Fri, Jun 16, 2017 - Page 9 News List

The eurozone’s hidden strength

By Daniel Gros

Illustration: Mountain people

For years, the eurozone has been perceived as a disaster area, with discussions of the monetary union’s future often centered on a possible breakup.

When the British voted to leave the EU last year, they were driven partly by the perception of the eurozone as a dysfunctional — and perhaps unsalvageable — project.

However, the eurozone has become the darling of financial markets — and for good reason.

The discovery of the eurozone’s latent strength was long overdue. Indeed, it has been recovering from the crisis of 2011 and 2012.

On a per capita basis, its economic growth outpaces that of the US.

The unemployment rate is also declining — more slowly than in the US, but that partly reflects a divergence in labor-force participation trends.

Whereas labor-force participation in the eurozone is on the rise, it has been declining in the US since about 2000. The departure of Americans from the job market reflects what economists call the “discouraged worker” phenomenon, and the trend has accelerated since the recession of 2009.

In principle, declining labor-force participation should also be a problem in the eurozone given the prolonged period of high unemployment that many European workers have faced.

However, in the past five years, 2.5 million people in the eurozone have joined the labor force as 5 million jobs were created, reducing the overall decline in unemployment by half.

Moreover, the eurozone recovery has been sustained, somewhat unexpectedly, even in the absence of continuous fiscal stimulus.

The heated discussions about austerity have been misplaced, with both critics and official cheerleaders overestimating the amount of austerity applied. The average cyclically adjusted fiscal deficit has been about constant since 2014, at about 1 percent of GDP.

Of course, large differences in the fiscal position of individual member states remain, but this is to be expected in such a diverse monetary union. Even France, often considered a weak performer, has deficit and debt levels comparable to those of the US.

A comparison with the US, as well as with Japan, also undercuts the common perception that the eurozone’s fiscal rules, including the (in)famous Stability and Growth Pact and the 2012 “fiscal compact,” have been irrelevant.

True, no nation has been officially reprimanded for excessive deficits or debts, but the clamor over rule breaches at the margin has overshadowed the broad underlying trend toward sound public finances that the fiscal rules have fostered.

All of this suggests that the “soft austerity” pursued in many eurozone nations might have been the right choice after all.

To be sure, the eurozone’s long-term economic strength should not be overestimated. While the average growth rate might remain above 2 percent for the next few years, as the remaining unemployed are absorbed and the long-term trend of older workers rejoining the labor market continues, the pool of unused labor is to eventually be exhausted.

Once the eurozone has reached the so-called “Lewis turning point” — when surplus labor is depleted and wages start to rise — growth rates are to fall to a level that better reflects demographic dynamics.

Those dynamics are not particularly desirable: The eurozone’s working-age population is set to decline by about half a percentage point per year over the next decade at least.

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