One of the probable long-term consequences of the financial crisis is an acceleration of Europe’s economic decline. This is by no means an inevitable outcome, but I fear it is likely.
No matter what we do, China and India will eventually displace the European Union as the world’s largest economies. What I mean by decline is a decline in living standards. The financial crisis has led to a fall in potential growth in the entire North Atlantic region. Both the US and Europe will go through an adjustment period, during which growth will be lower. The US will be first to recover: it is a more dynamic economy, has a more coherent framework for macroeconomic policy, and, unlike the EU, has a genuine internal market which is not unravelling.
So what should the EU do? A good macroeconomic to-do-list for Europe came in an essay last week, published in Memos to the New Commission by the Bruegel think-tank in Brussels. It was co-authored by Professors Jürgen von Hagen and Jean Pisani-Ferry. They propose six points – not a complete list, but a sensible one.
First, don’t all rush to exit from stimulus policies at once. Ensure a proper sequencing, with the goal of preventing a double-dip recession.
Second, adopt a five-year growth programme. I would add that this is not to be confused with the competitiveness programmes the EU has been running for ages. This should be about policies specifically designed to raise the rate of potential growth in gross domestic product, without the usual long list of extra objectives.
Third, move beyond a mechanistic, legalistic adherence to the stability and growth pact, the current framework for fiscal policy co-ordination. This should not only include binding commitments on deficits and medium-term strategies, but also institutional reform, which is probably necessary in several member states.
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