Why the Euro Can't Compete

The euro is plainly in crisis, needing rescue from Treasury Secretary Larry Summers and probably not for the last time. But what is the problem and what is to be done? Business Week, on Oct. 2, offered a synthesis of current thinking. Sadly, every point combined error and nonsense in varying degrees. I reproduce Business Week's main arguments and my comments below, not to make fun of that journal, but because so many misconceptions are so well reflected in its reporting.

BW: Here's what's needed now: Short term, the leaders of the core European countries -- France, Germany, Italy, the Netherlands and Spain -- need to show they will back the euro with reserves from their national treasuries and central banks. In part, this means intervening when the timing is right to support the euro directly. But it also means building up a greater stock of euros in their national reserves as a matter of policy.

Excuse me? The euro is the national currency of France, Germany, Italy, the Netherlands and Spain. It is not some weird reserve asset, like the International Monetary Fund's Special Drawing Right . Sure, the Eurolanders could sell dollars and buy euros, bidding up their value. But transforming francs (say) into euros achieves nothing: It is just like transforming American quarters into dollar bills and then back again into quarters.

BW: In the medium term, Europe's politicians must make it crystal clear that they are serious about giving their shared economy a big push by forcing through a package of structural reforms that will make Europe as productive and flexible as the U.S. Taxes must come down further, labor markets must be deregulated and the process for setting up new businesses must be made easier...

But productivity is not the European problem. The output per-hour worked in France, Belgium, Holland and Norway is higher than in the United States. In Germany and Italy, productivity is only 13% lower, and nowhere in northern Europe is the gap very large.

The U.S. advantage is not productivity but full employment. We work more hours per person, more weeks per year, and more of our people are employed. The effect of full employment raises our per capita gross domestic product by 10% of the Organization for Economic Cooperation and Development average, while cutting that in Holland (for instance) by about 30% of that same average. In other words, we start with high productivity and add in a phenomenal amount of work. The Europeans also start with high productivity but squander it with low employment.

Moreover, despite many studies, there is no credible evidence that European unemployment is due to "inflexible labor markets." In fact, unemployment is lower in the egalitarian social democracies (Norway and Denmark) of northern Europe than in the more rough-and-tumble Italy, Portugal and Spain to the south. The European dilemma isn't market structure, but tight policies. Lower interest rates, more generous pensions, bigger universities, more health care spending and, above all, better housing and housing credit. That's what we did, and that is what they need.

BW: The European Central Bank and its president, Wim Duisenberg, lack the prestige and the power to salvage the situation on their own. While they can set monetary policy in the eurozone -- for good or ill --fiscal and economic policy is still firmly in the hands of national governments, whose leaders have made conflicting statements about the euro and followed contradictory economic policies. Until they work together, the markets aren't going to take the euro seriously. "The root of the problem is that the markets do not think [11] countries can act as if they were a single country," says Italian Treasury Minister Vicenzo Visco.

Actually, the European Central Bank has vastly excessive power. Unlike Alan Greenspan, who reports to Congress, Duisenberg is accountable to no one. And fiscal policy is also not really in national hands over there. Europe's countries signed away their right to set independent fiscal policies when they subscribed to the Maastricht Treaty, limiting deficits to 3% of GDP. The 11 eurozone countries are in fact all acting like one country, namely Germany under the dyspeptic Bundesbank. And you just can't get to full employment so long as the central bank is opposed to going there.

With tight money, tight budgets, a weak credit system and few public initiatives, the idea of Europe is indeed failing. That's a tragedy, for them and for the world. And it is natural that Europeans should look to the U.S. for the lessons of our recent success.

But the U.S. advantage is not a superior private sector alone. It is, rather, a large and imaginative combination of public and private resources -- in education, health care, pensions and access to credit, among many other things that create jobs, improve earnings, and increase total hours worked in our country. This is a secret the Europeans can't discover. Why not? Only because they won't open their eyes and see us as we really are.

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James K. Galbraith is author of Created Unequal: The Crisis in American Pay (Free Press, 1998) and director of the University of Texas Inequality Project. A professor at the University of Texas at Austin and senior scholar at the Levy Economics Institute, he worked for many years on the staff of the House Banking Committee, where he conducted oversight of the Federal Reserve. He welcomes your feedback and invites you to send it to James K. Galbraith .