Europe needs a growth strategy. In the short term, that means preventing an austerity spiral. In the long run, it means structural reform and a drive to create a genuine single market. The European Union summit this week is a chance to aim at both targets.
The euro zone crisis may be receding. Last week’s temporary fix of Greece’s problems with a 130 billion euro bailout is the most recent cause for optimism. But so long as the region cannot grow – and the European Commission has just forecast zero growth this year for the European Union as a whole and shrinkage for several countries including Italy and Spain – there is a risk of sliding back into crisis.
The European Central Bank’s provision of 500 billion euros of three-year money to the banks before Christmas – and the promise of a similar cash injection this week – has lifted spirits in financial markets. Some of that money will find its way into the real economy. But while monetary policy is lax, fiscal policy is tight. No fewer than 23 of the EU’s 27 countries are in what are known as “excess deficit procedures”, which require them to bring their annual borrowing down to less than 3 percent of GDP over the next year or so. Under the so-called “six pack” system of fiscal discipline, countries can be fined if they fail to stick to the required austerity.
Balancing budgets is a good idea. The problem is that, if overdone, austerity can drive economies deeper into recession. Taxes fall, meaning it is even harder for governments to balance their finances. If they then have to squeeze again, the economy just gets further squished. The rational approach would be to give governments such as Spain – which is especially vulnerable to this spiral – a little longer to cut their deficits provided they are genuinely dealing with their countries’ structural problems, for example by tackling excessively expensive pension systems and rigid labour markets.
There are some tentative signs that policymakers are coming round to such an approach. Mario Monti, Italy’s highly respected new prime minister, seems to have had some success in persuading Germany’s Angela Merkel that economic policy can’t be just about austerity. Meanwhile, the European Commission, which is responsible for policing the excess deficits, is equivocating about what to do with Spain.