The European Predicament
Its economy is enfeebled by high taxes and regulations. Unless leaders take unpopular steps today, Europe faces dire consequences.
By Robert J. Samuelson
Newsweek Feb. 9 issue - Let's be clear. If Europe's economy was healthy it would grow about 4 percent annually for a few years and then settle down to a respectable 2.5 percent or 3 percent. The initial burst would absorb surplus unemployment (the jobless rate is near 9 percent). Once that happened, Europe would ride the gains of new technologies. Nothing like this is occurring.
Since 2000, the economy of the "euro zone" (the 12 nations using the euro) has averaged growth of about 1 percent a year. That's bad for Europe—and everyone else.
In the past year, American-European relations have fixated on Iraq. What's been obscured is how much Europe's loathing of the war has distracted attention from its own failures. Europe's economic model could once be defended as a justifiable political choice. People could select their flavor of prosperity. America's flavor—more competition and insecurity—wasn't for everyone. Europe could pick less anxiety and more vacations. It could sacrifice some economic growth for a bigger welfare state (more jobless benefits, universal health care). This argument no longer works.
Why not? Well, the economy is so enfeebled by high taxes and restrictive regulations that it can't pay for all the benefits. The gap between promise and performance must widen and, in the process, spawn disillusion and discord. One early example involves France's and Germany's violation of the Stability and Growth Pact, which requires member countries to hold their budget deficits to less than 3 percent of gross domestic product (GDP). In 2002 and 2003, France and Germany failed and, rather than face penalties, forced other countries to suspend the rules. Naturally, smaller countries that complied were furious.
Greater conflicts loom. In May the European Union expands to 25 members by adding 10 countries with 74 million people (the largest: Poland, Hungary and the Czech Republic). The presumption is that shared prosperity will promote mutual good will. The danger is that shared stagnation will aggravate mutual ill will. A larger threat arises from aging populations and expensive retirement programs. Government spending in the European Union already averages 48 percent of GDP (the United States: 34 percent). By 2030 the older (65-plus) population is projected to rise 55 percent, while the working population (15 to 64) shrinks 8 percent. Promised benefits can't be paid without crushing taxes or implausible budget deficits.
For now, what's worrying is that Europe isn't helping the global recovery. True, growth in the euro zone should be better this year than last—perhaps 1.8 percent compared with 0.5 percent in 2003, estimates the forecasting firm Global Insight. But Europe is feeding off the revival of its export markets, including the United States (expected 2004 GDP growth: 4 percent to 5 percent). Even this is imperiled by the recent rise of the euro on foreign-exchange markets. It's now worth about $1.25; in December 2002 it was worth $1. Most economists think it will go higher—maybe to $1.50. By making exports more expensive, a stronger currency could undermine Europe's recovery.
Europeans will probably complain about this at a meeting on Friday of finance ministers from the world's richest countries. But little can be done. The rising euro is part of an inevitable adjustment. The global economy became overdependent on massive U.S. trade deficits, leaving foreigners with more dollars—earned by exporting to the United States—than they wanted. The shift out of dollars causes the euro, the yen and other currencies to rise. What the Europeans (and everyone else, too) really need is faster growth within Europe, which would reduce joblessness and bolster global trade.
One obvious step is to cut interest rates. Compared with the Federal Reserve, the European Central Bank (ECB) has been overly cautious. Its key interest rate is 2 percent; the Fed's is 1 percent. The ECB's timidity reflects excessive worry about higher inflation (now 2 percent) and a more defensible belief that Europe's main economic problems are "structural"—meaning high taxes and regulations.
Thoughtful Europeans now recognize this and have begun to act. Last year Germany trimmed the length and generosity of unemployment benefits while also cutting the tax used to pay for health insurance; that meant reducing some benefits and requiring some co-payments by patients. In France, the government defied street demonstrations to increase the retirement age for public employees. Although these were remarkable political steps, they don't go far enough to reinvigorate Europe's largest economies or to avert the long-term budget problem.
The predicament faced by Europeans—one shared to some degree by all advanced nations, including the United States—is this: unless they take modestly unpopular steps today, they will be faced with hugely unpopular consequences tomorrow. But no one knows when tomorrow arrives and precisely what those consequences will be. The temptation is to do nothing in the hope that nothing bad ever happens. The lesson of Europe's present wobbly economy suggests that something already is.
© 2004 Newsweek, Inc. |
