As we begin the new year, Europe confronts both good and bad news. First the good news. Growth is finally picking up in the euro area as it is slowly emerging from the deep recession. The bad news? Still nearly 20 million people are unemployed. Until the effects on employment have been reversed, we cannot say that the crisis is over.
Two trends are particularly troubling, now and for the future. First, the high level of long-term unemployment gives me great cause for concern: almost half of those without a job have been unemployed for more than a year. Second, I still worry about the large number of young people without jobs: nearly one quarter of Europeans under the age of 25 who are looking for a job cannot find one. In Italy and Portugal, more than one third of under-25s are unemployed, and in Spain and Greece more than one half are.
Jobs and growth—a two way street
A new book called “Jobs and Growth: Supporting the European Recovery,” authored by IMF staff, analyzes today’s challenges head-on and proposes a roadmap for the continent’s recovery. The book and its roadmap should contribute to the ongoing debate around these pressing issues.
The book’s analysis is informed by the relationship between jobs and growth, which is the proverbial two-way street. When unemployment is high, growth is slow because people consume less, and firms invest and hire less. This means that the most effective way of boosting jobs is to get growth going again. By some estimates, an additional percentage point of growth in the world’s advanced economies would lower unemployment there by about half of a percentage point, pulling over 4 million people back into jobs. So, in order to create jobs, we must lift economic growth.
How can this be done? In the near term, there is no doubt that it will take smart monetary and fiscal policy to protect the recovery.
Roadmap for recovery—three priorities
But what next? The new book’s roadmap for recovery highlights three medium- and long-term priorities.
For the euro area, I believe that enhancing the institutional framework of the monetary union is urgent. Putting in place all of the elements of a banking union would be an excellent place to start. This would ensure the continued stability of the financial sector and address spillover effects from potential instability. The capacity to undertake a timely, effective, and least cost resolution of ailing banks with a common backstop will help break the adverse link between banks and sovereigns, where government support for a weak banking sector calls into question the sustainability of public debt, which feeds back into concerns about the strength of the banking sector, which typically has large holdings of government debt. It will also go a long way toward reducing the uncertainty of investors.
As a second priority, households, corporates, and ultimately also the public sector need to reduce high debt levels. A lasting pick-up in growth will remain out of reach until the balance sheet legacies of the crisis are addressed. Given the slow pace of global demand growth, there is—unfortunately—little hope that these sectors will simply grow out of their debt problems. This means they face increased pressure to deleverage, to actively reduce their debt through higher savings, which threatens the recovery.
IMF analysis indicates that high levels of private sector debt may be particularly problematic and should therefore be addressed first. Private sector deleveraging today can support self-sustained growth later on. Depending on country circumstances, policymakers might be able to do this by putting in place or reinforcing appropriate microstructures, such as effective insolvency frameworks—featuring, for example, fast and flexible personal and corporate bankruptcy proceedings—to help avoid lengthy periods of deleveraging and to protect growth.
Government debt also has to come down. In a lower-growth environment, the trick is to move gradually as long as markets allow, with policies anchored by a durable commitment to sustain fiscal consolidation at a steady but reasonable pace over the medium-term. In addition, consolidation should be seen as an opportunity to make budgets more growth friendly, for example, by shifting from direct to indirect taxation.
Turning to the third priority, product and labor market reforms can make a significant contribution to realizing a country’s full growth potential. Being nimble and competitive opens up new opportunities in a world where production processes increasingly span more than one country. The Czech Republic and the Republic of Slovakia—which established themselves as important intermediate producers for the German automobile industry—are good examples of how integrating into a supply chain can, over time, enhance domestic value added and growth. Importantly, structural reforms tend to have the greatest impact when they are undertaken in a way that is comprehensive instead of piecemeal. I am well aware, of course, that reform priorities and design will vary widely across countries. For example, reducing structural rigidities in the German services sector—including via a review and harmonization of entry requirements in professional services—can help boost productivity there and spur domestic demand. Meanwhile, in Spain, recent labor market reforms show signs of success.
The road ahead is certainly challenging, and different views exist on what policymakers should do—kick-starting and sustaining growth is a complex challenge that requires action on many fronts. It is a debate that engages us all because it affects us all—every citizen, in Europe and beyond.