[A-List] Godot's Europe

[Sabri Oncu <soncu@xxxxxxxxxxx>]

Stephen Roach calls himself a recovering Euro-skeptic. I envy
him. I am yet to start my recovery.

Sabri

==========================

Global Economic Forum
Morgan Stanley, April 26, 2002

Global: Godot's Europe

Stephen Roach (from Venezia)


The ease of Internet connectivity has become one of my personal
favorites in gauging the potential for economic transformation in
recent years. On that basis, Europe is going nowhere. Time and
again, I find that telephone systems at the very best of the
European hotels just aren?t up to speed when it comes to the
simple task of the modem connection. The engineers and
technicians that are dispatched by hotel business centers are
pleasant and helpful -- and I now know many of them on a personal
basis -- but they can?t turn stone into gold. That?s true,
literally everywhere across the continent --from France and Spain
to Germany and Switzerland and, of course, in Italy, where I am
"e-marooned" at the moment. Over the past six weeks, I have
traveled extensively in Asia, Canada, the United States, and now
Europe. Let me assure you, Europe remains at the bottom of the
connectivity heap.

Fortunately, Europe has a lot more going for it. Economic
integration under the guise of the European Monetary Union is
widely presumed to be the catalyst of a powerful new wave of
structural change. At least, that?s been the euro-mantra of the
past decade. The theory has it that EMU forces the creation of a
new common denominator of macro and micro efficiency that no
individual country can afford to avoid. It is the driver of
cross-border harmonization of taxes, costs, pricing, and
deregulation. Courtesy of the Stability Pact, it now comes with
the trappings of a common approach to fiscal policy. And, of
course, there?s a new central bank determined to inherit the
credibility of the once proud Bundesbank. Pan-European policy is
the macro leash that supposedly forces individual countries to
march to the beat of the same drummer. The new hard currency is
thought to be the icing in the cake. The centimes and the
millions of lira have vanished before our eyes, only to be
replaced by the finely calibrated decimalization of the crisp new
euro. Again, the theory has it that the common currency forces a
new transparency to pricing that weeds out the uncompetitive
outliers.

But even the most diehard of the Euro-enthusiasts concede that
there must be more to pan-regional success than cross-border
integration. The biggest leap of faith is that the new strictures
of a unified Europe will drive a powerful wave of structural
change that will lead to a significant acceleration in the region
?s underlying productivity growth. Eric Chaney, co-head of our
European economics team, has predicted that labor productivity
growth is headed to 2% in the euro-zone over the next few
years -- a virtual doubling from the anemic 1% pace of the 1990s.
At work are thought to be the EMU-driven imperatives of improved
labor market flexibility, together with a powerful wave of
corporate restructuring -- the latter stemming from Europe?s
newfound shareholder value culture and the surging wave of
cross-border M&A activity it has spawned. Europe?s
under-investment in new information technologies -- which spared
it from the bubble-like excesses that torpedoed America in the
late 1990s -- should also work to its advantage in the years
ahead. The coming "IT catch-up" is widely thought to spur a wave
of capital-labor substitution that can only add to the region?s
productivity dynamic. Needless to say, a doubling in underlying
European productivity growth -- should it ever occur -- would go
a long way toward dispelling the doubts of generations of
Euro-skeptics.

So much for theory. All along, the biggest constraint in all of
this has been the potential collision between economics and
politics -- that the political economy of "eurosclerosis" would
be an enduring feature of both pre- and post-EMU Europe. The hope
has been that the politics of the Old Europe would give way to
the economic realities of a New Europe -- that pan-regional
integration would be the wedge that tips the balance of economic
performance toward structural change and improved
competitiveness. While those hopes remain an enduring feature of
the "Euro-dream," they have been dealt a harsh blow by three
events in the spring of 2002 -- disappointments on the German
wage front, labor unrest in Italy, and an election shocker in
France. If Euroland?s three largest members are in trouble --
countries that collectively account for nearly 70% of the region?
s GDP -- the rest of the euro zone can hardly be expected to save
the day.

Inflexible labor markets have long been the Achilles' Heel of
Europe. Yet there have been signs for several years that euro
labor markets have been becoming increasingly flexible.
Particularly noteworthy in that regard has been the expansion of
part-time and temporary employment. According to Christel Rendu
of our Euro team, the "flexi-portion" of Euroland?s work force
(part-time plus temporary workers) has risen from 21% in 1991 to
an estimated 29% in 2000. But there are problems suddenly
emerging in the "non-flexi" portion of the region?s workforce.
That?s especially the case in Germany, where labor-market
rigidities have long been singled out for special attention. The
nearly 4% wage increase just awarded to chemical workers for 2002
is more than double the 1.5% rise in 2001. While that?s a small
sector -- chemical workers account for just 1.7% of total German
employment -- Elga Bartsch of our Euro team worries that it could
set the pace for other larger industries. The growing risks of a
strike by Germany?s metal workers -- more than six times the size
of the chemical workers -- is especially worrisome in that
regard.

Meanwhile, worker backlash has boiled over in Italy. The general
strike of 16 April was the first such action since late 1994 and
apparently the most disruptive work stoppage since June 1982. Not
surprisingly, the issue is reform -- in particular, a protest
against the measures proposed by the Berlusconi government to
eliminate lifetime employment by lifting firing rigidities.
Aftershocks are evident ten days later, with selected work
stoppages still popping up in several Italian cities. Nor are
there encouraging signs in France these days. The 35-hour
workweek was one thing -- a first sign of labor resistance to
EMU-driven efficiencies -- but now there?s the stunning protest
vote in support of the right-wing Mr. Le Pen. If Le Pen stands
for one thing, it is a protectionist, anti-European agenda. While
everyone has been quick to judge this as a typically French
protest vote -- virtually guaranteeing a landslide election for
Mr. Chirac on 5 May -- there is good reason to take this voter
message seriously. If it spells trouble for the upcoming
legislative election on 9 June -- threatening the right-wing
support for the legislative agenda of the President -- France
will find it most difficult to muster the political support it
needs to implement the pension and public sector reforms that are
so vital to EMU-based progress.

It?s easy to dismiss all this as nothing more than bumps in the
road on the journey to a New Europe. As a recovering
Euro-skeptic, I certainly hope that?s the case. But I must
confess that I?m having some doubts again. The heavy lifting of
structural change is always a delicate balance between the
economics of efficiency enhancement and the politics of labor
acquiescence. The United States has led the charge in this model
of restructuring. Its tenuous social contract with compliant
workers has been a key element of this success. But for Japan?s
corporate welfare state and Europe?s public sector welfare state,
it has been much harder to bring labor into the restructuring
equation. The recent ominous signs in Germany, Italy, and France
only serve to underscore how hard it will be for Europe to reach
the "Promised Land."

Meanwhile, there are the more mundane matters of the business
cycle to contend with. After a sharp bounce-back in the early
months of 2002, the nascent Euroland recovery is quickly running
into trouble. Germany?s all-important Ifo survey disappointed on
the downside in April, with the consumer the weak link in the
chain. According to Vincenzo Guzzo of our Euro team, Italy?s
general strike translates into at least a two-percentage point
plunge in industrial production in April.

Year after year, we speak of a newfound resilience to Euroland,
able to withstand external shocks far better than other segments
of the industrial world. We did that a year ago when the IT
slowdown first unfolded and we did it again in the face of the
synchronous global slowdown of late last year. The lesson is that
it takes a long time for structural change to bear fruit --
possibly a lot longer than the Euro-optimists are willing to
concede. That doesn?t make me a Euro-skeptic, again, but it
certainly gives me pause. To paraphrase Godot, I find myself
always in wait of the New Europe. That?s true of Internet
connectivity as well as the long-heralded dynamism of a
supposedly transformed European economy. It?s a wait not without
considerable fatigue.

Full at:
http://www.morganstanley.com/GEFdata/digests/20020426-fri.html