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News Release

Major New Economic Reforms Needed In Europe

September 14, 2004

Contact:    Martin Neil Baily    (202) 328-9000
    Jacob Funk Kirkegaard    (202) 328-9000

Washington, DC—A new study from the Institute for International Economics concludes that the major economies of Western Europe must pursue three top reform priorities to raise their productivity growth and thus their economic prosperity over the next few years:

  • land-use reform;
  • elimination of the remaining trade barriers that protect manufacturing companies from global competition; and
  • completion of service-sector liberalization and privatization.

At the same time, the Europeans face three other priorities for increasing employment:

  • sharply reducing the legal and financial barriers that prevent companies from restructuring and that discourage hiring;
  • reforming social welfare policies to encourage people to work instead of encouraging them not to work; and
  • facilitating a widening of the distribution of wages paid by employers while preserving social equity through reformed social policies.

The new study, Transforming the European Economy , argues that economic reform is essential if Europe is to take its place as a dynamic and competitive leader in the world economy—the bold vision set by the EU leaders in Lisbon in 2000. The European Union has been plagued by high unemployment for many years. More recently, it has been unable to achieve the high productivity growth experienced in the United States since the mid-1990s.

Authors Martin Neil Baily and Jacob F. Kirkegaard argue strongly for comprehensive reforms of Europe's social systems and product markets to generate the essential flexibility needed to fulfill the goals of the Lisbon Agenda. Their study reveals that the challenges facing the EU members are severe but it punctures the myths that Europe is doomed to economic decline or that destruction of the European welfare state is inevitable in the reform process. They indeed show that there has been a great variety of performance among European economies, some of which have already carried out social reforms that have raised employment while maintaining high levels of social protection. Similar variety exists in product markets. Baily and Kirkegaard demonstrate, using detailed case study evidence, that European industries have achieved strong productivity growth when faced with the correct competition-enhancing regulation.

Building on these past European experiences, as well as results from the United States, Baily and Kirkegaard propose reforms aimed at improving the incentive structures faced by all European economic actors: workers, the unemployed, companies and regulators. The policies that have unsuccessfully attempted to preserve specific old jobs must be replaced by policies that encourage new job creation. There should be employment security—the availability of new jobs when needed—rather than a fruitless effort at job security.

The authors show that macroeconomic variables play an important supporting role in generating sustained economic growth in Europe. Hence they also make proposals for reform of the EU's Stability and Growth Pact: EU government budgets need discipline but in a way that does not unnecessarily constrain countercyclical expenditure and can be credibly enforced. On the monetary side, the European Central Bank should promote growth, as well as be a strong and credible inflation fighter, and it should recognize the costs imposed when inflation falls too low.

Progress on reform is being made in Europe. The pace, however, is uneven and slow. This book offers a positive way forward for Europe that the authors hope Europe's decision makers will embrace. They conclude that standing still is not an option, given the sweeping forces of change occurring within Europe and Europe's key role in the global economy.

About the Authors

Martin Neil Baily, senior fellow at the Institute for International Economics since 2001, was chairman of the Council of Economic Advisers of President Clinton (1999–2001) and a member of President Clinton's cabinet. He is a senior adviser to the McKinsey Global Institute. He was a senior fellow at the Brookings Institution (1979–89) and a professor of economics at the University of Maryland (1989–96).

Jacob Funk Kirkegaard is a research associate at the Institute for International Economics. His current research focuses on European economies and reforms, offshoring, and the impact of information technologies. Before joining the Institute, he worked with the Danish Ministry of Defense and the United Nations in Iraq. In 1996 he graduated from the Danish Army's Special School of Intelligence and Linguistics with the rank of first lieutenant.

About the Institute

The Institute for International Economics, whose director is C. Fred Bergsten, is the only major research center in the United States that is devoted to global economic policy issues. The Institute's staff of about 50 focuses on macroeconomic topics, international money and finance, trade and related social issues, and international investment, and covers all key regions—especially Europe, Asia, and Latin America. The Institute averages one or more publications per month; holds one or more meetings, seminars, or conferences almost every week; and is widely tapped over its popular Web site.

Transforming the European Economy
by Martin Neil Baily and Jacob Funk Kirkegaard
September 2004 • 368 pp. • $31.95
ISBN paper 0-88132-343-8