Tue, Nov 09, 2004 - Page 9 News List

The long decline of Western Europe?

By Alberto Alesina and Francesco Giavazzi

It's election season in Germany, France and Italy, so the time for structural reforms is over.

Paradoxically, this could be good news for those who think that Europe should start contributing to world growth by expanding domestic demand. Current wisdom has it that the reason why France recently grew twice as fast as Germany is that French consumers have stopped worrying about social reforms.

As soon as French Finance Minister Nicolas Sarkozy decided to leave the government and start campaigning for the presidency, incumbent President Jacques Chirac abandoned all plans for reforms that might antagonize voters. So health reform or even partial pension reform must wait a few years.

A recent "white paper" produced by a working group headed by the IMF's former boss, Michel Camdessus, which was charged with proposing the type of structural reforms needed to achieve growth, was received with the usual outcry from trade unions. Most of its reasonable proposals will soon become another example of forgotten good intentions. Back to business as usual in France.

German households, on the other hand, according to a recent poll published in the influential daily Die Welt, are in a more sober mood: most plan on cutting down their vacation travel -- which, obviously, does not mean that they will work more; they will just spend some of the many weeks of their paid leisure at home -- and postponing large item purchases. Why? They are worried by the talk of pension reform, changes in the health system, and new eligibility rues for unemployment benefits.

To be sure, their mood may soon turn brighter: German Chancellor Gerhard Schroeder is also preparing for re-election. He may even have a shot at winning, as the SDP, his party, is reviving in the polls. Accordingly, references to the need for pushing ahead with reforms have disappeared from his speeches. As a result, perhaps the long-awaited turnaround in German consumption -- which has been flat for the good part of a decade -- is about to happen.

In Italy, Prime Minister Silvio Berlusconi waited three and a half years before deciding to deliver on his main electoral promise of a tax cut. ?But real tax cuts also mean spending cuts and, as elections loom barely a year from now, it is too late. Concerned that cutting spending might lose him votes, Berlusconi is proposing a tax cut of less that 0.3 percent of GDP -- and one that is partly to be financed by other levies. If Germans are depressed, Italians are in a coma.

There is a lesson to be drawn from these experiences. Special interests have become so powerful and entrenched that any attempt at reform brings out a powerful lobby against it.

So politicians on the campaign trail promise the impossible: reforms that will produce instant prosperity at no cost to anyone. When -- surprise, surprise! -- this turns out to be impossible, they give up on reform altogether. In the meantime, they do serious damage because Europeans are so worried about the possibility of reform that the mere possibility of such reforms actually being enacted plunges them into a funk.

In fact, there are two problems with all this talk and little or no real action on structural reforms. First, it makes consumers anxious and depresses demand. Second, it leaves time for anti-reform lobbies to organize and prevent any progress toward completion of the reform effort. A politically more successful plan would be to adopt the "big bang" approach: implement quickly a broad set of reforms that will break the opposition of special interests and leave enough time before the next election for the benefits of reform to be felt by voters. When consumers see the benefits of market deregulation, for example, perhaps they will feel compensated for having to work longer for their retirement. But no European politician on the horizon is likely to take this approach.

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