Is Europe’s Economic Stagnation Inevitable or Policy-Driven?

Written by | Wednesday, March 18th, 2015
European Values

Christian Odendahl (Centre for European Reform)

Europe is facing economic stagnation. This is manifested by a very low level of investments, which leads to the prolongation of the period of below-average growth. This stagnation in Europe is further aggravated by the asymmetry of the monetary union, which offers only weak instruments needed to help cushion shocks to the economy. The potential growth is also hampered by the market fragmentation, stricter regulation, various problems in the area of human capital, and the persistent low inflation rate. Hence, the governments should agree on significant structural reforms and implement them in the field of labor law as well liberalization.

Moreover, Europe is undergoing demographic changes which could jeopardize the potential growth. The transformation of population composition in Europe is uneven – France and Great Britain are exposed to the risk, while Italy and Germany should be wary. The states should approach the labor policies differently and abandon the mantra of balanced budgets and they should also strive to increase the growth of the GDP per capita. To deal with the predicament of aging population, the governments will have to compete with one another and seek to attract immigrants to their respective countries.

In addition, the gap between the poor and the rich is widening in Europe. While the inequality among countries has grown, the transfers of wealth in between states are nearly non-existent. It is vital to create automatic stabilizers and improve the level of long-term investments to support productivity. The inequality among states as well as among people could threaten the efforts of the pro-growth policies themselves. The protection of low-income citizens and less qualified professions should be encouraged. The efforts to reduce the differences in the level of income could then, for example, endanger the insistence on budgetary discipline and austerity.

The European banking sector should too undergo a change. The recapitalization of banks is necessary and the public funds should be used to fund this process. Furthermore, the banks should clean up their balance sheets. A stronger central regulator would also be welcome in order to reduce the states’ power to protect their national champions. Finally, it is vital to boost the liquidity in banks and to harmonize the laws regulating the banks’ solvency across Europe.

If the Old Continent is to escape the menace of stagnation, European politicians must unite or the Eurozone will collapse. Europe needs only one common monetary, fiscal and structural strategy. An EU-wide fiscal architecture is necessary. The governments must trust each other and jointly implement the macroeconomic policies. The European governments should definitely not replicate the German approach and the Germans themselves should realize that they too were once debtors.

(The study can be downloaded here)

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