Europe Stalls on Road to Economic Change

By RICHARD BERNSTEIN NYTimes.com Homepage: April 14, 2006

BERLIN, April 13 — After this week's extremely close election in Italy, there is a strong sense in Europe that, because of weak governments and divided publics, the Continent's big three countries are unable to make the economic changes that most political leaders agree are essential for restoring growth. "Everybody in Europe agrees that things can't go on the way they are going," said Wolfgang Nowak, a German economist who is in charge of the Deutsche Bank's International Forum. He was speaking about the near-zero-growth economies with high deficits, rigid labor markets and intractable levels of unemployment and social welfare budgets that are increasingly difficult to afford.

"Everybody wants change," Mr. Nowak continued. "At the same time, everybody does everything so that things don't change." At stake, in the view of many European experts, is the ability of countries like the big three — Germany, France and Italy — to adapt to a globalized world in which Europe's high labor costs and low population growth could portend a long-term decline, not just of economic power but of political influence as well. There is an official set of goals, known as the Lisbon Agenda, that European Union members, fully aware of the long-term danger of decline, pledged to meet in March 2000. These include sustaining an average growth rate of 3 percent and creating 20 million jobs, in large part by encouraging innovation through investments in education and technology.

But the big three countries have not even come close. Their failure stems from a mutually reinforcing combination of timid, uncertain leadership, deep political divisions and large European populations ready to explode in furious opposition when changes are presented to them. "The political leaders of all these countries know what needs to be done, and it's not rocket science," Charles Grant, director of the Center for European Reform, in London, said in a telephone interview. "The Lisbon Agenda lays out objectives. But as Jean-Claude Juncker, prime minister of Luxembourg has said, everybody knows what reforms we need to implement but nobody knows how to implement them and win an election afterwards." The picture is not bleak all across Europe, nor do the three leading countries have precisely the same problems. Spain, Britain and Ireland have had years of strong growth. The Scandinavian countries have managed to cut back on social welfare spending and yet retain basic protections and guarantees even as they have stepped up growth in the past few years. And Germany has produced better-than-expected growth figures.

Indeed, in his last two years in office, the former chancellor, Gerhard Schröder, a Social Democrat, was able to push through a series of changes that have by now made a difference, including a sharp reduction of unemployment benefits. Germany also has new rules enabling employers to fire workers in the first two years. But France was convulsed by general strikes and huge street demonstrations when its government announced similar rules that would apply to workers under 26 years of age. Germany is also the only one of the three Continental powers whose leader, Chancellor Angela Merkel, campaigned on the need for far bolder changes, including weakening the power of the unions. But, as Mr. Nowak puts it, "the voters gave a powerful 'yes' to Mrs. Merkel and a powerful 'no' at the same time."

They brought her to power, he explained, but as is the case with Romano Prodi in Italy, just barely, and in such a way that she has to govern in a coalition with partners — in her case the Social Democrats — far less disposed to change. "l think that Merkel has solved the principal unsolvable problems inside her own party," Mr. Nowak said. "The problem for her now is the Social Democrats." By contrast, France is in disarray, with the government of President Jacques Chirac possibly fatally weakened by the mass protests that greeted its modest proposal to relax the labor laws. Nobody now expects this deeply shaken government to advance any new changes before the presidential election next year. Aside from the immediate weakness of Mr. Chirac, there is an additional, more general opposition to the sort of free-market reforms that have been embraced, at least in theory, by European Union leaders.

"The problem is a lack of leadership and an intellectual climate that is extremely hostile to economic liberalism in much of Continental Europe," Mr. Grant said from London, using the word liberalism in the European sense, as a movement in favor of free markets and economic deregulation. "The anti-liberal clerisy has basically won the intellectual argument in much of Europe," Mr. Grant said. "They've fostered the view that liberal economics leads to a kind of Dickensian vision of child labor and old women crying in the streets." In France, even with a youth unemployment rate of 23 percent, nobody is likely to be elected by campaigning for free-market reforms and deregulation. "The old heartlands of the Eurozone are clogged by high unemployment and starved by low growth," the British newspaper The Independent editorialized after the Italian vote count. "And yet the political systems of France, Germany and now Italy are failing to produce the necessary solutions."

It is far too early to tell what Mr. Prodi may be able to do in Italy, assuming he does take power. But already, it seems clear that his election by so bare a majority demonstrates how divided Italy is, and how far away the country is from any consensus on what needs to be done. As some commentators have pointed out, Italy can afford to do nothing even less than France or Germany can. Its growth rate last year was zero, its deficit is particularly high and some of its primary industries, like textiles and shoes, are exposed to rugged competition from China and India. In his five years in power, Prime Minister Silvio Berlusconi has largely failed to carry out his promise of reform, even though he leads the center-right coalition, which is pro-free-market.

Mr. Prodi is on the center-left, but his coalition includes Italy's Communists, who can be counted on to oppose any strong economic medicine. "The trap has snapped," the Italian daily La Repubblica commented earlier this week on the almost even split of the country's electorate. "It is as if Italy has been stung by a poisonous scorpion: it cannot build a new government, but it also can't keep the old one. It is perfect metaphor for Italy."