The European economy of tomorrow

According to forecasts contained in the latest report of the European Commission (Quarterly Report on the Euro area, December 2013), if there is no structural intervention the potential per capita GDP of the Eurozone will grow by less than 1% over the next decade, about half of the growth posted during the pre-crisis period 1998-2007. This would mean a widening gap with the United States: by 2023 per capita GDP of the Eurozone would fall to 60% of that of the US, reversing a converging trend which, beginning in the post-war period, appeared to have ended in the mid-1990s. According to the Commission, the causes of the disappointing long-term performance of the European economy are not related solely to the current economic situation, but rather are due to structural factors, such as the low rate of growth of labour productivity and an ageing population.

This worrying diagnosis can be summarised as follows. In the long run, GDP per capita depends on the average productivity of labour (calculated as value added per hour worked) and on participation in the labour market (the ratio working age population to total population). In Europe the growth in labour productivity had been adversely affected by the poor performance (on average) of total-factor productivity (TFP), a measure of the organisational efficiency of output and technical progress. The low birth rate and ageing of the population also led to a drop in labour supply. The conclusion reached is that, “under a no policy-change scenario”, the growth rate of GDP per inhabitant will continue to drop.

Despite the apparent pessimism of the Commission, it is not resigned to such a future: the Eurozone may be able to safeguard wellbeing and competitiveness if member States implement the necessary structural reforms. So the aim is to raise productivity and participation in the labour market. To this end the Commission has presented some proposals, already present, in embryonic form, in the Lisbon Agenda (2000) and in “Europe 2020″ Strategy” (2010):

• Liberalisation of goods and services markets. This would facilitate access to markets and raise competition, reducing excess profits of producers and keeping prices under control. There would be tangible advantages for consumers and for the international competitiveness of nations;

• Rise in labour supply, with raising of the retirement age and facilities to encourage the hiring of women, youngsters and low-skilled workers. To incentivise the participation of women day nursery services will be expanded;

• Actions to mitigate unemployment, matching supply and demand in the labour market. Proposals include a reduction in unemployment benefits (so-called reservation wages), better active policies to encourage vocational retraining, and appropriate tax breaks for businesses;

• Tax reforms shifting the tax burden from direct taxation on labour and businesses to indirect taxation on consumption. This measure favours in particular export firms, which are not weighed down by higher VAT, but take advantage of relief on labour costs;

• Actions in the area of school education and training to raise human capital levels;

• Support for productivity and technological innovation, using instruments such as tax credits for private spending on Research & Development.

According to forecasts, if this package of reforms were enacted by each country it would raise aggregate GDP of the Eurozone by 6% by the end of the next decade. There would be spillovers on incomes, domestic demand and competitiveness in overseas markets. The public deficit and public debt would become more sustainable, and trade imbalances between core and peripheral nations would be reduced. The only proviso is that since the effects of these reforms would be seen only after a few years, it is crucial for all countries to introduce them as soon as possible, overcoming corporative resistance within them.

While we share the concerns about the future of the Union, and agree with the need to adopt prompt measures to correct the route being taken by Europe, we have strong reservations about the reformist efficacy of the Commission’s agenda. We are not convinced about the general framework of the reforms, being overly biased on the supply side, with instruments such as tax reductions, tax breaks, liberalisations, reductions in social safety nets and social security spending. Reforms on the supply side are based on the assumption that the market, through the pricing system, is the best way of allocating production factors, maximising general wellbeing and employment. When this does not happen, and there is higher unemployment or lower GDP, it is because there are rigidities – to be ascribed to external factors – that do not allow prices (and wages) to find their own equilibrium. This is the case of overly generous unemployment benefits, which lead to a decline in labour supply, or restrictive rules on redundancies, which discourage firms from hiring workers. The task of economic policy should be to eliminate such distortions.

This vision has no empirical confirmation. In the period 2008-2013 the number of jobless rose by 4 percentage points in the Eurozone (source: Eurostat), despite peripheral countries injecting massive amounts of flexibility into the labour market, reduced social protection, benefits and labour costs per product unit, and introduced important reforms to raise the age of retirement. Far from depending on supply conditions, the exponential rise in unemployment is due to the lack of demand for consumer goods and capital goods on the part of businesses and households, which in turn is caused by brutal tax consolidation policies (spending cuts and higher taxes) imposed by European institutions on member States. It is clear that unless there is a radical change in economic policy, Europe is at risk of coming undone at the seams.

The new driving force of growth in the Union must come above all from domestic demand, thus reducing the incidence of exports. For this to happen (demand side) policies are needed that can put a stop to the intolerable social suffering of the people and steer long-term economic development towards paths of environmental sustainability, social justice and material wellbeing. Public investments should be undertaken in support of these efforts, as they have immediate multiplier effects on income and employment. If they are channelled to specific sectors, for example research, physical and non-physical infrastructures, environmental protection, they can also improve the quality of product supply in the medium and long term.

 A huge amount of resources needs to be mobilised for such an investment plan, yet funding sources are available: Eurobonds, environmental and financial transactions taxes, more structural funds, and a radically reformed European Central Bank, whose new target is full employment.

Obstacles to change are all of the political (and ideological) variety. We shall see whether in the forthcoming European elections in May the ideas of change will finally prevail over vested interests.

Federico Stoppa

Fonte: questeistituzioni

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