Angela Merkel's poor showing in Germany's recent election has now put into cold storage any hope of a serious overhaul of the country's famously rigid economy. British Prime Minister Tony Blair was waiting for her to help launch a drive to make the current British presidency of the EU a historical turning point for the union's economy. Now Blair has no project, and all would-be reformers are most likely downsizing their ambitions. Europe appears to be more stuck than ever. But is it?
To start with, the private sector is doing well. Technology travels fast and is swiftly adopted. Firms have responded to inhospitable conditions by cutting workforces and boosting productivity through more capital-intensive production processes and, when needed, by offshoring their capacities. The laggards are to be found only in the service industry, which is largely insulated from international production chains and even from internal European competition.
More fundamentally, there is no such thing as a "European economy." The union's 25 member countries are very diverse. The Nordic countries are high-tech leaders; Spain has slashed its unemployment rate by half (it stood at 25 percent not so long ago); and the new members from Central and Eastern Europe are cruising briskly along a steady catch-up path.
The really sick countries are three of the EU's four biggest: France, Germany and Italy. But even they have carried out some reforms -- not enough and too recently to make a difference yet; nonetheless, they have started to move.
More importantly, no one ignores that the old ways have to go if prosperity is to be maintained. Except for a fringe of die-hard Marxists -- which can still collect up to 10 percent of the votes -- there is a keen sense that deep reforms are needed to come to grips with the high unemployment and poor growth of the last decade.
Continuing budget deficits have visibly failed to deliver what die-hard Keynesians had promised. These days, no politician dares to suggest that continuing to pile up debt is the way to go, even though few are prepared to articulate a credible plan for fiscal consolidation.
The problem, of course, is that the most urgently needed reforms will hurt a lot of people. Most economists agree that high levels of employment protection merely hold down the creation of new jobs rather than reduce joblessness. But reducing employment protection scares workers in the private sector. This is understandable, given an unemployment rate of around 10 percent in France, Germany, and Italy; with so few new jobs, becoming unemployed is a major disaster.
To be sure, comfortable unemployment benefits soften the blow. The problem, though, is that some people have even become addicted; they now aim at living on welfare benefits alone. This is why economists want to change the unemployment and welfare systems to raise the incentives to go back to work. Successful experience notwithstanding, most people interpret "incentives" as painful kicks in the butt, and they want none of it.
Then consider these countries' bloated public services, where jobs are guaranteed for life, promotion is by seniority rather than merit, and customers are seen as a nuisance. The result is red tape all over and a huge drag on productivity. Shaping up the public sector is an obvious goal, but civil servants are adamantly opposed to what would in effect mean new and much less attractive work contracts.
Economists know that important parts of the population are bound to lose from reform. Their answer is that more people stand to benefit, and that the benefits far outweigh the costs. This is true, but it provides little solace for the potential losers.
Reforms are relatively easy in smaller countries, probably because winners and losers are likely to be personally connected to each other as relatives, neighbors or friends. In large countries, the fear of being on the losing side is not outweighed by people's appreciation that the country as a whole will do better.
One solution is just to go ahead and reform anyway, regardless of the resistance. This is the Thatcher solution, which took almost everyone by surprise. Angela Merkel was sometimes called the German Iron Lady, and that seems to have scared enough people to rob her of an expected victory. Even if she becomes chancellor, she has no mandate for deep reform.
Meanwhile, the French presidential hopeful, Nicolas Sarkozy, who was associating himself with Merkel and articulating a bold reform program, suddenly seems weak.
Clearly, if reforms are to be carried out in Europe, something else must be tried.
Here is one idea. Why shouldn't winners compensate the losers? Surely, for example, there is a price tag that can be attached to breaking civil servants' existing work contracts. If a fair one-time payment is offered, it is likely to be taken up by a majority of civil servants, and public opinion will frown upon the greedy or lazy ones who turn it down.
It might be expensive to compensate all potential losers, but we must put our money where our mouth is; if a reform is certain to pay off handsomely, it will pay for the buy-offs, and more. Governments can borrow what they need to pay out now, and service this debt as reforms yield benefits.
Not only is paying up-front against future benefits efficient and fair, but it also can provide strong incentives for policy makers to weed out bad reforms. If a reform is as good as we think it is, then so is public debt to finance its political acceptability.
Charles Wyplosz is professor of international economics and director of the International Center for Money and Banking Studies at the Graduate Institute of International Studies, Geneva.
Copyright: Project Syndicate
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