The hidden power of the Eurozone

Brussels — for many years the Eurozone is considered a disaster zone, and the discussion of the future of the currency Union often focuses on the topic of its possible collapse. Last year when the British voted to leave the European Union, their decision was partly dictated by the perception of the Eurozone as a non-performing project, which probably can’t be saved. But lately, the Eurozone has turned into a pet of financial markets — and for good reason.

The discovery of the latent forces of the Eurozone for a long time delayed. For recovery after the crisis of 2011-2012, the Eurozone countries took several years. But now in terms of per capita economic growth in the Eurozone is higher than in the United States. The unemployment rate also falls. Yes, he falls slower than in the US, but this is partly explained by the difference in the trends in the economically active population.

While in the Eurozone the number of economically active population is growing in the US since around 2009, it is reduced. The departure of the Americans from the labor market due to the phenomenon that economists call “discouraged workers” (people who stopped looking for work). After the recession of 2009, this trend intensified.

In principle, the reduction in the number of economically active population had become a problem for the Eurozone, as the period with very high unemployment that affected many workers in Europe were long. However, in reality, over the past five years, the size of the labour force in the Eurozone rose by 2.5 million people. And since during the same period, there have been five million new jobs, the rate of decline of unemployment has halved.

In addition, the recovery in the Euro area was stable, which is kind of unexpected in the absence of permanent fiscal stimulus. It turned out that the hot debate about policies to reduce government spending was incorrect: the critics of this policy, and the official defenders overestimated the scale of their budget cuts. Average, cyclically-adjusted, budget deficit remains almost unchanged since 2014 and is at the level of 1% of GDP.

Of course, in the Eurozone there are considerable differences in the situation with the budget. But this was to be expected under conditions when the monetary Union is so heterogeneous. The truth is that even in France, often referred to as lagging, the budget deficit and the size of the national debt is at a level similar to the us.

The comparison with the United States, and Japan, and refutes the popular opinion that the budget rules of the Eurozone, including (sadly) the famous Pact of stability and growth and the “fiscal compact” in 2012, detached from reality. Yes, no country officially not punished for exceeding the deficit or debt. However, the noise over certain violations of the rules overshadows a broader, fundamental trend of a responsible attitude to public finances, aided by EU budget rules. All this means that “soft policies to reduce government spending”, which is implemented in many countries in the Eurozone, apparently, was ultimately the right choice.

Of course, one should not overestimate the economic power of the Eurozone in the long term. In the next few years, the average growth rate of the economy here may still be under 2%. But as the labour market will absorb the remaining unemployed, and older workers will continue to return to this market, sources of unused labor will eventually be exhausted.

Once the Eurozone reaches the so-called “point Lewis” (when the surplus of labor is exhausted and begin to grow wages), the growth rate will fall to a level that better corresponds to its demographic dynamics. This dynamics is particularly favorable: the population of working age in the Euro area will decline by about half a percentage point every year for — at least — the next decade.

But even in this case, the pace of per capita growth in the Eurozone is unlikely to be much less than in the U.S. because the difference in their rate of productivity growth is now negligible. In this sense, the future of the Eurozone might look like a Japanese now: real annual growth rates slightly exceed 1%, inflation remains stubbornly low, but the rate of growth of per capita income comparable to the rate in the United States and Europe.

Fortunately for the Eurozone, it will be included in this period of high unemployment and low growth in good condition, including due to the very controversial policy of reducing government spending. But the United States and Japan, by contrast, are approaching full employment at a time when their budget deficit exceeds 3% of GDP, which is about 2-3 percentage points higher than in the Eurozone. The US and Japan is also much higher debt burden: the debt to GDP ratio is now equal to 107% in the U.S. and more than 200% in Japan, while in the Eurozone the figure is 90%.

There is evidence that in the period after the financial crisis, when monetary authorities become ineffective (for example, nominal interest rates are at the zero level), the increase in spending due to budget deficit has an unusually strong stabilizing effect. But there is an important unresolved problem: if the situation on financial markets calmed down, whether it’s continuing budget deficit to provide the same strong incentives?

The fact that the process of economic recovery in the Eurozone has started to catch up with a similar process in the USA, and in the absence of any consistent policy of fiscal incentives means that the answer to this question is no. Moreover, the experience of the Eurozone shows that, although the planned incentives through the state budget may change during the acute recession, the abolition of incentives in that moment, when the acute need for them has disappeared, is more preferred option than saving data incentives indefinitely. Because of the policy of reducing government spending (i.e. deficit reduction immediately after the recession) the recovery might take more time, but as soon as this happens, the economic indicators become even more stable, because the public finances are in a stable position.

John Maynard Keynes once said “in the long run we are all dead”. From the point of view of the longer term, this may be true. But this does not justify the rejection of long-term planning. Moreover, the Eurozone seems to have appeared in the long run, and its economy is quite alive.