OECD warns euro zone to tackle a series of problems to sustain faster growth

Posted in Other | 05-Jan-07 | Author: Carter Dougherty| Source: International Herald Tribune

A Euro sculpture is seen in front of the European Central Bank building in Frankfurt.

FRANKFURT: Even as the euro-zone economy grows at its fastest rate in five years, an influential research group warned Thursday that the region must seriously tackle a series of economic problems if it wanted to sustain faster growth and make its experiment of monetary union pay off.

The group, the Organization for Economic Cooperation and Development, said that economic growth rates of the euro club — which gained its 13th member with Slovenia on Monday — would continue to lag behind the United States and Britain unless it loosened rules that prevent quick job cuts.

Among other politically unpopular measures that OECD advocated were reducing the cost to employers of pension systems and clearing regulatory hurdles that prevent the smooth creation of new companies, notably in the service sector.

The advice is a familiar prescription for Europe's woes that many economists say governments are pursuing too halfheartedly even at a time when the region's economy is expanding.

"Governments have not been honest enough about what a successful currency union entails," said Simon Tilford, an economist with the Center for European Reform in London. "And without that happening, it's hard to see how we do not see further divergence within the euro zone, and the political instability that comes with that."

In an apparent acknowledgment for the need of further economic overhauls, President Jacques Chirac of France on Thursday proposed to reduce company taxes to 20 percent from 33 percent, a step Germany embraced late last year, while obliquely criticizing past French tactics for stimulating growth with a 35-hour work week.

"We must guard against ideologies and illusions like reducing working times as a solution against unemployment and raising taxes rather than making reforms," Chirac said, Reuters reported.

Chirac also acknowledged the need for looser hire-and-fire rules, yet economists were quick to note that his government backed away from a new employment contract last year for young people amid fierce street protests.

Despite the successful introduction of the euro, the Continent's larger economies like Germany and France, with more rigid policies, suffered lower-than-average growth, in contrast to more small but supple economies like Ireland, Finland and the Netherlands, making for a significant black spot on the record of the euro zone in its first eight years, said the OECD, an organization of industrialized countries based in Paris.

The organization predicted that the euro-zone economy grew 2.6 percent last year and would slow a bit to 2.2 this year. Those rates are considerably higher than earlier this decade.

But the OECD said that the euro zone was experiencing a cyclical upturn, rather than a new era of higher growth — a phenomenon the United States, the only other economy of similar size, experienced in the late 1990s.

"With the recovery under way, attention can shift back to the euro area's longer-term challenges: subdued potential growth and a lack of resilience due to structural shortcomings," the OECD said. "The early years of monetary union have shown that less flexible economies can have a rough ride, missing out on the full benefits of the single currency."

In the main, politicians have avoided the tough prescriptions for change that most economists have recommended for the three largest euro-zone countries: France, Germany and Italy. Germany, for example, curbed unemployment benefits in 2004 to promote job- seeking, but already some economists complain it is being implemented halfheartedly.

The failure, in the view of most economists, is most evident in the euro-zone unemployment rate, which is slightly below 8 percent — good news by European standards but still high.

The OECD pointed out that higher growth in 2006 and 2007 masks significant differences in growth rates over the past five years. Ireland has grown at a rate over 4 percent, while Portugal has expanded at under 1 percent, with the largest economies closer to the latter than the former.

While the largest euro-zone economy, Germany, has climbed out of the hole it was in early in the decade, Italy has in recent years emerged as the problem child of the region, and the OECD alluded to how the failure to change hit that country particularly hard.

Italian exporters had long relied on a weak currency to help lower their costs, but with the euro they were stripped of that tool. Most economists — including those at the European Central Bank — anticipated that companies would respond by cutting costs and moving into less price-sensitive product lines to avoid losing out.

Exactly that happened in Germany, whose managers were long accustomed to dealing with a strong currency. But in Italy, and to a lesser extent France, executives were slow to react.

"The main built-in balancing mechanism — the competitiveness channel — has been slow to act," the OECD said in its report. "This can lead to boom-bust cycles in some countries and depressed activity in others."

The OECD report painted a largely flattering view of the European Central Bank, based in Frankfurt, the chief institutional steward of the euro zone, and said it had delivered on low inflation. But the organization said the bank would face a tough test in the coming years as the effects of higher energy prices are felt, and as the economic upturn tempts companies to pass on higher costs to consumers.

"The ECB needs to act in a manner that preserves the credibility of its commitment to maintain price stability," the OECD said.

Consumer prices increased at an annual rate of 1.9 percent in December, Eurostat, the European Union's statistics agency, reported Thursday. That was the fourth straight month that inflation, after a spike earlier in 2006 due to soaring oil prices, had sunk to within range of the ECB's target of below, but close to 2 percent.