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Economics – Damned if you do…

Over the past few weeks, Europe has dominated the headlines and there is a
widespread feeling that the EU is now at something of a crossroads. The public
debate, however, seems at times to confuse several separate issues – the
proposed constitution, the single currency and the performance of the European
economy. From the UK’s perspective, they are in many ways inter-related.

When this government first came to office in 1997, it was transparently
Europhile, committed to placing the UK at ‘the heart of Europe’. Now, as Tony
Blair starts on his final term, that stance has shifted almost 180 degrees.

Hostility to the constitution and talk of the single currency area breaking
up both appear to be the result of the continuing stagnation of the eurozone
economies. The British public’s scepticism about closer integration seems
justified and the politicians are following suit.

Since the single currency was conceived at Maastricht, the eurozone’s
economic record has been lamentable. In terms of growth and job creation, the 11
members have consistently lagged behind the UK. As a result, in 2004 the
unemployment rate averaged 8.6% in the eurozone (and even higher in France,
Germany and Spain), compared with the UK’s 2.7%. Formerly the ‘sick man of
Europe’, Britain is now the region’s most successful economy.

In the search for the guilty, European fingers point to the single currency.
Polls in several countries suggest that a majority would favour the restoration
of their original currency. While this is technically difficult and expensive,
the sentiments are understandable. As many claimed at the time, the eurozone
countries are very different from each other and at different points in their
respective business cycles: they do not form an optimal currency area. It is not
surprising, therefore, that a policy designed to suit the average works for
hardly anyone.

The eurozone interest rate is set by the European Central Bank, which has an
inflation remit less flexible than the terms of reference set by Gordon Brown
for the Bank of England. As a result, the ECB has been inflexible and cautious,
focusing more on inflation than growth.

Fiscal policy has also been a problem. By locking themselves into the growth
and stability pact, governments gave up a weapon to counter cyclical downturns
in their own countries. In fact, during the long gestation period between
Maastricht and the launch of the euro in 1999, too much policy attention was
paid to getting countries ready in terms of the inflationary and budgetary
convergence criteria and not enough on the structural issues which determine
economic performance.

While euro-related policies are partly responsible, the so-called structural
issues are a much bigger factor in Europe’s deep-seated malaise. In the period
since 1945, Europeans enjoyed a rising standard of living, improvements in
social protection, longer holidays, high social benefits and shorter working
weeks. Any threat to reform this social model is fiercely resisted by

But the global economy has moved on from the time when Europe was a dominant
economic force. Today, European workers cost about 20 times as much per hour as
the Chinese, even though China produces increasingly sophisticated goods in
direct competition with Europe. In the modern world, it is not enough for
Germany or France to be more competitive than Italy or Spain: they have to be
able to take on China and other Asian suppliers. This means wholesale changes,
liberalising many parts of their economies, particularly the labour market. To
many Europeans, such reforms are seen as an attack on the coveted social model.
This was a major factor in the French rejection of the constitution – the
feeling that they would have to embrace the Anglo-Saxon market approach to life.

It is something of an irony that while sentiment in Britain seemed to be
opposed to the constitution, many Europeans were against it because it appeared
to threaten them with the free market principles that have served the UK well
since our own painful reforms of the 1980s.

European politicians are caught in a classic catch 22. Many governments are
unpopular because of slow growth, declining living standards and unemployment.
Radical restructuring of welfare states, tax systems, labour markets and public
sectors are a necessary prerequisite to reverse the downward trend, but this
would only make politicians even more unpopular. Those not brave enough to face
up to the need for change have one alternative – protectionism – and this
promises an even faster slide downhill.

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