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Europe’s growth challenge

27 February 2012 By Hugo Dixon

Europe needs a growth strategy. In the short term, that means preventing an austerity spiral. In the long run, it means structural reform and a drive to create a genuine single market. The European Union summit this week is a chance to aim at both targets.

The euro zone crisis may be receding. Last week’s temporary fix of Greece’s problems with a 130 billion euro bailout is the most recent cause for optimism. But so long as the region cannot grow – and the European Commission has just forecast zero growth this year for the European Union as a whole and shrinkage for several countries including Italy and Spain – there is a risk of sliding back into crisis.

The European Central Bank’s provision of 500 billion euros of three-year money to the banks before Christmas – and the promise of a similar cash injection this week – has lifted spirits in financial markets. Some of that money will find its way into the real economy. But while monetary policy is lax, fiscal policy is tight. No fewer than 23 of the EU’s 27 countries are in what are known as “excess deficit procedures”, which require them to bring their annual borrowing down to less than 3 percent of GDP over the next year or so. Under the so-called “six pack” system of fiscal discipline, countries can be fined if they fail to stick to the required austerity.

Balancing budgets is a good idea. The problem is that, if overdone, austerity can drive economies deeper into recession. Taxes fall, meaning it is even harder for governments to balance their finances. If they then have to squeeze again, the economy just gets further squished. The rational approach would be to give governments such as Spain – which is especially vulnerable to this spiral – a little longer to cut their deficits provided they are genuinely dealing with their countries’ structural problems, for example by tackling excessively expensive pension systems and rigid labour markets.

There are some tentative signs that policymakers are coming round to such an approach. Mario Monti, Italy’s highly respected new prime minister, seems to have had some success in persuading Germany’s Angela Merkel that economic policy can’t be just about austerity. Meanwhile, the European Commission, which is responsible for policing the excess deficits, is equivocating about what to do with Spain.

That said, it’s not easy for Europe to get itself off the austerity spike on which it has impaled itself. When the single currency was launched, governments were supposed to keep their deficits below 3 percent of GDP. Within a few years, those rules were effectively thrown in the bin, helping fuel the current debt crisis. The idea behind the “six pack” – and the even more stringent new treaty on fiscal discipline which is in the works – is to re-impose those rules in a more binding form. If this straitjacket is abandoned at the first sign of trouble, bureaucratic credibility would be shot to bits.

Some way must be found of squaring the circle. The best approach would be for Europe’s leaders to agree that what matters is medium-term rather than short-term fiscal prudence. That would not just be beneficial for growth in the short run, helping ensure that the current slowdown is mild not steep. Policies such as raising retirement ages and getting more young people into work would also boost Europe’s long-term potential.

But even more needs to be done. The most important way of combating Europe’s sluggish growth prospects is to complete the region’s single market, which covers all 27 EU nations, not just the 17 which use the euro. Twenty years after the single market was created in 1992, it is still pretty fragmented. There are, for example, 4,600 regulated professions, while the cost of setting up a business is nearly four times that of doing so in the United States. Creating a real single market by sweeping away restrictive practices and simplifying regulations would boost the EU’s GDP by 800 billion euros or nearly 7 percent, according to the UK government.

In recent years, attempts to inject new life into the single market agenda have floundered. For example, an initiative known as the Lisbon Agenda in 2000 aimed to make the EU the “most competitive and dynamic knowledge-based economy in the world” by 2010. That failed. Vested interests conspired to neuter most suggested reforms.

There may, though, be a window of opportunity to relaunch this plan. The UK’s David Cameron is certainly pushing it at this week’s summit. This might not seem to count for much, given how the British prime minister has been isolated in recent months over how to fight the euro crisis. However, he is not on his own this time. Eleven other leaders have joined him in writing a letter advocating measures to boost growth.

Cameron’s most important ally is Monti. Italy’s prime minister cares passionately about the single market, having written a blueprint two years ago on how to revive it. He has given a lot of thought about how the winners and losers can be balanced so that there is something in the single market for pretty much everybody. His voice also carries increasing weight in Europe’s discussions. The key will be to win over the two biggest economies – Germany and France – which were not part of Cameron’s letter-writing exercise. The politics won’t be easy. But Europe’s biggest need in both the short-term and long-term is growth. Its leaders should step up to the challenge.


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