The economy of the European Union (EU) is currently doing quite well. We are most likely at the end of an expansionary phase of the business cycle, average incomes have risen above pre-crisis levels and the average unemployment rate of EU member states is down to 7% from almost 11% in 2013.
The doomsayers, who argued that budget discipline and structural reforms would not work and that the market economy was not delivering for ordinary Europeans, have been proven wrong. Again. What’s more, new first-class research by Harvard economist Alberto Alesina and co-authors shows that the best austerity measure is cutting spending rather than raising taxes. And in reality, we can see that in the countries that started first, the development is the best.
However, we must not rest on our laurels, because there are challenges ahead and many necessary reforms are yet to be carried out. For example, the average EU debt-to-GDP ratio is 81.5% (Q1, 2018). Eight member states do not meet one of the most central requirements for economic success that we have set up ourselves. Further budget consolidation is necessary.
Also, even though structural reforms for enhanced competitiveness have been carried out, Europe is still lagging behind in a number of ways. Looking at the rankings of the World Economic Forum, Europe includes some of the world’s most advanced economies, as well as some serious laggards. The Netherlands, Germany, Sweden, the UK and Finland are among top ten countries, whereas Greece is ranked 87th, Romania 68th, Latvia 54th, Italy 43rd and Portugal 42nd, just to name a few countries from various parts of the continent.
The results of the Global Innovation Index are similar. Seven of the top ten countries are EU member states in the northwest of the continent, whereas countries like Romania, Greece, Bulgaria, Portugal and Italy are found much further down on the list.
We need cohesion in structural reforms in order to achieve a convergence of growth, where the new norm should be based upon the best performers. What is possible in one country is possible in other countries. Such a cohesion, focused on structural reforms, would in itself increase the average growth in EU dramatically.
And then there is the risk of a trade war, that together with Brexit present a clear and present danger to the economies of all countries involved. Not only do these two trends challenge the cohesion and global leadership of the Western world, something that may have dramatic long-term consequences also from an economic perspective. They also create economic problems in the short and medium term. Simulations that were done by the Bank of England estimate that a full-blown trade war could cost the world economy more than 2000 billion dollars. That is four times the size of the Swedish economy.
It is of paramount importance that European politicians do not give in to the worldview of the U.S. President. We know from economic theory dating back 250 years or so, as well as from extensive empirical evidence and hands-on historical experience, that autarky and economic nationalism are bad ideas. We have seen how economic integration at both regional and global levels have vitalised economies, raised incomes and defeated poverty worldwide. This is a battle we must not shy away from. When Donald Trump makes the U.S. smaller, we should make the EU taller. The EU must aim to be a centre for global trade, to be open and dynamic, in order to ensure prosperity and all the political benefits that ensue.
Another important economic challenge is to be taken on at home. We need to continue to combine stable public finances with increased growth. We have official targets and policy instruments in place; we just need to take them seriously. EU countries must adhere to the budget constraints defined by themselves both as key to economic success and as rules to be followed. There is no shortcut. Only hard work will lead to long-term success. The overall aim must be to secure a potential growth in all member states of 3%. Budget discipline needs the help of structural reforms, in order to be successful. Taxes, labour markets and rules and regulations have to be relaxed. Entrepreneurship should be encouraged. In its budget, the EU should devote more money to R&D and university research and less to hand-outs.
When looking around, an important point is that there is something to learn from most countries. The rest of Europe should not adopt Scandinavian tax levels, for example, but may very well learn something from the general business climate. We should be impressed by the German example when it comes to labour markets, but we should avoid the bureaucracy involved when starting a business. France has a well-functioning legal system, but registering property is cumbersome. The Baltic States have demonstrated that making it easy to start a company pays off, that digitalisation and budget discipline are combinations that lay the ground for success.
In Europe of today, we can see a lot of successful achievements, as well as the consequences of political failures. If we learn from both, we may avoid future failures and we will be able to secure stable high- level growth for the coming decades, making Europe not only more prosperous but also much stronger in the global economy, being a guardian of free economies and free trade. We are not there yet, but we can get there if we want to. That would be good for the free world, now that its former leader has abdicated.