Slipping Behind - Exel: Drexel University's Research Magazine

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Slipping Behind
Europe is beset by a host of severe economic problems, says Marco Airaudo. Unless something is done to correct them, the region may become increasingly irrelevant to the world economy.

_Marco Airaudo

Airaudo is an assistant professor in the School of Economics in the LeBow College of Business.

Being from Italy, economist Marco Airaudo has taken a keen interest in the economic structure of Europe, which is undergoing more than its fair share of economic woes these days. The turmoil has gripped Greece, Ireland, Portugal and other nations, and to hear Airaudo tell it, the continent’s three biggest problems are indeed tricky ones: low growth, public finances and unemployment.

In the last 20 years, the annual growth rate in the Euro area—the countries sharing the Euro (its current value is approximately $1.3 per Euro, while it was around $0.85 per Euro 11 years ago when the Euro became Western Europe’s official currency) as common currency—has rarely exceeded 1 percent. Thus, European countries are unable to compete with the thriving economies of India and China.

“If we want the Euro area to survive future global crises, we need to rethink the whole structure of the European Union. Having a centralized monetary policy and several decentralized—and effectively rather arbitrary—fiscal policies, as we have now, is problematic,” explained Airaudo. “We need a clear and effective fiscal mechanism of risk-sharing across European countries, on which all countries have to agree, in bad times and in good times. This is the way the United States federal system works. Since the Euro area was created with the U.S. as a model, we need to make that extra step.”

Public debt and deficits have been rising consistently in most countries, particularly southern Europe. High public debt means higher interest payments, leading to higher deficits and even higher debt. “It’s a vicious spiral that’s hard to stop during such a harsh and prolonged recession,” says Airaudo.

Europe is beset by a host of severe economic problems, says Marco Airaudo. Unless something is done to correct them, the region may become increasingly irrelevant to the world economy.

Average unemployment in the Euro area is almost 12 percent (meaning about 18 million people are seeking jobs and not getting one). At the lowest end, Austria’s unemployment is 5 percent. At the highest end, unemployment in Greece and Spain is 27 percent.

In Italy, total unemployment is 11.5 percent, below the Euro area average. However, for young people, it’s 40 percent, 15 percent higher than the Euro area average, according to Airaudo. “To me, this is clear evidence that, in Italy, structural policies and labor regulations do not create the right incentives for firms to hire new young workers,” says Airaudo.

Another big problem Europe face, he says, is institutional. The Euro governments have seemingly shirked their responsibility to create solid, stable long-term economic plan, he says.

“Europe as a political identity has to gain more credibility,” he says. “At the moment, its power is mostly concentrated in market regulation and immigration laws, while—with respect to fiscal and structural policies—their role is much more limited. Having a concerted fiscal policy plan at a Europe-wide level would have probably helped tackling the crisis.”

The problem, of course, is one that has been an issue for the Euro nations from the start: Where they draw the line between the good of their nation and the good of their Euro partners. Not surprisingly, Airaudo says, nations are often reluctant to give up their local interests.

“Although there are no institutional barriers to it, labor mobility across EU countries is still limited—lower than what we see in the U.S. Two obvious reasons are the language and the social culture,” he says. “The vast majority of the population in southern European countries is not fluent in any other European language. In the U.S., an American losing a good job in New York might decide to move to Los Angeles for an equally rewarding job. In Europe, an Italian losing his job in Rome would rather accept a low salary job there rather than a stable job in Berlin. This no-mobility phenomenon is widespread in Italy; it takes an enormous amount of effort for an Italian to leave his hometown … This makes citizens very much concerned about local policies—since they know they will mostly live there till death—and, therefore, much less interested in what goes on in the rest of Europe.”

In the end, Airaudo says, there is no “quick fix” to Europe’s economic woes.

Substantial structural r eforms are needed to make Europe more competitive in global markets. Countries need to reduce labor costs, increase competition in the banking system, move from quantitative to qualitative public spending, and encourage firms to invest and in their global peers.

“Europe and the U.S. are big trading partners, both in goods and assets. It is the interest of both to have their counterpart in good economic health. A prolonged recession in Europe can harm U.S. firms exporting to European markets and, as a result, the (gross domestic product),” says Airaudo. “Moreover, financial markets are closely connected. A European debt market crisis would most likely imply a crash in asset markets across the whole continent, and probably spill-over to the U.S., as institutional investors diversify their portfolio across the two continents.”