Alberto AlesinaMoscow December 2010

Europe after the Great Recession

Pre crisis (the bad stuff)Not enough fiscal rectitude during good

times (especially Italy Greece Portugal)Real estate bubble burst Spain and IrelandLow productivity growth especially in

service sectorUnfinished reforms in labor market: dual

labor markets, low participation of elderly workers

Unfinished reforms in service sectors

Pre crisis (bad stuff)Confusion on the issue of “fiscal union” and

central powers in BrusselsGSP unenforcedNo clue about what to do in cases of fiscal

insolvencyMarket lending to basket case countries at

ridiculously low rates.

Pre crisis (the good stuff)Reforms in Northern Countries in the

ninetiesFlex security model seems to work, the

Netherland in particularLabor market reforms and wage

moderation in Germany in the 2000Progress in liberalization of goods market

After the crisisFiscal crisis in Greece Ireland PortugalSpain and Italy in the vergeDelayed ad hoc policy interventionFiscal stress on bans too late, not very

satisfactory (on government default risk)Pocket of bank weaknesses stillTotal confusion on proceduresExample Sarkozy Merkel plan, good idea

bad timingCacophony of voices.

What to do?Fiscal adjustments (UK style).Growth enhancing policies.Be prepared with some orderly possible

restructuring (Greece? Ireland?)Fiscal rules and fiscal union

Fiscal adjustments: what do we knowSpending cuts better than tax increases.They can be quite large.Some of those on the spending side have

not caused recessions.Easy monetary policy helps.Devaluations help but not a necessary

condition

What are they doing?Good points: for the first time emphasis on

spending cuts on public wages and pensions reforms.

Moderate optimism.Recessions? Possibly no.Risk of recession much larger without fiscal

adjustmentsPolitical consequences? Will adjustments

last?

Conventional wisdomFiscal adjustments lead to electoral defeats

and therefore this is way they are postponed

Fiscal adjustments on the spending side are socially very costly.

Conventional wisdom wrong?There is not evidence that larger budget

deficits increase changes of reelection.Larger deficits are (weakly) associated with

less success at the polls.

 

GrowthFiscal adjustments need growth to workDifficult balancing act.What is missing in Europe is productivity

growth especially in service sectorsFrom 1995 onward job creation but fall in

productivity growth relative to US especially un Southern Europe.

Labor marketsLabor market reformed to be pressed in

several directions more participation of the elderly, elimination of dual labor markets, flex security

Women labor supply

Restructuring?Bad words for policymakers.Will it happen? How?Greece? Ireland?European bail out funds?

Fiscal rulesInternational imposed fiscal rules rarely

workThey need to be internalized by national

legislation. (I.e Germany)Conflict France-Germany on this point

ConclusionThe Euro will surviveThe future of Europe depends on whether

this crisis becomes an opportunity to do reform, long delayed or another opportunity to muddle through.