What’s Wrong with Europe (and how to fix it)?*

Paolo ManasseUniversity of Bologna, Italy

Athens, Biennale, 12 October 2013

with Isabella Rota Baldini, forthcoming on CEPR Policy Insight Discussion Paper and Voxeu.org

1. The Eurozone, unlike the US, is not recovering from the crisis (persistence)

2. Some countries are more vulnerable than others (heterogeneity): Why?

3. «Demand shocks» - Fiscal austerity (the Troika) - Credit crunch (Sovereign default)3. «Supply Factors»: - Wage and Price rigidities4. «EU Institutions»: Europe’s «upside down»5. What should be done?

Outline of the talk

1. The Eurozone is not recovering: GDP per capita

1. The Eurozone is not recovering :Divergence in real incomes

Eurozone USA

7.5 8 8.5 9 9.5 10 10.5 11 11.5-0.06

-0.04

-0.02

2.77555756156289E-17

0.02

0.04

0.06

0.08

Figure 3.1: Less Convergence in Eurozone

2007-2000 Linear (2007-2000) 2012-2007Linear (2012-2007)

Initial per capita GDP

Cum

ulat

ive

gro

wth

in G

DP p

c

10 10.5 11 11.5 12 12.5-0.005

0

0.005

0.01

0.015

0.02

0.025

0.03

0.035

Figure 3.2: More Divergence in USA

2000-2007 Linear (2000-2007) 2007-2012Linear (2007-2012)

Initial per capita GDPC

umul

ativ

e gr

owth

in G

DP

pc

1. The Eurozone is not recovering :Unemployment keeps rising

2. Why Are More Country Vulnerable? «Demand Shocks and Supply Rigidity»

2. «Supply Factors»: Unemployment rises more were already high

Eurozone USA

2 4 6 8 10 12 14 16 180

2

4

6

8

10

12

Figure 6.1: Divergence of unemployment in Eurozone

Ave Unempl. 2000-08

Cum

ulat

ive

incr

ease

in u

nem

-pl

oym

ent 2

012-

2008

3 4 5 6 7-1

0

1

2

3

4

5

Figure 6.2: Divergence of unem-ployment in US

Ave Unempl. 2000-08

Cum

ulat

ive

incr

ease

in u

nem

-pl

oym

ent

2012

-200

8

2.«Supply Factors»: Income falls more where productivity growth was lower (but also demand matters)

-0.1 -0.05 0 0.05 0.1 0.15 0.2 0.25 0.3 0.35-0.2

-0.15

-0.1

-0.05

0

0.05

0.1

0.15

Figure 5: TFP and crisis in the Eurozone

cumulative TFP growth 2000-08

Cu

mu

lati

ve p

c G

DP

G

row

th 2

00

8-1

2

3. «Demand Factors»: Debt and DeficitsThe Role of federal/state budget (debt) in US/EUZ

Deficits Debts

3. «Demand Factors»: Income falls more where budget tightens more (but also supply matters)

-1 0 1 2 3 4 5 6 7-25-20-15-10-505

101520

Figure 10: Fiscal Adjustment and pc GDP in Eurozone

Cumulated Change in the Budget/GDP 2009-12

Cu

mu

late

d c

han

ge

in

pc G

DP

0

9-1

2

CountryNet contribution (€

Millions)% GDP

Belgium -1369 -0,36Bulgaria 725 1,94Czech Republic 1455 1,01Denmark -836 -0,34Germany -9002 -0,34Estonia 350 2,31Ireland 383 0,31Greece 4622 2,22Spain 2994 0,29France -6405 -0,31Italy -5933 -0,38Cyprus 6,8 0,04Latvia 731 3,62Lithuania 1368 4,63Luxembourg -75 -0,24Hungary 4418 4,67Malta 67 1,15The Netherlands -2213 -0,36Austria -805 -0,27Poland 10975 3,10Portugal 2983 1,81Romania 1451 1,08Slovenia 490 1,40Slovak Republic 1160 1,71Finland -652 -0,34Sweden -1325 -0,33UK -5565 -0,32

Table 1: Net contributions to the EU budget

Source: Eu commission, 2011 data

4.«Institutions»: Redistribution/insurance in EU almost absent

4.EU institutions: «upside down»

No Budget for Stabilization against aggregate shocks/ No Redistribution-insurance

Fiscal Policy at country level + ineffective contraints (GSP, fiscal compact)

Bail-out system: costly and ineffective (ex-post)

No Debt restructuring mechanism (Threat of Exit)

5. What should be done?

Each Country: Fix Supply Side: Restore convergence and resilience- reduce market power of firms and unions,

banks (supervision /regulation); improve productivity growth

Fix Demand Side:- Budget Deficit (Corruption, Burocracy,

Political Fragmentation and Electoral Rules, Fiscal Rules)

5.What should be done?

EU architecture EU Budget for Stabilization/Insurance

(e.g.backed by VAT) Fiscal Rules at country level (No Troika,

please) + No bail out commitment Debt restructuring mechanism Difficult! But alternative is Euro disintegration: risks of widespread insolvencies, competitive devaluations, restrictions on movements of goods, services, people

Thanks for your attention!