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A recent slowdown in economic growth and potential further snags resulting from the subprime meltdown will test the ability of Europe’s leaders to push through economic reforms. Newly elected center-right parties might have only a short time to push through economic reforms before the European electorate becomes restless and demands a return to left-wing policies. While these could provide comfort and security for Europe’s citizens, they will not set in place structural reforms needed to address the Continent’s pending pension crisis, nor will they set it on a path of stronger economic growth. In the short term, strong economic growth across the European Union would allow leaders to push through reforms; slow growth will force leaders to proceed more cautiously, at Europe’s expense.
Economic statistics released Aug. 14 showed second-quarter growth below most economists’ expectations in three of Europe’s largest economies: Germany, France and Italy. Second-quarter growth rates were also lower compared with those of the first quarter. In Germany, the region’s largest economy, annualized growth slowed to 2.5 percent in the second quarter from 3.9 percent in the previous three months. The French economy grew 1.3 percent during the second quarter — lower than economists’ predictions and first-quarter growth of 2.1 percent. Overall, growth for the 13 nations that use the euro was the slowest since in the fourth quarter of 2004.
Slow economic growth could put a dent in recent increases in employment levels across the European Union. An employed union is a happy union, and happy Europeans are less likely to protest attempts to make changes to Europe’s generous welfare programs and labor protections, which make Europe the most expensive place in the world to hire workers. These labor costs make companies wary of hiring, expanding or even operating in Europe, which has contributed to the Continent’s relatively slow growth. This is particularly relevant for France, which is behind Germany in implementing pension and business tax reforms and has one of the strongest (and most strident) labor constituencies in the world.
What is at stake is the future of the reforms, and what is in question in France — and Europe as a whole — is whether the citizenry has the will to press forward with reforms even in economically hard times. Changing demographics in Europe are resulting in a rapidly shrinking worker/retiree ratio. The number of workers paying into the system and transferring their wealth to retirees is getting smaller and smaller. European budgets thus inevitably will be increasingly directed toward covering pensions.
The degree to which pensions soak up European economic activity will depend on how Europe tackles its structural problems now. One way to address this is by raising the retirement age. Thus, in early 2007, the German parliament passed legislation increasing the retirement age from 65 to 67. Further, implementing general economic policies that increase labor flexibility — many companies do not expand in Europe due to labor rigidity — will be necessary to increase business activity, which in turn will increase government tax receipts.
France and Germany are continental Europe’s largest economies, and what transpires in both will either hold back or accelerate European economic competitiveness. And what happens in Germany undoubtedly will impact policies in France, and vice versa, as neither country wants to be significantly less competitive. For instance, France probably will have to cut corporate taxes due to Germany’s recent cuts in order to prevent a mass corporate exodus.
Newly elected French President Nicolas Sarkozy understands his political limitations and the limited patience his electorate has for reform. He is therefore seeking to push through as many reforms as possible while he still enjoys a political mandate. Sarkozy, who won the presidency on a pledge to make France a more competitive economy, has already pushed through several reforms during his first 100 days, including a measure allowing employees to work overtime without paying increased taxes.
Though Sarkozy has met little resistance to his proposals thus far, when he returns to Paris from vacation in September he will meet resistance on pension and further labor reforms. One pension proposal includes a plan to reduce the amount companies contribute to the state-run health care and pension systems. To make up for the lost income, the government would raise France’s value-added tax (similar to a sales tax in the United States), an unpopular move among French consumers, who claim it would significantly dent their purchasing power.
While France is in a generally upbeat mood, and for the time being more receptive to reform, this could change quickly. In 1995, then-Prime Minister Alain Juppe faced weeks of nationwide strikes, contributing to his loss of power, after he attempted to promote pension reform. And the last time the French government implemented pension reforms, in 2003, workers participated in a nationwide strike that crippled the French transport system. Pushing through reforms will be all the more difficult if economic growth slows.
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