19 July 2011

IMF: The solution is more, not less Europe

Antonio Borges writes that it is hard to hold the course in the middle of a storm, but European policymakers need to if they want European integration to succeed. The sovereign debt crisis is a serious challenge which requires a strong, coordinated effort by all involved to put it finally behind us.

Surviving the storm will be of little consequence if the euro area finds itself trapped in the perpetual winter of low growth. Germany may be expanding at record speed right now, but it wasn’t so long ago when it grew much more slowly—just 1.5 per cent per year between 1995 and 2007. In contrast, Sweden grew by 3 per cent a year and the United States by 2 per cent during the same period.

Many experts fear that without reforms, growth in Germany could drop even lower in the next 5‑10 years and beyond when global trade cools again. The situation is worse in the countries that currently find themselves in the eye of the storm.

High growth―that relies on both strong exports and healthy domestic demand―is a must to preserve the stability and resilience of the region’s Economic and Monetary Union.

Reforms to deepen economic governance

The course to higher growth leads through structural change and deeper economic integration. All of this is easier said than done, of course. Governance reform to deepen integration can be gruelling work. But in light of recurring sovereign debt troubles, it will be crucial to improve collective fiscal discipline. This will require:

• a stronger Stability and Growth Pact;
• national fiscal institutions with more say;
• completing the budding European financial stability framework;
• stronger economic governance will support confidence in the euro area and help calm down volatile markets that threaten to deter investment and lower growth.

How to lift growth

Yet, the even bigger worry is that the euro area could fail to lift growth. Higher growth is crucial, not only because it would make for a stronger currency union, but also because the potential for improvement is large. Research conducted as part of the IMF’s regular euro area surveillance suggests that the right reforms could lift annual growth by about ½ -1¼ percentage points depending on a country’s starting condition—no small feat. The key will be to make labour and capital more productive through better technological progress, with the help of deregulation and investment in workers’ skills. Growth also tends to be much higher where market integration is deeper, likely reflecting the beneficial impact of competition on investment and innovation

Seizing the moment

All this suggests that higher growth is not only feasible but linked to very specific reforms, including national efforts to make product and services markets more flexible and completing the single European market. The mobility of equity capital is particularly crucial, not least in the financial sector where the desire to protect “national champions” has limited cross-border takeovers in the past. The key will be to seize these opportunities while the memory of the crisis remains.

Europe has faced rough weather before. As the IMF’s John Lipsky recently remarked, the story of European integration since the Second World War has been an incredible success―not least because the leaders that built the European Union and the euro area looked beyond the crises of their day.

If today’s policymakers want successfully to stay the course, they will have to press ahead with structural changes and deeper economic integration. Many welcome initiatives are underway—from planned improvements to the Stability and Growth pact, to the measures promised under the Euro Plus Pact to improve competitiveness and strengthen fiscal discipline. But the reforms are not yet strong enough to ensure success, and politicians and the public remain reluctant to renew their vows to the European project. Additional steps are needed to make them succeed.

To put the crisis behind us, we need more Europe, not less. And we need it now.

IMF's blog
IMF's regular euro area surveillance

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