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Deflation Isn't What's Holding Europe Back

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website
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As the European Central Bank gets ready for quantitative easing, overriding German arguments that buying government debt creates moral hazard in debt-laden countries, it is reacting to the threat of deflation. Yet slow-growing prices aren’t at the heart of what ails the euro area, and QE won’t fix the deeper problems that are.

It’s easy to see why so many economists are concerned about deflation in Europe. According to a recent report from Bruegel, the Brussels-based think tank, 30 percent of the euro zone’s inflation basket is now in negative territory, and that number doesn't even take into account the recent steep drop in oil prices. All of this has led to comparisons with Japan, and warnings that Europe may also be in for a “lost decade.”

What evidence we have, however, suggests there’s no clear link in Europe right now between declining prices and low growth. According to Eurostat, in the second and third quarters of this year, eight European Union countries -- Belgium, Bulgaria, Greece, France, Hungary, the Netherlands, Poland and Romania experienced deflation -- that is, the harmonized consumer price index in these countries was lower in September than it was in March. Denmark showed exactly zero change in prices. Yet, of these countries, only Greece showed negative growth over the same period. 

Indeed, according to Eurostat's GDP data, the average growth rate in these countries (minus Romania, for which the European statistics agency has no raw GDP numbers) over the two quarters was higher than for the euro area as a whole: 1.3 percent compared with 0.5 percent. 

Economists say deflation is dangerous, because when prices begin to fall, consumers delay purchases and stop borrowing. Paul Krugman provided the classic popular explanation a few years ago. But that's not how things appear to work in real life, at least not in Europe right now. In the EU countries that experienced deflation in the second and third quarter of 2014, private spending mostly increased (Eurostat has no relevant data for Bulgaria):

So consumers, especially relatively poor people, may not be as rational as economics suggests: When they can afford more stuff, they may just buy it without giving much thought to next month's consumer price index. The other prediction is that companies will invest less when prices are going down, because they make less money or expect their profits to fall. That hasn't been true for Europe in mid-2014, either. Eurostat data show fixed capital formation increased in all the deflation countries except France, and that stands to reason: if consumer spending has been increasing, there's no need for firms to cut their investment plans.

Perhaps the effects Krugman described are going to manifest themselves yet. But even if the ECB floods the euro area with cash to boost demand, any growth created won’t be sustained for long. That’s because a relatively tight monetary policy is not the reason all European countries have been underperforming the U.S.

Europe's biggest economies are weighed down by bloated social security systems and severely restricted labor markets. In Germany, retailers have been unable to persuade the government to allow stores to open on Sundays. In France, there's the famous 35-hour workweek. In Italy, Prime Minister Matteo Renzi is only now pushing through legislation that would make it possible to fire workers who have open-ended contracts. In Spain, which has succeeded in driving down labor costs since the 2011 debt crisis, workers are still automatically entitled to 30 days annual vacation plus 12 paid public holidays -- more than a typical U.S. employee gets after 20 years of loyal service.

East European countries, forced to take the dive after the fall of communism, now have some of Europe's highest growth rates. Latvia, Lithuania and Estonia have business environments closer to the U.S. model than to the European one, and have all been growing faster than the EU average this year.

In core euro area countries, getting rid of all the added social costs and restrictions might spur economic growth to rival that of the U.S., but it might also cause the politicians responsible to lose their next elections. So these governments have stalled and borrowed to tide them over. Now, the ECB is going to back that approach by acquiring some of the debts it created, emulating the U.S. practice of quantitative easing.

That's no way to fix the real problem: If Europe wants more growth, it needs to emulate U.S. entrepreneurial ruthlessness, not its monetary gimmicks. If, however, Europe wants to keep its focus on reducing inequality, it needs to get used to low growth rates as payment for this political priority.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
Leonid Bershidsky at

To contact the editor on this story:
Marc Champion at