Economic Growth in the Euro Area - No Time to Relax
Europe is growing, and more strongly than was thought only a few months ago – that’s the positive message to come out of the European Commission’s spring economic forecasts, published on May 7th. Growth of 2.7% in 2006 represents the best performance by the euro area since 2000, and with forecast growth of around 2.5% in both 2007 and 2008, the upswing appears firmer than previously thought – helped in no small part by a more optimistic outlook for the euro area’s biggest economy, Germany.
So far, so good. But as economists will usually tell you at this point in the economic cycle: the work doesn’t stop here. Economic reform is a pill best swallowed when the economy is growing.
First, more flexible and competitive product, labor and capital markets remain critical to improving the euro area’s long run growth potential: the Commission’s forecasts suggest potential growth of around 2¼% per annum in the euro area over the coming years, still well below that of the United States. True, there are some strong performers, such as Spain, Finland and Ireland. But there are also those whose performance continues to act as a drag on the euro area as a whole – most notably, two of the euro area’s largest economies, Germany and Italy (where potential growth is estimated to be around 1½% to 1¾%). Reforming labor markets would also help ensure that the current declines in unemployment reflect not just a cyclical upswing, but a fall in structural unemployment over the long-run.
Second, the benefit of over 8 years experience with a single currency should have demonstrated the importance of making preparations during the good times, affording each economy the flexibility to respond to future economic shocks within the policy constraints inherent in a monetary union. Again, that means improving flexibility in labor, product and capital markets to help each economy adjust more rapidly to the next downturn.
And it means countries must not relax their commitments to continued fiscal consolidation, despite the temptation to spend the “growth dividend” rather than use it to improve their public finances. Governments need to build themselves the room, within the EU’s rules on government debt and deficits, for fiscal policy to respond in a future slowdown.
The European Commission has called on members of the euro area to strike while the iron is hot. When growth was slower, member countries perhaps found it politically more difficult to implement the reforms they know are necessary if the ambitious goals of the Lisbon Agenda are to be met; now, there is much less excuse. The true test of whether they meet this challenge may be several years away, but the Commission is absolutely right: a sunnier outlook is not an excuse to relax; it is exactly the right time to renew efforts.