Michael J. Boskin
A Five-Step Plan for European Prosperity
WASHINGTON, DC – Though the Greek crisis has been placed on pause, the
economic situation in Europe remains bleak. Eurozone growth is up
slightly from its near-recession levels of a few months ago, but
projections by the International Monetary Fund for 2015 and 2016 barely
exceed 1%. Unemployment remains above 11% – and twice that among the young (and doubled again in countries like Greece and Spain).
Greece's exit from the eurozone would likely be less disruptive now
than it would have been a few years ago. The countries most at risk of
contagion – Portugal, Spain, and Italy – are less vulnerable now in the
eyes of the markets; the European Union has established a bailout fund;
and the European Central Bank has launched a large bond-buying program.
The real challenge in Europe is continued stagnation and rising
public-sector fiscal pressures in bloated welfare states with rapidly
aging populations. Restoring growth, opportunity, prosperity, and
financial stability will require bold solutions to five inter-related
problems.
The first problem is fiscal. The math is simple. The tax rate necessary
to fund social spending must equal the ratio of the number of people
receiving benefits to the number of taxpayers (the dependency ratio),
multiplied by the average benefit relative to the income being taxed
(the replacement rate). It was this math that led Mario Draghi, the
president of the European Central Bank, to declare that,
“The European social model has already gone." Too many Europeans are
collecting too many benefits, but so far governments have mostly ducked
the issue, taking on massive debt in order to postpone the reckoning.
Reform that targets social spending at true need is long overdue.
The second problem is economic: growth in Europe has fallen far short
of that in the United States, decade after decade. Though economic
theory predicts convergence in standards of living, Europe lags behind
the US by 30% or more. High taxes and burdensome regulations stifle the
labor market and potential new businesses. Overgenerous social-welfare
payments create disincentives to work, hire, invest, and grow. Chronic
sluggish growth is insufficient to create opportunities for the
continent's masses of unemployed and underemployed young people.
The third problem is the banking crisis. In Europe, banks supply
roughly 70% of the credit to European economies, compared to 30% in the
US. But many European banks are over-leveraged zombies, kept alive by
emergency public infusions of liquidity.
Fourth, there is the currency crisis. The euro's many benefits –
cross-border pricing transparency, lower transaction costs, and
inflation credibility – required surrendering independent monetary
policies and flexible exchange rates. But, given limited interregional
transfers and labor mobility, this means that the continent has far less
ability to absorb disparate shocks through the operation of so-called
automatic stabilizers. In the US, by contrast, people in
high-unemployment Michigan move to, say, Texas, where jobs are
plentiful, even as the federal tax and transfer system automatically
shifts money in the opposite direction, cushioning the local downturn.
Finally, Europe faces a severe governance deficit. Citizens are
becoming increasingly disenchanted with European elites and
supra-national institutions such as the European Commission, which
impose rules and regulations that conflict with their countries'
economic interests and sovereignty. Voters are restless, as the Greek
election result demonstrated. Nationalist sentiment is rising, and
demagogic parties of the far right and left are gaining in every poll.
Addressing these problems will be difficult, but not impossible. The
core challenge is fiscal; Europe cannot escape the need to scale back
its sclerotic welfare states. By recognizing that, and implementing the
following series of mutually reinforcing policies, the continent can
move beyond its current torpor.
Gradual fiscal consolidation
– reducing the projected future size of government spending, and hence
future tax rates – will have to be at the center of the effort. This
should be combined with the mutualization of some portion of the
liabilities of highly indebted countries – defined as a debt-to-GDP
ratio above, say, 60% or 70% – and modest write-downs in exchange for
long-term zero-coupon bonds. The “Brady bonds" that the US used to help
resolve the Latin American debt crisis in the 1990s could serve as a
model.
Meanwhile, Europe's zombie banks will have to be rapidly resolved by
acquisition or temporary takeover, cleanup, and asset sale, as was done
by the Resolution Trust Corporation during the US savings and loan
crisis in the 1980s. Structural reforms that increase labor-market
flexibility and reduce red tape and related obstacles to new business
formation must also be implemented.
Finally, the eurozone should adopt a two-track euro with a fluctuating
exchange rate – an idea championed by the American economist Allan Meltzer.
Systematic rules would have to be developed to determine when members
of the eurozone are demoted to “euro B" or promoted to “euro A." Such a
halfway house – call it “depreciation without departure" – would avoid
some (but not all) of the problems of a country's complete withdrawal
from the eurozone. It would create its own set of incentives, which, on
balance, would pressure individual countries to avoid demotion, just as
top-tier football (soccer) teams seek to avoid relegation to the minor
leagues.
Together, these policies would reduce sovereign debt, lower interest
rates, ameliorate tax pressures, enable countries to increase
competitiveness with fewer sacrifices to living standards, and provide
Europe with a road map to prosperity. Until now, the EU's leaders have
followed the easiest, but least productive path, patching temporary,
partial fixes on problems as they erupt. The possibility of a brighter
economic future should be a prize large enough to evoke the same type of
leadership through which Europe rose from the ashes of World War II.
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