Judy Asks: Do Europeans Really Want Economic Reform?

Is the medicine of structural reform too bitter to take? The EU institutions, the IMF, and many economists look at structural reforms as the solution to all of Europe’s problems. Their argument: structural reforms—especially labour market reforms—make an economy more flexible and increase productivity, and are therefore a precondition for growth.

Prudent policymakers acknowledge that liberalizing an economy might actually make things worse in the short term. If it becomes easier to fire workers, it should, over time, become more attractive to hire them as well.

But, initially, firms will use their new freedom mainly to lay off employees, especially when demand is as weak as it is in Europe’s periphery. This is the main reason why it is difficult to get voters to support reforms when times are tough.

The paternalistic view is that countries must be treated like children who may have to be forced to take bitter medicine. But children sometimes rebel and refuse to do what their parents think is good for them. Currently, the EU is treating entire countries like sick children. We should not be surprised when they rebel.

Of course Europeans want economic reform, but they are arguing—as they should be—over who should bear the cost of the reforms. This debate must become much more explicit.

Fiscal austerity, for example, imposes much of the costs of the adjustment—in the form of soaring unemployment—onto workers in the deficit countries. It can also force part of the cost onto small and medium-sized businesses, especially in the services sector, in the form of weak domestic demand and higher taxes. As a result, we are already seeing disinvestment and the flight of capital from deficit countries, which of course exacerbate the impact of fiscal austerity.

If austerity becomes politically unbearable, which seems to be happening, historical precedent suggests that the deficit countries will intervene—directly or indirectly—in trade. There are many ways they can do this, but if they were to abandon the euro and restructure their debt, much of the cost would be pushed onto German manufacturers, German banks, and middle-class savers in the deficit countries, the value of whose savings would be eroded.

As John Maynard Keynes pointed out ninety years ago when discussing German reparations, it is not hard for an economist to figure out how to resolve the crisis. It is just a question of deciding who will pay. But this is ultimately a political question, not an economic one. This issue needs to be addressed explicitly, and it needs to move to the center of the debate. Otherwise, Europe’s crisis will be resolved in a disorderly way and at a much greater cost.

Of course Europeans don’t want reform! Are you kidding?

When reforms were imposed in Germany in 2003–2005, chancellor Gerhard Schröder was voted out of office. He went to work for Russia’s Vladimir Putin, which has been a fruitful enterprise for both sides.

When Nicolas Sarkozy was elected, he declared that he wanted an “American France” but capitulated as soon as the first union went on strike.

In Italy, the technocrats led by Mario Monti turned the word “reform” into an equivalent of “bitter medicine.”

Spain and Greece swallowed their dose only because default was threatening.

Populism is on the rise everywhere, even in the UK. The intellectual class, the Davos crowd, and the media gurus should all think again: why are we so hapless? Why can’t we give reform a good name?

Europeans think they want economic reform if it means maintaining the social state, reducing growing income inequalities, and ending corruption. They don’t want what the troika or financial markets define as reform. The demos is closer on reforms to Italy’s Beppe Grillo or even Silvio Berlusconi than to Mario Monti or IMF chief Christine Lagarde.

In the end, this may not matter. The people won’t have the power to decide, as politics seems to be subsumed by economics. The “dismal science” is creating a dismal Europe.