As the ECB meets tomorrow to decide its next move, it can now add the risk of a deflationary spiral to the list of the currency bloc’s afflictions. With rising real debt burdens, perennially high unemployment and stagnant growth, it is difficult to be optimistic about the Eurozone. The timidity of the response to this crisis from national and European policy makers has curtailed the prospects of recovery. Even if the ECB announces the introduction of quantitative easing, it is likely to be a watered down version to appease the Germans – perhaps involving national central banks buying their own government’s debt. Moreover, such a monetary expansion can only ever be the anaesthetic before the corrective surgery.
Monetary expansion must therefore be tied to deeper and more far-reaching structural reforms if it is to be part of a solution to the continent’s woes. Unemployment in France and Italy continues to rise, reaching 10.3% and 13.4%, and in Spain almost a quarter of the workforce remains jobless. Half of young people in Spain and Greece are unemployed. Such staggeringly high unemployment rates are in themselves a social and economic catastrophe. Yet even that cannot fully explain the dire labour market situation in the highly leveraged southern European economies. Labour force participation in Italy is at 65% and in Greece and France it hovers at around 70%. In the south of Italy, labour force participation is as low as 40%. This compares to approximately 80% in the UK and Germany.
There is a real danger that these elevated rates of unemployment will ossify and lead to a new slow-growth, low employment equilibrium across much of the Eurozone. This would be an unacceptable outcome and must be challenged with more open, more flexible and more competitive markets. These economies suffer from limited product-market competition, especially in services, heavily regulated labour markets and inefficient public spending and taxation systems.
Excessive regulation and barriers to entry limit competition and push up costs for consumers and erode the ability of firms to grow and benefit from economies of scale. Efficiency remains low and the penetration of innovation and FDI is limited. Heavy labour market regulation such as Italy’s infamous Article 18 makes it more expensive and time consuming to take on new workers. This is compounded by layers of government administration and fiendishly complex tax systems along with high payroll taxes. The IMF estimates that structural reforms in Italy which would halve the gap in product and labour markets with the rest of the Eurozone would raise real GDP by almost 6% after 5 years and by 10.5% in the long run.
Whilst some steps have been taken in the right directions on this front, the progress so far has been slow. Binding QE with structural reforms would also allay German concerns over monetary easing. Only by embracing market liberalisation and more competition do the Eurozone economies have a chance to improve their underlying growth rates and start to cut the ranks of the unemployed.
