Why Europe's Economy Failed And Will Fail

by: Carlos X. Alexandre

If you didn't know, Cyprus is next in line to assume the presidency of the EU Council, and current EU Commission's President, Jose Manuel Barroso, held a press conference in Brussels, as reported by Cyprus Mail.

Barroso said that it would be during the Cypriot presidency that the EU would conclude negotiations on the financial perspective for the next period 2014-2020. He was referring to the promotion of the EU's growth strategy which involves targets for the year 2020 on employment, innovation, education, social inclusion and the climate and energy. "We need the structural reforms ... but we also need some investment at a European level for achieving higher degrees of growth in the medium term," Barroso said.

Growth strategy? That is what everyone is yearning for, and the plan is outlined in "Europe 2020," a blueprint that is branded as "the EU's growth strategy for the coming decade." The five targets are as follows:

1. Employment: 75% of the 20-64 year-olds to be employed
2. R&D/innovation: 3% of the EU's GDP (public and private combined) to be invested in R&D/innovation
3. Climate change/energy: greenhouse gas emissions 20% (or even 30%, if the conditions are right) lower than 1990; 20% of energy from renewables; 20% increase in energy efficiency
4. Education: Reducing school drop-out rates below 10%; at least 40% of 30-34-year-olds completing third level education
5. Poverty/social exclusion: at least 20 million fewer people in or at risk of poverty and social exclusion

The plan is replete with fluff and there's even a statement on "allowing entrepreneurs to restart after failed businesses." Allowing? I thought that entrepreneurs were the ones to make that determination. I am always in awe of pristine projections that live in a vacuum, and the same question always emerges: How? Let's take R&D for instance, and try to determine how and where exactly will governments efficiently deploy the funds, and how is private industry directed to invest just because someone said so. Complicated and not clear at all, and that holds true for every target.

And who's in charge of overseeing the execution of the strategy? According to the plan, they are - drum roll, please - European Council, Council of the EU, The Commission, European Parliament, European Economic and Social Committee, Committee of Regions, European Investment Bank, and European Investment Fund. In short, eight institutions to oversee five targets, and that's how it's done in the mind of those that worship bloated bureaucracies.

The plan rarely mentions the private sector, and if one finds some parallels between the strategy above and what we hear in the U.S., it's not a coincidence because the playbook is similar. We hear about "structural reforms" but have never been able to pinpoint what they actually are, and while the credit spigots were open and senseless spending fostered an era of apparent achievement, all seemed well. Now it's time to put the ever bright nonsense to the test.

One of my favorites sections of the plan is found under "inclusive growth" and pertains to the "agenda for new skills and jobs."

Collectively - modernizing labor markets to raise employment levels, reduce unemployment, raise labor productivity and ensuring the sustainability of our social models.

As I suspected, they are still ignoring current events because the "social models" have been proven to be unsustainable. But since productivity is mentioned, I shall borrow an excerpt from a speech delivered in 2006 by Jean-Claude Trichet, the former chief of the European Central Bank, which highlighted how the European condition is only a reflection of policies and socioeconomic habits that have come home to roost.

But there is a second paradox in the case of Europe or perhaps more than a paradox: a conundrum. Why is it that not only we did not improve our productivity when the U.S. did it - around the mid eighties - but that we observed on the contrary a very significant diminishing of our productivity? This phenomenon seems to me only half understood through traditional explanations: The impact of specific policies aiming at drawing back to work a significant number of previously unemployed unskilled workers - with a low level of productivity - that have been launched in several European economies; and a degree of under-investment hampering the stock of capital allocated to each employee. But it explains only around half of the diminishing of the labor productivity growth. The other half seems to be explained by a significant diminishing of total factor productivity which is extremely surprising because it occurs precisely at the moment of powerful historical surge in science and technology.

In short, Europe was too busy nurturing its political agendas and missed the opportunity presented by technology, and I am certain that "Europe 2020" is only a reprint of previous ideas and slogans. Then productivity is further examined.

The evolution of the "total factor productivity" growth in Europe seems to confirm that phenomenon. From an average level of 1.3 % in the 80s it diminished to an annual average of 1.1 % during the 90s and 0.7 % between 2000 and 2004. These observations are calling urgently for structural reforms, in particular all the reforms that would augment the flexibility of all markets - labor, goods and services and financial - in the euro area economy.

Yes, one can make the argument that European countries exhibit different productivity levels, but that's yet another reason why one currency and one monetary policy were never a good fit. Keep in mind that these words came from an European insider, not some foreigner with an ax to grind. Mr. Trichet delivered yet another speech in June of 2007 - before the housing crisis was in full bloom - where he highlighted part two of the European economic condition.

Benefit systems that are too generous discourage job searching, early retirement schemes encourage early withdrawal from the labor market and marginal tax rates that are too high discourage labor market entry and have a downward effect on average hours worked.

Although the damage had already taken place by then, Mr. Trichet's politically inconvenient truths continued to be ignored only because the credit markets kept the charade from crumbling, and "Europe 2020" is nothing but a vague and purely academic political flyer designed for uninformed public consumption. The emphasis is placed on how government is still viewed as the master and engine of growth, constantly salivating to have its hand in every facet of society.

The Wall Street reported that "French Front-Runner Pledges 75% Tax Bracket," referring to François Hollande, France's Socialist candidate currently leading Sarkozy in the polls. Hollande announced that a special tax bracket of 75% would be imposed on those earning 1 million euros or more if he is elected. But the tax in itself is the least of anyone's worries, because when they get to the point where they realize that the wealthy cannot support runaway and unconscionable government spending, politicians will inevitably increase taxes on every layer of the social strata.

Then again, redistribution yields power, and when the fallacy of such policies is exposed, the finger always points in every direction and never to the root cause and source of our discontentment. Even if the eventual bankruptcy of several nations delivers a clean slate, we will be back to square one within one generation without a change in political mentality.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.