Let’s start with the unmistakable signs of Europe’s recovery. Its stock markets are buoyant. In 1997 the German market is up about 50 percent, the Italian 35 percent and the British 20 percent. Surveys of business confidence show big gains. Growth prospects have improved. Economist Thomas Mayer of Goldman Sachs in Frankfurt predicts that Europe’s gross domestic product will increase 2.3 percent in 1997 and 2.6 percent in 1998, up from 1.7 percent in 1996.
Europe finally seems to have overcome the aftershock of German reunification. This exerted a heavy drag on growth. Germany financed the huge costs–providing new roads and social benefits while closing inefficient companies–largely by borrowing. The Bundesbank (Germany’s Federal Reserve) feared the spending boom would raise inflation. To prevent that, it increased interest rates. Other countries–which had no boom–had to follow suit under Europe’s fixed-exchange-rate system. (It virtually mandates similar interest rates; otherwise, money flows among countries would alter exchange rates.)
The depressing effect of high interest rates has now passed, because the Bundesbank has gradually lowered them. Its key short-term lending rate is now 3 percent. The invigorating effect is being further amplified by a drop of most European currencies against the dollar and yen. In 1997 the German mark (along with all the currencies linked to it) has fallen almost 20 percent against the dollar. This enhances Europe’s export prospects by making its products less expensive on world markets. So far, so good.
But what really matters is whether the recovery is long enough–and strong enough–to reduce joblessness from the present 11 percent to, say, 6 or 7 percent. In theory, Europe’s economy ought to be able to expand 3 to 4 percent annually for a number of years through lower unemployment and normal labor-force and productivity growth. But a sluggish expansion would barely affect unemployment. What haunts Europe is the fear that higher growth would trigger higher wages–and then higher interest rates to halt inflation. Can this stagflation be overcome?
Perhaps. One major country has already done it: Britain. Its unemployment has dropped from more than 10 percent in 1993 to less than 7 percent now, reports the Organization for Economic Cooperation and Development. The simplest explanation is that Margaret Thatcher broke the unions. A deep recession in the early 1980s–meant to suppress high inflation–raised unemployment and bankrupted many unionized firms. New labor laws made strikes harder. In 1984 and 1985 Thatcher faced down the powerful coal miners’ union in a strike.
As job security and union power eroded, wage bargaining became more restrained. Wages no longer automatically rose with prices. Settlements varied more among companies. Workers had to consider that they might price themselves out of a job. ““Things like plant productivity and the individual financial performance of companies became more important,’’ says economist Douglas Godden of the Confederation of British Industry.
Something similar needs to happen in the rest of Europe. If workers never fear losing their jobs, there’s little reason to restrain wages. Some uncertainty, anxiety and fear are essential. But of course, uncertainty, anxiety and fear are unpopular. The paradox is that the things governments do to minimize these scourges–legal job guarantees, higher minimum wages and various industry protections–weaken job creation. Unemployment drifts up because the young can’t find work, and some industries shrink.
The central question for Europe is whether it can use its recovery to pare back self-defeating policies and practices. Let’s imagine a virtuous circle. As the recovery accelerates, governments loosen protective policies precisely when their constituents need them less. Unemployment drops, sustaining the recovery and enabling the process to continue. Wages (and inflation) remain tame, because heightened job insecurity–the consequence of past unemployment–prompts wage restraint. In Germany, one poll found that the share of workers worried about their jobs rose from 29 to 42 percent between 1991 and 1995.
Granted, the odds against this are long. Countless politicians who have tinkered with the present system have been hurled from office. France’s recent conservative government is the latest example. Even Thatcher’s success was a bit of a fluke, says economist David Walton of Goldman Sachs in London. Her early policies were unpopular (unemployment was 12 percent in 1983). What re-elected her in 1983 was victory in the Falklands War the previous year. Finally, there’s the stigma of seeming to ditch the ““European economic model’’ for the allegedly cruel ““Anglo-Saxon model.''
But the odds are not impossible. The debate over rival models is artificial, because the differences are exaggerated. Each mixes government protections and market forces. Even many Europeans see their mix as too protective. Among economists, there’s growing disillusionment. Companies are increasingly hostile and more willing to resort to layoffs. The common European currency would require more flexibility to adapt to new competitive conditions. Timing is everything in politics, and an improving economy and a shifting intellectual climate create an opportunity. It gives Europeans a chance for renewal. If they miss it, they can blame only themselves.
