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.
Illustration: Mountain people
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.
Even then, the eurozone’s per capita growth rate is unlikely to be much lower than that of the US, because the difference in their productivity growth rates is minor.
In this sense, the eurozone’s future might look more like Japan’s present, characterized by headline annual growth of a little more than 1 percent and stubbornly low inflation, but per capita income growth similar to that of the US or Europe.
Fortunately for the eurozone, it is to enter this period of high employment and slow growth on sound footing — thanks, in part, to that controversial austerity.
By contrast, both the US and Japan are facing full employment with fiscal deficits higher than 3 percent of GDP — about 2 to 3 percentage points higher than those of the eurozone.
The US and Japan also have heavier debt burdens: The debt-to-GDP ratio is 107 percent in the US and more than 200 percent in Japan, compared to 90 percent in the eurozone.
There is evidence that in the wake of a financial crisis, when monetary policy becomes ineffective — for example, because nominal interest rates are at the zero bound — deficit spending can have an unusually strong stabilizing effect.
However, there remains a key unresolved issue: Once financial markets have normalized, will maintaining a deficit for a long time provide continuous stimulus?
The fact that the eurozone’s recovery is catching up with that of the US, despite its lack of any continuing stimulus, suggests that the answer is no.
Indeed, the experience of the eurozone suggests that while concerted fiscal stimulus can make a difference during an acute recession, withdrawing that stimulus when it is no longer vital is preferable to maintaining it indefinitely.
With austerity — that is, reducing the deficit once the recession has ended — recovery might take longer to become consolidated, but once it is, economic performance is even more stable, because the government’s accounts are in a sustainable position.
The economist John Maynard Keynes famously said: “In the long run, we are all dead.”
That might be true on a long enough timeline, but it is no excuse to dismiss longer-term considerations.
For the eurozone, the long run seems to have arrived — and the economy is still alive and kicking.
Daniel Gros is director of the Brussels-based Center for European Policy Studies. He has worked for the IMF and served as an economic adviser to the European Commission, the European Parliament and the French prime minister and finance minister.
Copyright: Project Syndicate
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