A union in disarray
Nov 25th 2002
From The Economist Global Agenda
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"As usual, European leaders have found it easier to postpone difficult decisions than face up to them at an early stage."
Finance ministers from the European Union are again discussing their economic problems at a time of growing international concern about Europe's weak economic performance. Is the EU doomed to permanent underperformance?
EUROPE’S problems are piling up fast. Its economies are struggling to regain momentum, and the biggest, Germany's, is teetering on the brink of another recession. Several countries are now set to breach the budgetary guidelines that underpin the euro, known as the stability and growth pact. This agreement was criticised from the outset by some economists, but in the past year or so, as the impact of the downturn on government finances has become clear, the chorus of complaints has become deafening.
Yet Europe’s response is to engage in another of the theological arguments which so often pass for action in the European Union (EU). To the fury of some EU finance ministers, the president of the European Commission, Romano Prodi, recently described the stability pact rules as “stupid”. The Germans—who are about to breach the rules they were so keen to put in place in the late 1990s—are particularly angry at what they see as the commission’s attempts to wreck the pact, aided by the French government. Mr Prodi, though, seems motivated by a desire to acquire more power for the Commission in operating the pact’s rules. Territorial bickering has largely usurped serious debate about the substance of the pact.
There are signs that the commission will soon formally propose substantial modifications to the pact. These might include making it easier for countries with sound public finances to have more fiscal flexibility, while tightening the constraints on those tempted to behave irresponsibly. Although such modifications might help avoid future problems, they will do little to address the current disarray.
The fiscal bind in which the underperforming euro-area economy finds itself has only served to draw attention to the lack of monetary stimulus. While America’s central bank, the Federal Reserve, slashed interest rates in 2001, the much more cautious European Central Bank (ECB) made far fewer and more modest cuts. It has continued to resist cuts this year, in spite of clear evidence of a sharp slowdown in many euro-area economies and in spite of the half-point cut in American interest rates made by the Fed earlier this month.
In explaining its reluctance to move, the ECB points to the fact that for the past couple of years, inflation has almost continuously bumped up against, or even exceeded, its target ceiling of 2%. With recession a real possibility, at least in Germany, and growth across the euro area sluggish at best, this excuse does not wash with many economists. In a striking departure from the usual convention that central banks refrain from commenting about each other, several senior members of the Fed have made it clear that they think the ECB should cut rates sooner rather than later.
What exasperates the Fed is that while American policy is directed at averting another slowdown, Europe is failing to do much, if anything, to help stimulate global recovery. Japan has long been written off as an engine of global—or even regional—growth. But there is a feeling in America that Europe, with a population bigger than America’s, should be doing more. Instead, the perception in Washington is of a group of economies and political leaders too inwardly focused, too preoccupied with their own problems.
Europe does indeed have many longer-term challenges to preoccupy it, though some are of its own making. In the spring of 2000, the so-called Lisbon agenda was launched at a summit in the Portuguese capital, aimed at making the EU the most competitive global region by 2010. That now seems hopelessly optimistic, mainly because European governments themselves have shied away from the changes such a boost in competitiveness would require.
Germany is only slowly waking up to the urgent need for changes in the way its labour market operates—and even the changes the government now envisages are too timid for most economists. France has steadfastly resisted the opening-up of some of its most protected markets, such as energy: it was seen as progress when the government in Paris mentioned making headway on this by 2007-9. In most of Europe, governments have yet to confront the implications of their ageing population and the burden state-pension obligations will place on public finances.
As if these problems weren’t enough, the EU now finds itself with a new distraction—enlargement. Ten new countries, mostly from Central and Eastern Europe, are set to join in May 2004—and applications for others to join later are pending. Politically, enlargement is an important step in the process of integrating the former communist states into the global economic and political system. The experience of Greek, Spanish and Portuguese membership shows that the EU can play a key role in consolidating democracy.
The economic and social difficulties, however, are substantial. The potential for the free movement of goods, labour and capital across 25 countries, at widely different stages of economic development and at different levels of integration into the European economy, will eventually force big changes in the way the EU functions as an economic block. New patterns of agricultural trade, for instance, make reform of Europe’s notoriously expensive Common Agricultural Policy (CAP) inevitable. Yet France, the CAP’s biggest beneficiary, has successfully blocked any change until at least 2006.
As the EU expands, the institutions that run it will have to change in fundamental ways if the Union is to avoid seizing up altogether. Yet negotiations about quite what changes should take place, and how, have dragged on for years. In another example of what some critics see as unhealthy navel-gazing, a grandly named (and grandly run) constitutional convention is deliberating on the potential for radical changes to Europe's constitution. Given that it is chaired by an ageing former president of France, Valéry Giscard d'Estaing, and that an early draft talks about a United States of Europe, the scene seems set for yet another ideological battle which will end in a fudge.
As usual, European leaders have found it easier to postpone difficult decisions than face up to them at an early stage. As a consequence, they will have to make many of them, all at once. If they fail, some parts of the European economy could become as irrelevant to the global economy as Japan.
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