Europe’s Only Choice: No longer able to devalue its way to competitiveness, Europe must reform its welfare states
Greece, Italy, and many other countries obscured the problem of unsustainable social-welfare benefits for too long. For many of these countries, meaningful reform is now unavoidable.
The social-insurance systems in Europe, as in the United States, Japan, and elsewhere, were designed under certain economic and demographic circumstances—rapid economic growth, rising populations, and lower life expectancy—vastly different from those prevailing today. Governments (the focus is on Greece and Italy at the moment, but they are not alone) promised too much, to too many, for too long. My 1986 book Too Many Promises pointed to the same problem with America’s social-welfare system.
This fundamental problem has now manifested itself in these countries’ unsustainable debt dynamics. Euro membership, which temporarily enabled massive borrowing at low interest rates, merely aggravated it.
Reforming social-welfare benefits is the only permanent solution to Europe’s crisis. One hopes that with the help of national governments, the European Central Bank (ECB), the International Monetary Fund (IMF), and the European Financial Stability Facility (EFSC) the holes in the sovereign-debt-funding dike will be temporarily plugged, and that European banks will be recapitalized. But this will work only if structural reforms make these economies far more competitive. They must both lower the tax burden and reduce bloated transfer payments. Too many people are collecting benefits relative to those working and paying taxes.
Meanwhile, the bond market’s concern over fiscal deficits and debt dynamics is driving these countries’ borrowing costs higher. Unless temporary fixes are combined with fundamental long-term structural reform, another disaster like the current one—or worse—will become inevitable.