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London - Japanisation is shorthand for slouching towards
that country's noxious mix of low growth and high debt. Eurozone governments
will find it tough to keep the ugly new word out of their lexicon.
Concern is mounting over a deterioration in Europe's
long-term growth prospects that, unaddressed, will make it even harder to
tackle the banking and debt problems underlying the current life-or-death
struggle over the euro.
The financial crisis that has been rocking the global
economy since 2008 has permanently reduced trend growth across the industrial
world. The Organisation for Economic Cooperation and Development (OECD) in
Paris reckons the potential output of its 34-member countries has dropped by
about 2.5%.
"A lot of countries are going to take a permanent hit
to their trend rate of growth. This is not an ordinary recession and so we're
not going to see countries bouncing back to pre-crisis rates of growth,"
said Philip Whyte, a senior research fellow at the Centre for European Reform,
a London think-tank.
As firms have gone bust, capacity has been lost for good.
With demand subdued, profitable companies are not replacing old plant.
And as high unemployment persists, skills atrophy. This
weakens productivity and shuts people out of the job market for longer and
longer periods - a danger stressed by Federal Reserve chairperson Ben Bernanke
at the US central bank's Jackson Hole symposium last month.
Apart from sapping animal spirits and forcing governments to
raise taxes or cut spending, diminished growth closes off one route for
lowering the high sovereign debt to gross domestic product ratios that have
locked Greece, Ireland and Portugal out of the bond markets and are unnerving
investors in Italian and Spanish debt.
Against this background, and with the scope for fiscal and
monetary stimulus all but exhausted, politicians might be expected to grasp the
nettle and push through reforms to improve the supply side of the economy -
policies such as making it easier to hire and fire, promoting greater
competition and investing more in training.
Far from it. Pier Carlo Padoan, the OECD's chief economist,
says he is less optimistic about the prospects for deep-seated change than he
was at the start of the year.
"I see that measures are being announced. I would like
to see them being implemented," Padoan said.
With policy ammunition running desperately short, he said it
was time for governments to overcome their squeamishness about confronting
vested interests opposed to change. "This is a luxury that many countries
cannot afford any more. The situation does not allow it."
Southern discomfort
The vicious circle of rising debt and falling growth is made
worse by the fact that those countries drowning in debt on the eurozone
periphery are also the ones that have dragged their feet on freeing up their
product and labour markets, or modernising their education systems.
"They're going through some truly horrible times. I'm
very worried about the whole southern European fringe, not just on an 18-month
to 2-year view but looking out a decade or longer," said Whyte with the
Centre for European Reform.
By contrast Germany, derided a decade ago as the sick man of
Europe, is being held up as a model, at least when it comes to jobs.
"The remarkable resilience of the German labour market
in the last few years, where wage moderation and flexible time accounting
shielded the economy from excessive job destruction, illustrates admirably the
promise of well-structured reforms," European Central Bank president
Jean-Claude Trichet said approvingly in Jackson Hole.
How much are countries missing out by not pressing the
reform button?
Padoan says Europe's trend growth has fallen in recent years
to an average of just 1.5% a year, but he says some members of the 17-nation
eurozone could almost double that rate with a supply-side jolt.
Italy needs to liberalise its service sector, open up
professions to new entrants and improve energy efficiency, Padoan said. Greece
needs to do all that and overhaul its labour market and competition policy at
the same time.
Poor advert for free markets
Germany, too, could grow faster still if it liberalised
services, which would trigger increased investment.
These policy prescriptions are well worn. Leaders of the
European Union enshrined them and a host of other reform goals in the 2000
Lisbon Agenda, which they promptly ignored.
The pledges have since been repackaged as the Europe 2020
Strategy, but Whyte says the havoc wrought by the near-collapse of the
international financial system will make politicians more wary than ever of the
social disruption that reforms entail.
"The Great Financial Crisis hasn't been a great advert
for free market capitalism," said Whyte. His research outfit publishes a
booklet this week exploring how Europe could take off by embracing innovation.
But in this area, too, Whyte fears the political climate
means policy is likely to be increasingly hijacked by incumbent firms hostile
to competition from startups.
Europe is not doomed to go down Japan's path of economic
stagnation. Its potential growth rate is low but stronger than Japan's -
estimated by the Bank of Japan at just 0.5% a year because of a fast-shrinking
working-age population.
But the spectre of a renewed recession is a reminder for
governments that, even if they can spirit away the eurozone's currency and debt
woes, they still have to find the elixir for growth.
"I'm not saying politicians will implement reform, but
they should," Padoan said. "Some politicians resist reform because
they are captive to interest groups. Well, the price for those governments in
terms of sustainable growth will be very high."
