Economic Problems of European Union

Since 2007, the EU has experienced a deteriorating economic situation. This has been most concerning for southern members of the Eurozone, such as Greece, Italy, Portugal and Spain. Economists fear that with the current EU economic problems, we could see a lost decade of high unemployment, low economic growth and deteriorating social conditions.

Main Problems Facing European Union

 

1. Unemployment. Unemployment in the EU has reached a critical point. In Spain, unemployment has increased to over 25%, and youth unemployment rates have reached 50%. The recent rise in EU unemployment is primarily due to the prolonged recession. Long term structural unemployment is also a problem.
2. Prolonged Fall in GDP



After the deepest recession since the 1930s, Europe has still not been able to recover. Weighed down by austerity measures and a weak global economy, the EU economy has fallen back into recession. The concern is that structural problems and the current monetary and fiscal policies will create several years of below trend economic growth. (Evaluation of EU Policies for economic growth)  

 
3. Competitiveness Problem. The Euro has caused a divergence in competitiveness. Countries who face higher labour costs cannot regain competitiveness in the usual way through depreciation. Prices become uncompetitive, leading to lower domestic demand, and high current account deficits. Since 2011, current account deficits have fallen in countries like Ireland and Spain, but it has been at the high cost of reducing domestic demand and rising unemployment. Countries are seeking to regain competitiveness through internal devaluation (lower demand, pushing down prices) But, this is much more damaging to the economy than the traditional approach of depreciating exchange rates. more on EU competitiveness.
4. The ECB is too concerned with low inflation The ECB has been accused of giving too much priority to the goal of low inflation. It is argued they have sought to maintain low inflation at the expense of lower growth. The ECB have rigidly stuck to an inflation target of 2%, despite the rise in unemployment and poor performance of nominal GDP.
   




5. Bond Yields. Membership of the Euro, has created a tendency for bond yields to rise much more quickly. After concerns were expressed over Greece, market fears soon spread to other Eurozone countries, like Ireland, Spain and Portugal. This increased borrowing costs and also put countries under pressure to pursue austerity measures to reduce budget deficits. However, these austerity measures have been implemented when the economy is already weak, causing a big negative multiplier effect and causing the economic downturn. Countries with their own currency and ability to print money have been able to maintain low bond yields, which reduces borrowing costs and gives them more time to reduce budget deficits. See more at Euro Debt crisis  - Note - although bond yields fell in last half of 2012, they are still higher than they should be, and there is concern without strict austerity, the ECB may be unable to prevent rising bond yields in the future.
6. Stability and Growth Pact. This is a constraint on expansionary fiscal policy because in theory it limits governments borrowing to 3% of GDP. In a recession a European government is unable to use monetary policy (ECB set rates for whole Euro zone) but also they are unable to reflate the economy through higher spending and borrowing. 
7. Inflexible Labour Markets. This is frequently held up as a constraint on economic growth and a cause of structural unemployment. In particular rigidities in the labour market discourage investment from abroad. For example in France there are laws which makes it difficult to fire workers once they are hired. This discourages firms from expanding and investing. Both the IMF and OECD have argued that further labour market liberalisation is needed to regain competitiveness. Even many of the European leaders acknowledge it is a necessity. However such reforms often face stiff opposition from powerful interest groups who wish to protect the interests of their members. Thus reform has proved very difficult and exceedingly slow. As Luxembourg’s Mr Juncker once said.
   ”We all know what to do, we just don’t know how to get re-elected after we’ve done it.”
8. Demographic Changes. Countries like Germany and Italy have a declining birth rate. This means that the population structure is becoming weighted towards those who are over 50. The traditional population pyramid is being inverted. The increased demands placed on benefits and decline in tax revenue is a serious burden for government spending. It is reflected in burgeoning public debt. As of 2006 Italy’s public debt stood at 105%. German and France just below 70% of GDP. Such high levels of debt are argued to cause crowding out of private sector spending. Unfortunately this problem is likely to be exacerbated as the 1960s baby boomers retire. Again there is much opposition to the reform of generous state pensions.

See also:

• Why UK will not join Euro
• Blog entries on Europe
• Costs of Joining Euro
• Should UK leave the EU?

References

• EU economic growth