Look at European history for the past 25 years, and you see that from the late 1970s to the early 1990s the continent was plagued by macroeconomic instability, high unemployment, over-regulated markets -- including, importantly, financial markets -- unregulated monopolies and inefficient state-run industries. Over the past decade Europe has made important progress in restoring macroeconomic stability, but it has been less successful in enacting the micro-level reforms that are necessary to deregulate markets and improve their efficiency. Why is this? Is there a lesson in this for the countries of Central and Eastern Europe as they prepare to join the EU?
High inflation and mounting public debt generated a feeling of crisis in the early 1990s in some EU countries -- when one's house is on fire, the costs of doing nothing are too large to continue sitting back and doing nothing. It took the exchange-rate crisis of 1992, for instance, to make Italy's leaders realize that something had to be done about the country's public-finance mess. The fear of being left out of the euro did the rest, by creating a political consensus in favor of taking the right and necessary steps.
Today, Europe's economic house is no longer on fire. So it has become much harder to break the back of special interests in order to liberalize markets and improve economic efficiency. Just this past June, for example, France went through a 1968-style month of strikes and street protests only to implement minor pension reforms -- the elimination of a few special privileges enjoyed by public sector employees.
In a sense such pusillanimous reforms are the outcome of Europe having become a more "normal" place. Europe simply could not afford the failure of the euro project, so its leaders did what was necessary. But no one, it seems, will stop this rich continent from living with slow growth, high unemployment and inefficient markets. There is no crisis associated with that choice -- just slow decline.
The Maastricht convergence criteria that led to the euro's creation worked because they were imposed by a multinational agreement and were monitored multinationally. More importantly, the punishment for not complying was clear, strong and certain -- exclusion from the monetary union. None of that threatens Europe today, so member states have precious little incentive to continue the reform process.
But could something like the Maastricht process be used to implement structural reform? In a sense, such a process is already at work.
One mechanism that has often been effective at reining in powerful special interests in individual EU states, and thus at implementing structural reforms, is action by the European Commission. France decided to permit a very mild opening of its domestic electricity market the day before the start of formal proceedings against France at the European Court of Justice for infringement of an EU directive. Italy ended 70 years of active involvement by the state in industry thanks to the determination of the EU competition commissioners, Karel van Miert and his successor, Mario Monti.
Obviously the European Commission can play a positive role only if it embraces a stance in favor of liberalizing markets and does not fall into the trap of focusing on coordinating national regulation throughout the Union. Regulation of markets does need to be coordinated; but it also needs to be eliminated in many cases.
Consider Europe's financial markets, which provide an alternative way to break the reform deadlock. In the old Europe, with fragmented financial markets, Chancellor Gerhard Schroeder's request that Mannesmann remain a German company in the face of a (successful) takeover bid by Vodaphone was tantamount to his following an order by the company's mostly German shareholders. As it turned out, such action no longer works in a world in which European companies are exposed to the scrutiny of international investors.
European financial markets were, and to some extent still are, dominated by a few large banks. When the euro was launched, banks in Europe accounted for some 80 percent of total firm financing, as compared to 30 percent in the US. Banks are often less prepared to finance a risky, but possibly bright, idea. As lenders, they are also less efficient at monitoring firms than shareholders are.
Before the advent of the euro, local markets were small and illiquid. The development of modern, highly liquid financial markets has been one of the main benefits of the euro. In a few years, for instance, bank lending in Germany fell from 74 percent to 32 percent of the total funds raised by large German companies. In Italy the share of bank lending as a percent of the total funds raised by big Italian companies fell from 75 percent to 50 percent -- the difference being made up mostly by emissions of corporate bonds.
The lesson for new member countries from the East is clear: once you are in the EU, the outside pressure to reform decreases: the impetus to reform must be found at home. Reforms aimed at deregulating financial markets should be the priority.
Alberto Alesina is professor of economics at Harvard University and Francesco Giavazzi is professor of economics at Bocconi University, Milan. Copyright: Project Syndicate
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