Long-Term Growth in the European Union: Some Observations

1. Long-Term Growth in the European Union: Some Observations Dr. Danny M. Leipziger Prof. of International Business George Washington University

2. Five Factors to Consider • The Labor Market Factors • The Accumulation Factor • The Moral Hazard Factor • The Trichet Factor • The Looking East Factor

3. Labor Market Factors • Ageing populations should raise wages in the long-run; however, with an inability to adjust internally to productivity differences (MW)—the German Stakhanovite worker problem-- will increase income differentials (UD) • Possible solution could be Singapore Tripartite Councils to enforce wage adjustments, although the rich EU members will be able to invest in new capital and the poorer not • Other alternative is increasing transfers to reduce income disparities, but will all members agree?

4. The Accumulation Factor • Imbalances among members resembles the US and China—excessive savings and surpluses matched by stretched govt deficits • The imbalances perpetuate themselves since the deficit members cannot devalue and also cannot invest given their fiscal indebtedness • The short-term solution is subsidies and transfers among groups of members but the Germany public seems tired of this but leaders are unwilling to see Euro-exit

5. The Moral Hazard Factor • Cheating and off-balance sheet expenditures predates Greece • Debt restructuring seems unpalatable although perhaps the best among poor options of euro-exit or the status quo. • Impossibility of member default creates moral hazard and mis-alignment between incentives facing the Union vs individual members

6. The Trichet Factor • Notion that adjustments are handled inside the Club is short-sighted and adds to cost • Greece mishandled from the start • More Intra-EU bailouts to come • The ECB will buy distressed assets at inflated prices and this confuses monetary policy • Combined with the Chang-Mai Initiative, the EU bailout fund of $ 1 trillion makes global solutions and IMF seem out of date.

7. The China Factor • Given lack of aggregate demand in surplus, hyper-savers and fiscal squeeze limiting demand in the highly indebted, luckily exports to China have emerged to prod growth • But how long will it last? China will move into higher tech industries one way or another • Will the golden goose turn into a hawk? • ECB will have a tough decision whether to allow Euro appreciation hurting exports and growth or sterilize inflows.

8. How Much Are Surplus EU Members Willing to Pay? • Pay to buy semi-distressed members’ debt to protect Euro integrity • Fund transfers to the “ south “ to offset lagging productivity and widening intra EU inequality • Finance additional investments in the south since aggregate demand will remain depressed and productivity differences will grow unless workers move north • Divert monies from pro-growth spending to maintain competitive euro and low inflation policy mix—cost of sterilization and 2% target

9. Predictions • Demonstrated willingness to pay an enormous price for EU stability and unity will prevail • Chinese import demand alone will not suffice • Costs will rise with greater transfers needed • Welfare levels may well decline • According to behavioralists, Europeans may still be happier nonetheless