The need for immediate action is clear. The eurozone’s economy contracted in the last three months of 2011; even Germany’s shrank. The new year is looking grim. France is flat-lining (as is Britain). Italy and Spain have sunk into deep recession. Greece is in its fifth year of a slump. And eurozone unemployment is at record highs, with nearly one in two young people jobless in Spain and Greece.
The economic headwinds are formidable: fiscal austerity, high interest rates outside AAA-rated countries, credit cutting by banks, deleveraging households, weak private-sector investment, and declining exports as the global slowdown undermines demand.
Until growth resumes, any tentative financial stabilization will be extremely fragile. Recession will hit banks’ and governments’ already-weak balance sheets, increasing pressure for faster deleveraging. But, while gradual adjustment is essential, faster and deeper cuts are largely self-defeating: big reductions in private credit and government spending will cause a sharper slowdown – and thus a vicious downward spiral. A big new push for growth is therefore vital.
So far, the growth agenda has consisted largely of structural reforms, which are essential for boosting future productivity and flexibility. The crisis does provide a political opportunity for bold moves on this front in many countries; but structural reforms generally will not generate growth and jobs immediately (one exception is permitting shops to open longer).
On the contrary, a shakeout of less productive jobs, for example, would at first raise unemployment, increase government outlays, and reduce private spending. And, because demand is depressed, credit is in short supply, and barriers to enterprise are often high, it will take longer than usual for businesses to create more productive jobs. In short, structural reforms alone cannot be relied upon to stimulate growth in 2012.
Instead, the immediate focus needs to be on boosting investment and exports in economies with a current-account deficit – such as France, Italy, and Spain (and the United Kingdom) – and stimulating consumption in surplus countries such as Germany and the Netherlands.
The European Central Bank has acted decisively to prop up European banks; now it needs to support the real economy, too. While official interest rates are only 1%, solvent sovereigns such as Spain pay more than 5% to borrow for ten years, while creditworthy businesses in Italy can borrow only at punitive rates, if at all. So the ECB should do more to unblock the transmission mechanism for monetary policy; the European Banking Authority should discourage excessive deleveraging by insisting that banks raise specific capital amounts rather than hit a uniform 9% ratio; and, where necessary, national governments should provide guarantees for bank lending to small and medium-size businesses.
While improving access to finance is vital, governments also need to do more to boost investment. They should prioritize measures to make it easier to start a business, lift barriers to venture capital, and introduce temporary 100% capital allowances to encourage businesses to bring forward investment. At the EU level, the (callable) capital of the European Investment Bank should be greatly increased, as European Commission President José Manuel Barroso suggested in his State of the Union speech last September, so that the EIB can finance a big wave of pan-European investment, notably in infrastructure.
Boosting exports is also essential. Deficit countries need to become more competitive, increasing productivity while cutting costs. A more competitive currency would be welcome: just as the sterling’s collapse since 2008 has lifted UK exports, a weaker euro would help Mediterranean economies regain competitiveness for price-sensitive exports. A fiscal devaluation – slashing payroll taxes and replacing the revenues with a higher VAT – would also help.
Surplus countries, too, must do their part, which is in their own interest. Just as China needs to allow the renminbi to rise, so Germany – whose current-account surplus exceeds China's both as a share of GDP and in absolute terms – needs a higher real exchange rate. That means that Germans need to earn higher wages, commensurate with their increased productivity, so that they can afford more Greek and Spanish holidays. If businesses will not oblige, an income-tax cut would do the trick.
That brings us to fiscal policy. Governments that cannot borrow cheaply (or at all) from markets have no option but to tighten their belts. But they should pursue smart consolidation rather than unthinking austerity. So they should maintain investment in skills and infrastructure, while cutting subsidies and transfer payments. They should also legislate now for future reforms, notably to encourage people to work longer.
Last but not least, governments that can borrow at unprecedentedly low rates – 0% in real terms over 10 years in the case of Germany – must play their role in supporting demand. Would it be really be so difficult to see VAT coming down ahead of the German election next year?
Philippe Legrain is an independent economic adviser to the
president of the European Commission.
