How Europe Can Make Growth HappenRudi Dornbusch
Unemployment in Europe has been rising for 20 years. There was a brief interruption of that pattern in 1987-90, but that's history. Unemployment is projected to rise this year, next year, and for who knows how long thereafter. Mass unemployment has become the overwhelming problem of the decade.
Two decades ago, European unemployment was a comfortable 2% to 3%. There was work for just about everybody, and the thought of 25 million people out of work was a story out of the 1930s, not a peek into the foreseeable future. Today, unemployment is expected to reach 25% of the labor force in Spain. In France, it is in the low teens.
Explanations for high joblessness abound. One school of thought sees a lack of flexibility: Europe has become stifled by rules and regulations. Shops can't open when people want to buy, bars can't open when people want to drink. Workers must rest when businesses want to produce, and being green is far more important than growth and jobs.
A PERVASIVE STATE. Another school focuses on labor costs: On top of already high wages are piled a myriad of overheads that double the cost of labor. Prominent among these burdens are social security contributions by employers of up to 40% of earnings and all the other costs of an overly pervasive, expensive, and inefficient state. A third school concentrates on unemployment compensation. Workers are rational, and generous extended unemployment benefits make unemployment an attractive profession.
Finally, there is the Keynesian school: Unemployment is rising because there is no growth. To create jobs on a scale that avoids rising unemployment, demand must grow enough to outpace productivity growth and growth of the labor force. That hasn't happened. As is usual in a heated debate, every protagonist holds a piece of the puzzle. But some are more right than others.
European policymakers watch the U.S. economy with envy. It may not always seem that way in the U.S., but in general most people can find jobs, even if they aren't great jobs. Unemployment in the U.S. is moderate, and jobs are being created month after month--2 million new jobs since the trough of recession in 1991. Part of the reason is great flexibility, both in terms of employment (hire today, lay off tomorrow, if you must) and in pay. Europeans can't bring themselves to endorse a low-wage strategy, but they find flexibility an attractive concept.
France is trying to move maximum working hours from a weekly to an annual ceiling. Germany is flirting with privatization of telecommunications, and there are rumors that shops may be allowed to open on weekends. Two cheers for such flexibility. But by itself, it won't solve the problem of mass unemployment.
Unemployment will come down only when spending and output grow enough. Output growth must exceed 2.5% to 3% per year. Every percentage point of shortfall in growth translates into an extra one-half percentage point in the unemployment rate. The implications are clear: The consensus forecast of about 1% growth in Europe in 1994 means another percentage point added to the unemployment rate.
A lot is at stake in Europe. High unemployment fosters a political climate of nationalism and nasty politics. Internationalism fades, and provincial protectionism comes to the fore. High unemployment also stands in the way of reintegrating Eastern Europe. Without early market access, the East won't take off economically. More and more people from the East will migrate to the West, causing even greater unemployment and nastier politics. High European unemployment surely hobbles world trade. When people don't have jobs, the blame soon falls on imports. Before long, the world-trade system is seriously challenged.
How to spur more growth? Supply-side policies are good, but they take a decade to work, not a year. Real progress can come from achieving much lower interest rates, and insisting less on immediate fiscal correction. A return to lower interest rates is stymied by mulish adherence to the remnants of a European Monetary System. France, for example, could join Italy and Britain in severing the exchange-rate tie with Germany, cut interest rates, and enjoy growth. But--shades of the 1930s--the status quo is given priority over plain common sense.
DANGEROUS THINKING. Should countries whose deficits are inflated by high unemployment raise taxes to make unemployment even higher? Every finance ministry espouses the dogma that flexibility of markets and stability of rules are the only way to remedy unemployment. Stimulating growth would set back the clock. That is dangerous thinking today, just as it was in the interwar period. Unemployment will only yield to growth: Tight money and premature fiscal restraint are sure ways to choke growth.
So three cheers for making growth happen. Now is the time to shift to a new agenda. Lower interest rates and less insistence on immediate fiscal correction can create the growth that is needed to bring down unemployment in Europe.
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