Economic Problems of European Union

Despite a recent improvement in EU growth (last year GDP growth was 2.9%) there are concerns over fundamental problems with the EU economy. In recent years by far the worst performers in the EU have been the big 3 of Germany, Italy and France. Germany for example has experienced 6 years of sluggish growth and poor productivity rates. The OECD estimates that productivity growth in the EU has averaged only 1.5%, which is lower than comparative rates in the US.

Reasons for the Slowdown In European growth

  1. Some slowdown inevitable after wonder years of 1950s and 1960s. 50 years ago, as the Treaty of Rome was being signed, the German economy was undergoing a period of tremendous growth, combined with low inflation and low unemployment. To some extent a slowdown from this rapid expansion is a reflection of a maturing economy. However this is only a partial explanation.

  2. German Reunification. This has often been used to explain low growth in Germany and hence EU. Reunification was very expensive causing high levels of government borrowing. Because of high borrowing levels interest rates were higher than they needed to be. This was certainly a constraint on German growth in the 1990s however 17 years after the fall of the Berlin wall this is becoming increasingly less significant.

  3. The EURO. In particular it is argued that Germany joined the Euro at a rate that is too high making its exports less competitive. Other countries are also experiencing declining competitiveness as a result of a strong EURO. Italy has managed growth of only 1.3% since joining the EURO. Spain has a current account deficit of 8.5% of GDP; a reflection of poor competitiveness.

  4. ECB is too concerned with low inflation The ECB has been accused of giving too much priority to the goal of low inflation. It is argued they have sought to maintain low inflation at the expense of lower growth. Note their target is less than 2% rather than 2% +/-1 as in UK

  5. Growth and Stability Pact. This is a constraint on expansionary fiscal policy because in theory it limits governments borrowing to 3% of GDP. Therefore in a recession a government is unable to use monetary policy (ECB set rates for whole Euro zone) but also they are unable to reflate the economy through higher spending and borrowing. However in practise these rules have proved to be sufficiently flexible; there has been no attempt to penalise countries like France and Italy who have broken them.

  6. Inflexible Labour Markets. This is frequently held up as a constraint on economic growth. In particular rigidities in the labour market discourage investment from abroad. For example in France there are laws which makes it difficult to fire workers once they are hired. This discourages firms from expanding and investing. Both the IMF and OECD have argued that further labour market liberalisation is needed to regain competitiveness. Even many of the European leaders acknowledge it is a necessity. However such reforms often face stiff opposition from powerful interest groups who wish to protect the interests of their members. Thus reform has proved very difficult and exceedingly slow. As Luxembourg’s Mr Juncker once said.
    We all know what to do, we just don’t know how to get re-elected after we’ve done it.”

  7. Demographic Changes. Countries like Germany and Italy have a declining birth rate. This means that the population structure is becoming weighted towards those who are over 50. The traditional population pyramid is being inverted. The increased demands placed on benefits and decline in tax revenue is a serious burden for government spending. It is reflected in burgeoning public debt. As of 2006 Italy’s public debt stood at 105%. German and France just below 70% of GDP. Such high levels of debt are argued to cause crowding out of private sector spending. Unfortunately this problem is likely to be exacerbated as the 1960s baby boomers retire. Again there is much opposition to the reform of generous state pensions.

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Perma Link | By: T Pettinger | Saturday, March 17, 2007
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