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Europe’s Way Out
CAMBRIDGE – It seems that austerity is out of fashion in the eurozone – at least for the moment. The European Commission has given Spain, France, and the Netherlands more time to comply with the European Union’s 3%-of-GDP deficit ceiling. Even German government officials now concede that something more than fiscal belt-tightening is needed to revive the economies of the eurozone periphery.
Create comment on this paragraphAccording to the Commission, that “something more” is structural reform: easing of firing restrictions and other labor-markets regulations, liberalization of closed professions, and removal of controls on markets for goods and services.
Create comment on this paragraphBut this is merely old wine in a new bottle. From the outset of the eurozone crisis, the “troika” (the Commission, the International Monetary Fund, and the European Central Bank) insisted on such structural reforms as part of any financial-assistance package. Greece, Spain, and the others were told all along that these reforms were needed to spur productivity and competitiveness and help revive growth.
Create comment on this paragraphAfter three years, Greece’s experience is telling. As a new IMF report acknowledges, structural reforms there have failed to produce the intended effects, partly because they ran up against political and implementation difficulties, and partly because their potential to increase growth in the short run was overstated. Nor have Spain’s labor-market reforms worked as expected.
Create comment on this paragraphNone of this should come as a surprise. Structural reform increases productivity in practice through two complementary channels. First, low-productivity sectors shed labor. Second, high-productivity sectors expand and hire more labor. Both processes are needed if the reforms are to increase economy-wide productivity.
Create comment on this paragraphBut, when aggregate demand is depressed – as it is in Europe’s periphery – the second mechanism operates weakly, if at all. It is easy to see why: making it easier to fire labor or start new businesses has little effect on hiring when firms already have excess capacity and have difficulty finding consumers. So all we get is the first effect, and thus an increase in unemployment.
Create comment on this paragraphThere is little new in the European Commission’s approach, and few reasons to be optimistic that its “new” strategy will work better than the old one. Structural reform – however desirable it may be for the longer term – simply is not a remedy for these countries’ short-term growth conundrum.
Create comment on this paragraphThe eurozone periphery suffers from both a stock problem and a flow problem. It has too large a debt stock, and too little competitiveness to achieve external balance without significant domestic deflation and unemployment. What is required is a two-pronged approach that targets both problems simultaneously. The prevailing approach – targeting debt through fiscal austerity and competitiveness through structural reform – has produced unemployment levels that threaten social and political stability.
So, what can be done differently?
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