Abstract
The European Union risks entering a long period of relative economic decline unless it meets the challenges of global competition, climate change and severe pressure on public finances. With a reinforced commitment to the market economy, Europe will make progress. The key lies in political will.
On 3 March 2010, the European Commission published its recommendations for improving the competitiveness of the European Union's economy by 2020. They included five targets: raising the employment rate of the 20–64 age group to at least 75 from 69% today; increasing investment in research and development to 3% of gross domestic product; reducing greenhouse gas emissions by at least 20% from 1990 levels; reducing the share of early school leavers to 10 from 15%, and increasing the share of people aged 30–34 who have completed tertiary education to at least 40 from 31%; and lifting 20 million people out of poverty [9]. As the EU learned from its experience with the Lisbon Agenda, adopted in 2000, setting goals is one thing, achieving them another. In this paper I identify some of the priorities for keeping Europe at the top of the table of the world economy in 2020 and beyond.
Understanding the challenge
By 2025, the world will have 8 billion inhabitants, up roughly 20% from 6.5 billion today. Africa and Asia will account for almost all the increase. Some 61% of the world's population will live in Asia. The centre of gravity of world production will move to Asia, which will become an increasingly important destination for investment in research and development. China and India may account for about 20% of the world's research and development expenditure, more than twice their present level. The configuration of world trade will change. The EU's share of world trade, which stood at 39% in 2005, will fall to 32%. Asia's share will rise to 35 from 29%. In short, Europe, the United States and Japan will no longer dominate the world economy, even if it would be premature to suggest that China, India, South Korea, Indonesia and other Asian countries will be firmly in the driving seat [7].
For European governments, this outlook presents a particular set of challenges. Europe's economic growth rate was in steady decline even before the worst financial crisis and recession since the 1930s erupted in 2008. Real gross domestic product growth averaged about 2.25% per year from 1981 to 1993, and then slipped to 2% from 1993 to 2003 [16]. Over the past two years the crisis has struck harsh blows not only at Europe's public finances, by deepening budget deficits and piling up government debt, but at Europe's medium-term potential growth rate, which has been effectively halved. As Van Rompuy [22], President of the European Council, puts it: ‘The crisis has revealed our weaknesses. Our structural growth rate is too low to create new jobs and to sustain our social systems’.
In speech after speech since his appointment in November 2009, Herman Van Rompuy has emphasised the need to at least double the EU's GDP growth rate to 2% or more a year. Anything less, he says, risks jeopardising the ‘European way of life’—the form of advanced social capitalism that combines energetic private sector entrepreneurship with an array of generous, state-supplied public services. Businessmen well understand the importance of generating higher growth rates. According to BusinessEurope, the pan-European employers’ confederation that represents 20 million large, medium-sized and small companies, a doubling of the EU's growth potential in the 2010–14 period could create as many as 6.5 million new jobs by 2014 and reduce the public debt mountain by more than €450 billion. The annual savings on interest payments on public debt would be so great by 2014 that they would exceed current spending in the EU budget on competitiveness programmes [4]. The objective of higher growth is, then, clear; the question is how to attain it.
Completing the single market
In the memorable words of Jacques Delors, no one falls in love with a single market. With its 500 million citizens, however, full exploitation of the potential of the EU's single market is the key to delivering a long-term exit from the crisis in the form of expanded private-sector investment, more jobs and higher average growth rates. Examples abound of how the single market is underdeveloped. National rather than EU-level regulation of telecommunications networks and services costs Europe's businesses at least €20 billion a year. The retention of 27 different national copyright systems hinders consumers’ access to creative content from websites outside their own country. An effective single market in this field alone would quadruple revenues to €8.3 billion. The EU lacks a functioning single market for online services, with the result that only 7% of all transactions made by European consumers on the web are cross-border. About three in every five orders placed by a customer with an online shop located in a different EU country fail, either for technical reasons or because the trader refuses for legal reasons to serve a customer abroad [19].
It is in the service economy, which accounts for approximately 70% of EU output and employment, that the greatest political barriers to the completion of the single EU market are visible. The EU's most important legislative measure in this area was the 2006 Services Directive, a politically controversial initiative that became ‘a focal point for the tension between economic liberalisation and social protection, making it increasingly difficult to achieve meaningful consensus at EU level’ [23]. All Member States were obliged to have implemented the directive by December 2009, but there was much foot-dragging in evidence. Nine countries, including Germany and the UK, were judged to have made significant progress in putting the directive into effect; nine, including France and Spain, were reasonably well advanced; and nine, including Italy and Poland, were lagging far behind [13]. To achieve better results, the EU should strengthen the mechanisms by which Member States review each other's implementation of EU legislation and should improve cooperation among national enforcement authorities.
In the short term, governments can reaffirm their commitment to the target date of 2012 for cutting EU administrative burdens by 25%. But over the next 10 years, efforts should be concentrated on removing barriers to the single market in sectors with the highest potential to drive economic growth, such as low-carbon technologies, digital business and, above all, services. As a result of the limited scope of the 2006 Services Directive, national regulations continue to govern the audiovisual sector, education, health care, medicine, research and many other fields of activity. The ease with which an American in New Jersey can move to Florida or California and set up a new business stands in sharp contrast to the difficulties that a Belgian experiences when attempting the same in Portugal or an Estonian in Italy. Moreover, European companies continue to struggle with product conformity assessments that vary from country to country and distort the prices of goods. All in all, obstacles to the free movement of labour, capital, goods and services are estimated to cost companies between 2 and 15% of their annual turnover. Up to €350 billion a year could be generated from the removal of such barriers [5].
Opening global markets
The single market strengthens the EU's appeal as a trading partner and as a destination for foreign direct investment. Conversely, European prosperity is inextricably linked to an open, rules-based global trading regime. Completion of the Doha Development Agenda would allow European companies to compete more effectively in a dynamic global market. However, as the years have passed, the Doha negotiations, which started in 2001, have increasingly appeared to focus on yesterday's world trade priorities rather than the priorities of tomorrow. Progress on the removal of trade-distorting agricultural subsidies, as well as industrial tariffs and non-tariff barriers, would be welcome. But as far as the service sector is concerned, the most important driver of future world economic growth, the Doha talks have been almost paralysed since July 2008. Moreover, even though financial services ought to form a central component of any Doha agreement, the prospects for progress in this area are uncertain at best because of the backlash generated by the world financial crisis [1].
From the EU's perspective, the Doha talks need therefore to be complemented by deeper bilateral trade relationships with the world's major economies. The EU–South Korea pact, initialled in October 2009, is a pertinent example. It is expected to yield €1.6 billion in duty savings in 2010 alone. On a more modest scale, it was announced in March 2010 that the EU and Vietnam were to launch bilateral free trade talks. Similar negotiations are proceeding apace with Canada. Over the coming decade, however, it will be important to concentrate on securing ambitious trade deals across the globe. India should be an especially high priority, followed by the South American countries of MERCOSUR (Mercado Común del Sur, or Southern Common Market) and the members of ASEAN (Association of South East Asian Nations).
The EU should also consider a free trade agreement with the United States that would reach beyond each side's existing commitments under World Trade Organization rules. The two economies are already highly interdependent, with trade flows across the Atlantic amounting to about €1.7 billion a day [10]. This makes the elimination of all tariffs an attainable objective. With the notable exception of agricultural products, overall tariffs in the EU and US are already low. But the trade relationship is so vast that the aggregate effect on trade creation would be substantial—perhaps as much as €12.5 billion a year [12].
Modernising labour markets and education
Higher levels of economic growth will require an EU labour force that is better educated, better trained and no longer split into a privileged category of full-time employees enjoying excellent salary and pension benefits and a large minority of workers doomed to a succession of short-term contract jobs with few perks. Europe's two-tier labour market is a fortress of inefficiency that will be extremely resistant to assault, but governments will have no choice but to make the effort. Across the EU's 27 countries, the unemployment rate among people aged under 25 was two and a half times higher than the rate among workers aged 25–64 even before the onset of the financial crisis. Faced with employment laws that guarantee high levels of job protection and pension provision, businesses are understandably reluctant to hire younger people on a full-time basis [21].
Improving the quality of European education systems is one way to persuade employers of the benefits of hiring younger people. This implies a commitment on the part of governments to increase investment in higher education. Whatever the doubts about its methodology, the Shanghai ranking of the world's universities makes clear that far too many universities in Europe are underperforming. Yet in what will undoubtedly be an age of fiscal austerity, throwing more money at public universities will not be an option for EU governments. Arguably, it is not a satisfactory solution to the problem in the first place. Specialists have amassed evidence that universities tend to raise their performances when they are permitted more control over their budgets, including the setting of wages [3]. More autonomy for universities may be politically controversial and go against the European cultural grain, but it is likely to prove a more realistic path of action than to bank on receiving a greater share of scarce state resources.
As long ago as 2003, an experts’ report requested by Romano Prodi during his Commission presidency stated: ‘What is needed now is less vertically integrated firms, greater mobility within and across firms, more retraining, greater flexibility of labour markets, greater availability of external finance, in particular equity finance, and higher investment in both R&D and higher education’ [20]. These recommendations will remain as pertinent in 2020 as they are today.
Going for green growth
Over the past decade EU policymakers have increasingly based their energy policy strategy on the assumption that the fight against climate change will not merely heal the environment but will serve as a positive force for economic growth and job creation. In particular, much faith has been placed in the potential of wind power, solar power and other renewable energy sources. In 2005 the renewable energy sector employed 1.4 million people and generated €58 billion in value added to the economy. If the EU were to meet its target of a 20% share for renewables in total energy consumption by 2020, Commission forecasters estimate that the net benefit would be the creation of 410,000 jobs and 0.24% in additional GDP growth. This prediction is founded partly on the assumption of continuing strong investment in renewable energy installations in Europe and exports to the rest of the world [11].
Yet even optimists recognise that the EU is certain to depend heavily on imported energy, notably gas and oil, for many years to come. As Andris Piebalgs [18], the former Energy Commissioner, puts it, the EU ‘is by no means anti-fossil fuel. We cannot do without fossil fuels, and every realistic scenario confirms that even in a low-carbon future, there is a significant role for fossil fuels’. The continuing dependence on coal, gas and oil, and the likelihood that oil prices will remain high on world markets make it unlikely that increased use of renewables will in itself transform the EU's economic growth outlook.
However, other promising policy choices are available. One is to progress with the integration of the EU energy market, a step that the Commission estimates in its March 2010 report can add an extra 0.6 to 0.8% of GDP. Another is to intensify the EU's policy of maximising efficient use of existing energy resources. For businesses and households, this can mean practical steps such as the insulation of buildings and heating systems, the use of low-energy light bulbs and fully switching off electrical equipment when unused. The decarbonisation of the transport and power sectors is a third way forward. Some 70% of the technologies required for this are either available today or will become commercially viable in the next decade. As one influential study observes: ‘Energy efficiency is the low-hanging fruit of the clean-energy revolution’ [17].
Cleaning up the public finances
By now, there is a broad consensus that no long-term economic growth strategy is likely to make much progress unless European governments pay the strictest attention to restoring order to their public finances. In the German [15] view, ‘sound public sector finances are vital if the member-states are to be able to act, if there are to be positive conditions for growth and employment in the long term, and if the monetary union is to be stable’. However, this is not a view confined to fiscal hawks in Germany and like-minded states. From January 2009 onwards, business people were becoming concerned about the condition of sovereign debt markets, where rising tensions reflected nervousness about the fiscal outlook for Greece and several other peripheral euro area countries. By deterring banks from issuing loans to companies, especially small and medium-sized enterprises, and by raising the cost of capital, such tensions cramp new investment and impede Europe's efforts to accelerate economic growth. The problem is all the more acute because banks must comply with more rigorous rules on maintaining capital reserves, while at the same time they continue to labour under the burden of billions of euros of non-performing loans dating from the financial crisis [14]. Business has as keen an interest as government in responsible fiscal policies.
As is well known, the Maastricht Treaty set ceilings for countries wishing to adopt the euro of 60% of GDP for public debts and 3% of GDP for budget deficits. What is less well remembered is that the Treaty contained an escape clause. Countries with debts and deficits above the ceilings were to be allowed to join the euro area as long as their public finances were heading in the right direction. From such small bacteria are harmful diseases spread. The Stability and Growth Pact, the mechanism intended to guarantee fiscal rectitude in the monetary union, failed to function effectively almost from the start. Between 2002 and 2006 even Germany, the architect of the Stability Pact, ran an average deficit of 3.3% of GDP. Next year, largely but not entirely because of the devastating impact of the financial crisis, all 16 euro area countries will run deficits above 3%, and all except Luxembourg, Finland, Slovakia and Slovenia will have debts above 60% [8].
The longer-term outlook is more troubling still. In the event that the euro area undertook no important structural reforms to public finances over the next 6 years, and that it recorded 2% annual GDP growth and 2% inflation over the same period, the region's public debt would climb to 119% of GDP by 2016. Greece's debt would be 182%, that of Ireland 150% and that of Italy 143% [2]. Such projections do not even take into account the enormous pressure on state expenditure that will come from the retirement of the ‘baby boomer’ generation and its demands on pensions and health care provision. According to a Commission study, ‘though the debt and deficit increases are by themselves quite impressive, the projected impact on public finances of ageing populations is anticipated to dwarf the effect of the crisis many times over’ [6]. The real condition of Europe's public finances may be even more fragile than present data and future estimates suggest. Courageous measures to reduce debts and deficits are a sine qua non of higher economic growth both before and after 2020.
Conclusion
As this sketch of the condition of the EU's public finances suggests, the essential ingredient for rebuilding Europe's economic growth potential is political will. Naturally, businesses need to be creative and citizens need to be hard-working and responsible. International conditions over the next 10–20 years will not always be helpful. But Franklin D. Roosevelt was not far wrong when he declared: ‘The cure for what ails us is leadership.’