A Swap in EU-U.S. Economic Policy

The European Union (EU), the “sick man” of the contemporary global economy, should in 2006 abandon the outdated orthodoxy that has come to define its growth strategy and reclaim its economic sovereignty. It should do so by trading dogmatism for the realistic use of its powerful monetary and fiscal instruments. In brief, the EU should become more American. Conversely, the U.S. would be far better off if it focused on a disciplined economic policy in order to curb the abysmal “twin” deficits in its fiscal and trade accounts, i.e. if it (cautiously) followed the European economic way. The paradox of this chiasm between the European deficit of sovereignty and the American deficit of discipline is that if both blocs continue to follow their respective paths, each will probably hit its own wall, but, by trading courses, both can avoid a crash. Moreover, what is now one area’s liability could tomorrow become the other’s asset.

For the last five years, the Euro area, comprised of the 12 EU countries that have shared a common currency since 1999, has been incomprehensibly ruled (by the “stability and growth pact” and the European Central Bank (ECB)) like a collection of competing small economies, open to trade and investments but closed to macroeconomic stabilization and increasingly resorting to tax and social competition. The result has not only been slow regional growth and persistent unemployment but also growing divergence among member states and rising political tensions. The ECB, the most unaccountable central bank in the world, is bound to raise interest rates further in the coming months for fear of imaginary inflation (nowhere to be found in the data) and against the will of most national governments, who are struggling with frail growth and mounting resentment of Europe. Oddly enough, the most successful countries in the “old” EU are those which do not belong to the Euro area: the United Kingdom, Sweden and Denmark. With huge costs and scarce benefits, the risk of a European disintegration has never been so high. In reality—and this was precisely the rationale of the monetary unification gamble—the Euro area is a single large economy, and, as such, needs proactive and cooperative macroeconomic policy of both the fiscal and monetary variety if it is to survive and prosper. The most urgent structural reform the EU needs is not to scale back its welfare state but rather to upgrade its Keynesian arsenal.

The well-known American problem, on the other hand, is of the exact opposite nature. The American public and trade deficits are the symptoms of the aggressive macroeconomic policies that have followed the 2001 recession. Left unchecked, they could degenerate into global “malign neglect” if investors’ faith in U.S. productivity is shaken, and, consequently, massive amounts of dollars are sold on currency exchanges. Given the predominant role played by the dollar in transactions and reserves in every economic region of the planet, the collapse of the dollar would risk causing a global financial crisis.

But an Americanization of European economic policies and Europeanization of American economic policies could close the two enduring and threatening gaps: the US savings gap and the EU growth gap. Imagine a world where Europe would grow thanks to the exercise of counter-cyclical macroeconomic tools and America would save through the wise restraint thereof!

Unfortunately, this happy solution is unlikely to materialize because the global economic equilibrium seems stable as it is. Thanks to Asia, the transpacific economy is thriving, driven by what economists have characterized as a second, informal Bretton Woods system, in which Asian central banks finance America’s consumption.

This deceptive façade of stability places the burden of action on the EU, because the U.S. feels only limited pressure to reform; the EU should be the prime mover in any transatlantic economic revival, acting quickly to fully realize its growth potential by coordinating a macroeconomic push to give some domestic substance to its fragile export-led recovery. Then the U.S., partially relieved from its role in the last fifteen years as the only industrialised world growth engine, could concentrate a much-needed attention on reducing its deficits. And the world would live as one…

Éloi Laurent is a visiting scholar from Observatoire Français des Conjonctures Économiques at the Center for European Studies at Harvard University. He and Jacques Le Cacheux co-wrote “Integrity and Efficiency in the EU: The Case against the European Economic Constitution.”