Europe's lost decade

Unless Europe adopts measures of austerity and institutional reforms soon, it could well be headed towards a decade of ultimate loss, argue Nilanjan Banik & Pierto Paganini.

We are passing through an interesting time in the global order. There is a likelihood that a trade war between two of the world's biggest economies – China and the USA – may soon blow heavily out of proportion. The consequence may be another economic downturn in the offing. During an economic crisis, consumers spend less, and investors do not invest (or postpone their investment decisions). There is a general sense of pessimism about future earning prospects, leading to higher unemployment rates and lower productivity growth across diverse countries.

The economic crisis of 2008 did not persist that long (in comparison to the Great Depression of 1929) thanks to the coordinated efforts of the central bankers in Europe and in the US. Quantitative easing helped stave off the persisting consumer pessimism. China also played a constructive role by controlling its foreign exchange reserve. During 2015-16, rather than spending foreign exchange reserves on other economies, China made sure that the precious dollar is spent in its home turf. Taxes on consumer durables such as cars were slashed significantly. All these revived Chinese demand and its manufacturing grew to new unprecedented levels. Back in Europe, major economies were able to contain their public debt (as a part of austerity measures), and all these efforts were instrumental in reviving the economies around the world.

But, maybe, that option is no more a viable solution. Countries around the world are increasingly resorting to protectionist measures, something that may not spell very well for the future of economic growth. In order to understand what factors lead to a crisis, we have to step a little back into history.

Soon after the Second World War, when Europe was devastated, policymakers in the region wanted to re-build Europe on the premise of socialist capitalism. The underlying idea is that when the market is at a nascent stage, the state will ensure that a labour market comes into play and jobs become abundantly available to the given populace. For the elderly, and those without jobs, the state will provide care through a benevolent social security system — paying unemployment benefits and pensions to those in need.

The objective is noble, but to make the system more efficient, the government has to ensure that it collects funds through a system of taxation to pay dole for the unemployed and pension for the retired. Dole and pension are expenditures for the government, and to pay for it, the government has to collect taxes from the rest of its population.

The principal source of tax is the corporate income tax (contributing to nearly 80 per cent of the total tax collection), indirect tax (such as excise and service tax) and direct income tax (that is, taxing the working class).

At the time of recession, when businesses are not forthcoming or when people find it hard to get a job, it is quite natural that tax collection will be inadequate in comparison to its desired levels. Therefore, the government will meet its welfare objective (that is, to pay for dole and pensions) by printing excess money or through an elaborate process of borrowing. Both are perfect recipes for increasing the budget deficit and the public debt.

A higher budget deficit can be sustained, provided the economy is still showing prospects of growth. With countries around the world, including those in Europe opting for the ultra-right jingoistic path, the probability of economics winning over politics is increasingly becoming a dimmed option. This new wave of the 'country first' ideology with total disregard towards trade/economic specialisation may delay institutional reforms. In a socialist capitalist structure, wages are protected by trade unions. This is irrespective of labour productivity and an individual firms' ability to earn its profit.

A natural suggestion would be to reform the labour and pension laws (dubbed as austerity measures) and slacken the immigration laws. But, if the recent poll results provide any indication, it seems that voters would rather punish the parties in favour of austerity measures.

Take the case of Italy. Just a few days ago, a new government was installed which has openly defined itself as populist. The two political parties that make up the Yellow-Green coalition maintain that they have really understood the people's problems, which is something the traditional political forces have not been capable of doing.

The Italian electorate has, through their protest vote, chosen to ignore a return to economic growth, after years of depression (1.5 per cent GDP in 2017), a fall in unemployment (11.2 per cent) – above all among young people (18-25), a better control of public debt, and more substantial foreign investments. The jobs market is excessively fragmented and deregulated. Salaries remain stagnant, whereas the gap between the so-called 1 per cent of the population, the elites indeed, and the so-called forgotten has been further widened. It is a problem that is common to many EU countries.

A closer look at the European democracies suggests that it is run by the insiders made up of pensioners, trade union leaders, public sector workers and big farmers. The outsiders, consisting of a small number of immigrants, the youth and small private entrepreneurs have little to say in policy matters. It is a classic case of a socialist democracy in which the insiders are myopic, care too much about present benefits, and are deliberately voting parties to power that support their cause. On the contrary, the outsiders are quite powerless.

Even issues such as changes in labour immigration laws have been stalled. A flexible labour immigration clause is expected to resolve issues related to the dearth of a young skilled labour force. The brain drain from developing countries such as India and China has helped fuel economic growth in the US, but not in Europe.

Besides, dissimilar macroeconomic conditions (reflected in the debt-GDP ratio) may even threaten the existence of the European Union (EU). This is because it renders a common macroeconomic policy — expansionary monetary/fiscal policy during a recession and contractionary monetary/fiscal policy during an expansion — ineffective. But Europe is diverse, and when Greece is facing recession and Germany is doing well, then following an expansionary monetary policy may help Greece but will eventually heat up the German economy.

It will be to Europe's benefit if the nations prepare themselves for austerity measures and institutional reforms. Otherwise, like Argentina during the 80s and Japan during the 90s, a lost decade will be the ultimate reality for Europe and rest of the world.

(Nilanjan Banik is with Bennett University, India; Pierto Paganini is with Competere, Italy. The views expressed are strictly personal)

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