Europe’s triumphalism was premature. The euro zone is still expected to grow faster than the United States this year, for the first time since 1991. But scan the headlines of European newspapers, and it’s obvious all is not well. They offer a sobering diet of higher unemployment, falling industrial production and consumers unwilling to part with their euros. Many Europeans now wonder whether the stronger growth of the past year was merely an aberration. The slowdown also asks the question whether Europe–especially the core countries of Germany, France and Italy–will ever achieve the economic dynamism displayed by the United States.
How galling to discover once again how vulnerable Europe still is to America’s economic fortunes. Far from decoupling, our economies are far more interconnected than many wished to believe. As in the past, sinking U.S. demand for European products has taken its toll. The German export sector has been hit especially hard, since it also has to absorb many indirect effects of the U.S. slowdown. For example: emerging-market countries, seeing their exports to the United States plunge, have cut their purchases of German machine tools. And things could easily get worse. If the overvalued dollar falls against the euro, as seems likely, European businesses would lose much of the exchange-rate advantages they currently enjoy. And as their U.S. profits decline, European companies tend to cut costs across the board–spreading the pain to Europe.
The lesson is plain. Sadly, the old adage–“When the United States sneezes, Europe catches a cold”–still holds true. So how should Europe respond? The first rule is to refrain from falsely assigning blame. The second is to take an honest accounting of our shortcomings.
First of all, let us not blame the European Central Bank for the current malaise. The ECB has so far done a good job under its chief, Wim Duisenberg. I expect it to cut interest rates soon, as the U.S. Federal Reserve has done half a dozen times this year–and as the Bank of England did just last week. Those who decry an overly tight monetary policy are missing the point. Europe’s real problems lie elsewhere.
To wit: if Europeans want a truly vibrant economy and sustained growth–not to mention some insulation against outside shocks–they need to confront the problems summed up in the catchphrase “structural reform.” The biggest obstacles to Europe’s economic dreams for itself are such things as labor-market inflexibility and high taxes. Certainly, these inefficiencies sometimes yield their own benefits. They tend to moderate the sort of boom-bust cycle that often characterizes the U.S. economy, with its huge swings in quarter-by-quarter growth. On the other hand, this same fact excludes Europe from the economic high-flying that the United States is capable of–and that many Europeans so envy.
All of this is well known. International institutions from the OECD to the IMF have been harping on it for years. To their credit, the governments of Gerhard Schroder in Germany and Lionel Jospin in France have not been idle. Both have invested serious political capital in tackling these problems. Tax reform in Germany and liberalized labor laws in France are a welcome change from the past.
Trouble is, at the first sign of economic difficulties, Europe’s leaders invariably abandon even the pretense of reform. Even now, they hide behind the same tired excuses heard so often before. Upcoming elections and the current economic weakness make tough measures unfeasible at this point. Just let us get on our feet, the politicians plead, and then we will take the bold action necessary to keep growth going. Such attitudes put the cart before the horse. Simply put, Europe will never catch up to the United States unless it first takes the difficult path of seriously addressing its weaknesses.
In its way, the latest economic downturn is an opportunity. It should spur European leaders to fight harder for reforms, not retreat from them. Europeans should know that more, not less, belt-tightening awaits. Ultimately, these issues go directly to the heart of Europe’s future. Without the robust economy that Europe lacks today, such challenges as EU enlargement become tougher to achieve. This is not an ebb tide in the business cycle. It is a wake-up call for the continent.
