Europe's crisis: Why? And to what end?

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Europe's crisis: Why? And to what end?

Article by: ROGER FELDMAN
Updated: September 10, 2012 - 9:13 PM

In the ability to generate real growth, the eurozone seriously underachieves.

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European Central Bank ECB in Frankfurt, central Germany.

Photo: Michael Probst, Associated Press

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My wife and I arrived in Rome on a sunny day in May to find the transit workers on strike. Several striking employees had stretched a yellow plastic tape, like you see at a crime scene, across the entrance to the metro at the main Termini train station. No one crossed this thin barrier.

We asked someone what was going on. "Oh, they're just striking today. It will be over this evening," he said. Outside the train station, Rome's normally hectic traffic was reduced to a hopeless snarl.

The striking workers were not protesting low wages or bad working conditions. Unlike strikes in the United States, this was not a last-resort response after failing to reach a bargain with the employer. Instead, it was a show of strength: We have the power to shut you down, and we'll use it. In fact, the union flexes this power regularly and advertises the strikes in advance. Had we been more knowledgeable, we would have seen the schedule and adjusted our plans.

When we left Rome, the airline pilots were on strike, shutting down many flights to and from Leonardo de Vinci Airport. Fortunately, our airline was not involved in the strike.

This, in a nutshell, is Europe's economic problem. To pay for its generous social welfare programs -- free health care and early retirement benefits, for example -- it must create economic growth. But it is not able to grow because the economy is tied in knots.

The current European debt crisis is just a symptom of the underlying problem. For years, countries like Italy, Spain and Greece were able to run budget deficits and borrow at low interest rates. No longer: Greece has been forced to seek a bailout, and Spain recently received 100 billion euros (about $126 billion) to shore up its ailing banks. The 17 countries that use the euro are sliding into recession. Efforts to solve the debt crisis by raising taxes have been unsuccessful and are likely to contribute to the coming recession.

Another response is for the European Central Bank (ECB) to buy bonds of countries that use the euro, hoping to drive the prices of bonds up. Because bond prices and interest rates move in opposite directions, this would drive countries' borrowing costs down. On Sept. 6, the ECB announced such a policy with a commitment to make the program a "fully effective backstop" against a worsening of the debt crisis.

While this policy may be a short-term elixir, it is a questionable tonic in the long run. Ultimately, interest rates on sovereign bonds will be determined by the inherent riskiness of the bonds -- bondholders will want to know if the issuer can pay up -- and the bond-buying program does not address the inherent riskiness of Spain or Italy. The ECB is gorging on risk without resolving the problem of debt sustainability in the long run.

It's also questionable whether the ECB has enough resources to rescue every debtor country. France is the next country in the cross-hairs of the financial markets. Even though public debt has hit 90 percent of French gross domestic product, President François Hollande refuses to consider profound changes to the economic model built on a large public sector (53 percent of GDP) and protected labor markets. In response, Standard & Poor's downgraded France's debt in January and Moody's has put the country on review for a possible downgrade.

Real reform in Europe has to involve changing the labor laws that stifle economic growth. Spain has begun to face this harsh reality. Spanish air traffic controllers have a powerful union that negotiated an average salary of 350,000 euros ($440,000) per year.

On Dec. 3, 2010, they staged an illegal walkout to protest a government proposal to privatize some airports. The government finally had enough. It declared a national emergency and placed the controllers under military command, threatening them with imprisonment if they didn't go back to work.

Labor laws in Europe also make it extremely difficult to lay off workers. In Spain, laid-off workers are entitled to 33 days of severance pay for each year worked. As a result, about 90 percent of workers are hired on temporary contracts with few benefits and little on-the-job training. This has to change for the economy to grow.

Obstructive unions and labor laws are part of Europe's economic problem, but they are not the whole problem. European attitudes toward entrepreneurs also are to blame. Recently, the Economist published an interesting article contrasting the positive American attitude toward entrepreneurs with the generally negative European view. Among other things, Europeans regard failed entrepreneurs as akin to fraudsters

It is also very difficult to raise capital to start a company in Europe. The prevailing attitude seems to be one of not taking any risk. Consequently, there is no reward. Since 1975, the countries in the eurozone have given birth to only one of the world's top 500 companies. In contrast, California has created 26.

Governments also are responsible for creating the no-growth problem. European businesses face a morass of rules and regulations governing every aspect of their daily operations. On a World Bank ranking that measures the ease of starting and operating a local firm, the United States ranks fourth among all countries. Greece ranks 100th -- just below the Republic of Yemen at 99th (doingbusiness.org/rankings).

Given the maze of government rules and regulations, as well as Byzantine tax systems, European businesses often resort to bribery and tax evasion. Italy ranks 96th among countries on "dealing with construction permits" and 109th on "getting electricity." It's no wonder that the New York Times has described bribery "as a way of life" in Italy.

Finally, Europe has a semantics problem. Most discussions of "growth" in Europe assume that lack of growth is due to inadequate demand. Economist John Cochrane of the University of Chicago has pointed out the absurdity of this position: "50 percent of GDP spent by the government is simply not enough to keep their economies going." The problem is really inadequate supply.

It is not wrong to assume that governments can promote economic growth. Just look at the World Bank list of items that contribute to the ease of doing business. As well as dealing with construction permits and getting electricity, it includes things like "enforcing contracts," "resolving insolvency," "registering property," and "protecting investors." Governments can play a vital role in assuring these goals. Europe's semantics problem is equating growth with government-demand stimulus.

Europe's debt crisis offers two lessons for the United States. First, no country can issue bonds indefinitely without having its credit rating called into question. Second, the fundamental problem in modern economies is how to increase supply. These lessons should not be ignored.

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Roger Feldman is a professor at the University of Minnesota.

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