about 24 million new jobs during the same period, with only nine million due to rising population.

This job creation was not evenly spread across Europe, but it happened. That means that the EU now has successful employment models that can be emulated.

There is also solid evidence that Europe’s big companies have been competing relatively well globally. The number of Fortune 500 companies headquartered in the EU has grown over the last decade, while the number of those based in the US has fallen. Moreover, big European companies’ profits have grown 50 per cent more rapidly than those of their American counterparts.

Few deny the need for fiscal consolidation in many EU countries, especially in the south (and including France). But fiscal adjustment must be accompanied by structural reform. It is clear that the labour-market reforms undertaken by Germany a decade ago, painful as they were, have put the German economy in a far stronger position to compete globally. Similar reforms are urgently needed in countries like Italy and Spain.

Service sector reform is vital as well. Manufacturing productivity per hour in Europe compares quite well with the US, but Europeans work significantly fewer hours per year, which explains the annual per capita difference. But European countries lag badly in services, where restrictive practices, protectionism, and inefficiency hold them back.

Countries like Germany are adamantly opposed to a fiscal union, with a central EU budget for responding to asymmetric shocks, because they would be the chief contributors. But a variant that might elicit greater support would link fiscal support to labor-market reform. If Italy or Spain introduced changes that led to a short-term increase in joblessness, the fiscal costs would be met from a centralEU budget to ease the pain. This investment by wealthier countries should pay off if it leads to more flexible labour markets and higher productivity in the recipient countries.

Another proposal is a central budget subsidy to reduce employment taxes in the EU’s most economically challenged countries. The logic is that a country like Greece needs devaluation to enhance its competitiveness, but that leaving the euro would pose major problems. The alternative would be to cut nominal wages (‘internal’ devaluation) which is hard to do (though it has been achieved in Latvia and Ireland).

Reducing taxes on labour, perhaps for a defined period, would have a similar effect. That would be costly for governments in the short term, though an increase in output and employment might well justify the tax expenditure involved.

If Europe wants to revive sustainable growth and high employment, it must replicate what has worked in those countries that have performed successfully. Doing so will cost money. Governments must be prepared to persuade their electorates that it would be money well spent.

Howard Davies is a former chairman of the UK’s Financial Services Authority and currently teaches at Sciences-Po in Paris.

© Project Syndicate/Europe’s World, 2012.