Growth in Europe: don’t forget the long-run

Growth in Europe is projected to be weak in 2012 and 2013. This is true for the aggregate but the outlook is much worse for many of the countries in the South. The south of the eurozone is struggling with a twin challenge: high (external) debt and weak competitiveness. Efforts to reduce indebtedness are likely to continue, but progress will be slow because weak GDP growth will hinder the deleveraging process. Of course, GDP growth is weak in part because the private sector is attempting to deleverage.

Downward wage adjustment is necessary. It is, however, economically leading to export success only after some time and it increases debt problems in the household and corporate sector until employment picks up.  The South of Europe is stuck in a trap which is difficult to escape.
So what is to be done? In my paper with Alan Ahearne (Europe’s debt challenge) I focus on a number of priorities: (1) the need to make the necessary fiscal consolidation as little harmful to growth as possible by choosing the right mix of spending cuts and tax increases; (2) the need to avoid burdening highly indebted cohorts of a society too much; (3) the possibility to use structural funds for targeted export subsidies; (4) the need to remove regulatory and tax impediments to investment, in particular in current account surplus countries; (5) recognizing bad assets in the banking system with rigorous stress tests and using EFSF funds at low interest rates to recapitalize banks so that credit is flowing to the real economy; (6) a European wide investment strategy, for example in the area of energy transition, that has positive climate effects but also demand effects across the region as a whole; (7) and last but not least debt relief in some countries may become necessary.

Besides these measures, structural funds could play an important role in generating growth. My colleague Benedicta Marzinotto has done the math (http://www.bruegel.org/publications/publication-detail/publication/684-the-numbers-behind-a-new-eu-growth-fund/ ) and finds substantial amounts of money could be used and spent. She stresses, that money needs to be carefully spent. Let me add a few thoughts on that. Despite significant structural funds that have been channeled to the weak performers in Europe, long-term growth and productivity has not picked up. It appears that funds have not always been used productively. In addition, fundamental factors such as the quality of the education system and the efficiency of the public administration hamper innovation and growth, the key factors for growth.  In the attached figure I show the performance in the education system as measured in the Pisa tests run by the OECD. Some regions in the South of Europe performs below average. My colleagues Zsolt Darvas and Jean Pisani-Ferry have produced a heat-map of where structural reforms are particularly needed (http://www.bruegel.org/publications/publication-detail/publication/623-europes-growth-emergency/).

Some of Europe’s regions are thus in need of a good governance and education initiative. These are the pre-conditions for lasting and strong growth which are so vital to Europe. The EU should use structural funds creatively to promote such positive change. To give two examples: Small inducement prices to trigger competition for best practices among regions can have large effects on the behavior of public administrations. Such competitions have in fact already been used in other countries to detect red tape for example and incentivize to its removal. The Competitive Teaming of Excellence initiative by the European Parliament’s ITRE committee could help to attract and keep young talent in the region. The idea would be to have a competition between teams consisting of one convergence region united with one excellent research institution. Each of the team develops a proposal for a new research institute to be created in the convergence region under the management of the excellent research institution. Structural Funds could be used for such a contest.

Overall it is clear that the eurozone is in need of a strong, dedicated and creative growth strategy. Several big macroeconomic measures need to be taken to get growth going, facilitate the deleveraging process and reduce pressure from interest rates. But Europe’s adjustment challenge should not only be about that. Education and innovation systems need to improve to get productivity going. We should not forget the long-term.