The Future of Europe: reform or decline

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The Future of Europe reform or decline

• Alberto Alesina and Francesco Giavazzi
• MIT Press 2006
• Madrid July 9-10 2007

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Since the late 1980s Europe is loosing
groundIncome per person relative to the U.S.
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Why has the European miraclestopped
sometime in the 1980s

• Policies
• the answer to social demands of the 1960s.
  Effects on
• Meritocracy
• Inflation
• Public Finance
• industrial policy to help incumbents firms,
  workers. New firms, consumers never entered the
  picture
• Technology
• an economy able to imitate but not to innovate
  (like Japan)

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What explains differencesin income per person?

• Differences in
• fraction of the population employed
• hours worked per person employed
• hourly productivity

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Decomposing the growth rate of income per
person(growth rates, 1980-95)
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Decomposing the growth rate of income per
person(growth rates, 1995-2006)
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Annual hours Worked Over Time
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Weekly hours worked per person vs. marginal tax
rates
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Annual hours worked per full time employee vs.
share of workers covered by collective wage
agreements
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Weeks worked per year
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Job creation Europe vs. U.S.
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Spain a detour

• Exceptional growth of employment
• Very low productivity growth
• Real wage growth
• Decline in competitiveness
• Growth driven by domestic demand
• Can it last?

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Spain (detour)

• One key factor is productivity.
• Why so low?
• Optimistic view it is all temporary, new workers
  will soon learn to be more productive. No
  problem!
• Too optimistic?

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Spain (detour)

• Even accounting for some learning by doing of new
  workers, risk of continued loss of
  competitivennss.
• End of housing boom, decline in private domestic
  demand public demand may step in for a while
• Foreign demand?

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Spain (detour)

• Risk of prolonged slowdown in growth
• Example of Portugal very strong real wage growth
  with no gain in productivity
• Relative decline of Spain ahead?

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Should we be worried if others get richer ?

• political and military power depend on relative
  economic power
• happiness depends on relative, not absolute
  wealth
• countries with a cut off growth develop a culture
  of stagnation and give up innovating
• declining demography can be sustained and only by
  higher growth

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What can be done?

• Liberalization of goods and services markets
  then it will also be easier to liberalize the
  labor market
• Labor Market less judges, more generalized
  unemployed protection networks

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The lack of competition affects the labor market
Source Giuseppe Nicoletti et al, OCSE, 1999.
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What can be done?

• 3. Welfare taking from someone and giving to
  others (often to the same ones) is often a waste
  and it does not reduce inequalities and poverty
  youd better tax people less

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Expensive but ineffective welfare systemsper
cent of households at risk of poverty before and
after social transfers (2003)
Source Eurostat
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What can be done?

• University Research different rules, more
  incentives, more competition among universities
  (the legal recognition of the degree should be
  abolished)
• Reduce market entry barriers and the cost of
  doing business
• An inefficient civil justice is an entry barrier
• Pensions move toward a capitalization system

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What should not be done

• Think that university and research need more
  public money
• Believe the innovation needs public subsides
• Believe that infrastructures are the priority
• Be obsessed with the GSP
• Be obsessed with EU coordination, especially in
  social policies

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Could the EU be a solution?

• The EU has two souls
• a pro market one (single market polices,
  protection of competition, harmonization of rules
  of commerce)
• a dirigiste one Lisbon agenda, harmonization
  of social policies, imposition of common social
  goals to all member countries

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Could the EU be a solution?

• Single market, competition, euro YES
• Rhetoric of coordination, social policies
  harmonization, Lisbon agenda NO

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So what should the EU do?

• Do relatively little but do it well single
  market, competition, encourage structural reforms
• Stay out of areas where differences of opinions
  amongst members are much more important than the
  benefits of coordination

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Foreign policy

• Is there a role for a common EU foreign policy ?
• This is certainly an area where economies of
  scale (i.e. size) matter and savings from a
  common army might be large
• But are there common views amongst Europeans?

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Are European anti-market? Yes !Would you agree
with a market economy?(results of a survey by
the University of Maryland)
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Why ?

• Incorrect perception that any market oriented
  reform generate injustice, and inequality
• This is wrong. Often in justice and inequalty are
  created by distorted social policies.

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Getting rid of lobbies

• Throughout Europe a host of lobbies are
  overprotected and use the rhetoric of welfare to
  protect themselves
• older insider workers (against young entrants)
• shopkeepers
• relatively wealthy pensioners
• incumbent firms
• financial institutions protected by entry barriers

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How to win political support?

• Big bang, comprehensive reforms rather than
  gradualism
• Do the opposite of what Mao preached (Strike one
  to educate 100). Do not give the impression you
  are attacking one lobby at a time.
• Stress the point that more market does not mean
  more injustice often it works
• A period of social unrest possibly unavoidable