Europes Structural and

Competitiveness Problems
and the Euro
Dominick Salvatore

1. INTRODUCTION

URING the first half of the 1980s, Europe was said to face eurosclerosis,
or low growth, high unemployment, and reduced international competitiveness. In 1986, however, the old continent seemed to reinvent itself by
deciding to move to a unified market by 1992. The Europe 92 programme
provided a stimulus to direct investments (both domestic and foreign) which led
to renewed growth in Europe in the second part of the 1980s. With the ushering of
the 1990s, however, Europe found itself in recession and again facing an
economic crisis. In this paper, I will examine the nature of this new crisis and the
contribution which the move toward the single currency (the Euro) may make
toward resolving or ameliorating it.

2. EUROPES RELATIVE GROWTH RATE

Table 1 shows the average growth of real GDP in the European Union (EU)
and in its major members (Germany, France, Italy and the United Kingdom)
during the decades of the 1970s, 1980s and 1990s and compares these growth
rates to those of the United States, Japan, and the average for all industrial
(OECD) countries. The table shows that the average growth rate declined in all
countries and groups of countries during each decade (except for Germany during
the 19901996 period) but was consistently lower in the European Union than in
the United States, Japan, and the average for all OECD countries. During the
DOMINICK SALVATORE is Professor of Economics at Fordham University in New York. He
wishes to thank Ronald McKinnon, Robert Mundell, Michael Mussa and a Managing Editor for
helpful comments, but he alone is responsible for the content of the paper.
! Blackwell Publishers Ltd 1998, 108 Cowley Road, Oxford OX4 1JF, UK
and 350 Main Street, Malden, MA 02148, USA.

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DOMINICK SALVATORE
TABLE 1
Growth of Real GDP
(Average Annual Percentage Change)

OECD
United States
Japan
European Union
Germany
France
Italy
United Kingdom

19701979

19801989

19901996

19701996

3.7
3.5
4.6
3.2
2.9
3.5
3.6
2.4

2.8
2.8
3.8
2.2
1.8
2.3
2.4
2.4

1.9
1.9
2.3
1.7
2.6
1.4
1.2
1.2

2.9
2.8
3.7
2.4
2.4
2.5
2.5
2.1

Source: OECD, OECD Economic Outlook. (Paris: OECD, December 1996 and June 1997).

1970s, Italy and France grew as rapidly as the United States and did better than
Germany and the United Kingdom. During the 1980s Germany did much worse
than the other three major European Union countries, and all of them grew less
rapidly than the United States. The same is true for the 19901996 period, except
that Germany did better than the other large European Union members and grew
faster than the United States.
Over the entire 19701996 period, the United States grew at an average rate of
2.8 per cent per year as compared to the rate of 2.4 per cent per year for the
European Union. While the European Union rate is lower than the US rate, the
difference is not large. At a growth rate of 2.8 per cent per year, the US real GDP
would double in 26 years, while at a growth rate of 2.4 per cent per year the EUs
real GDP would double in 30 years. The difference between the US and the
European Union growth rate was also very similar in the most recent period (i.e.
19901996). Thus, the present crisis atmosphere in the European Union cannot be
due primarily to its inadequate growth rate because no such feeling of crisis exists
in the United States even though its average growth was only marginally higher
than that of the European Union (i.e. 1.9 per cent as compared to 1.7 per cent)
during the 1990s (Barro, 1997; Barro and Sala-I-Martin, 1995; Jorgenson, 1995;
Mankiw, 1995; and McCallum, 1996).

3. EUROPES RELATIVE INTERNATIONAL COMPETITIVENESS

One possible reason for Europes present crisis atmosphere is the widespread
belief that it is losing international competitiveness in high-technology products
with respect to the United States, Japan, and even some Asian developing
economies. Table 2 shows the changes in the international competitiveness in
high-technology products of the 12-member (15 in 1995) European Union with
respect to the United States, Japan, and Asia minus Japan, between 1980 and
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TABLE 2
EU Trade in High-Technology Products
(billions of Dollars)
Region/Country and Year Exports

N. America
Japan
AsiaJapan

1980
1990
1995
1980
1990
1995
1980
1990
1995

18.40
49.39
72.12
1.86
10.25
16.13
13.12
33.29
80.38

Imports

Net balance

Net balance
as % of tot. manuf.
exports of EU

22.88
56.52
77.96
12.89
45.63
60.49
3.53
22.91
56.41

!4.48
!7.13
!5.84
!11.03
!35.38
!44.36
9.59
10.38
23.97

!1.69
!1.12
!0.36
!4.17
!5.54
!2.74
3.62
1.63
1.48

Source: GATT/WTO, International Trade (Geneva: GATT/WTO, 1996 and various earlier issues).

1995. Asia minus Japan refers primarily to the Dynamic Asian Economies
(DAEs), which include the four NIEs (Hong King, Korea, Taiwan and
Singapore), Malaysia, Thailand and China. High-technology goods refer here
to chemicals and drugs, power generating machinery, electrical machinery and
apparatus, non-electrical machinery, office and telecommunications equipment,
aircrafts and parts, automotive products, and other transport equipment.
Automotive products incorporate many new technologies and can increasingly
be regarded as high-technology products. Other transport equipment refers
primarily to locomotives. The table gives data on the high-technology exports and
imports, the net balance, and the net balance as a percentage of total
manufactured exports of the European Union with respect to North America,
Japan, and Asia minus Japan in 1980, 1990 and 1995.
Table 2 shows that in 1980 the European Union exported to North America
$18.40 billion of high-technology goods, imported $22.88 billion, for a net
balance of !$4.48 billion, which represented 1.69 per cent of the total exports of
all manufactured goods of the European Union. In 1990, EUs high-technology
exports to North America jumped to $49.39 billion, its imports increased to
$56.52 billion, for a net balance of !$7.13, which, however, represented only
1.12 per cent of the EUs total exports of manufactured goods. Thus, while the
EUs net balance in high-technology trade with North America worsened, it fell
as a percentage of its total manufactured exports, and so we could say that the
EUs international competitiveness position vis-a`-vis North America improved
between 1980 and 1990. This improvement continued after 1990 and by 1995 the
EUs negative net balance as a percentage of the EUs total exports of
manufactured goods had declined to !$5.84 billion, which represented only
(!)0.36 per cent of the EUs total manufactured exports.
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Thus, despite the widely-held belief to the contrary, the European Union did
not seem to have lost competitiveness with respect to the United States during the
first part of this decade. The belief that the European Union had become less
competitive vis-a`-vis the United States during the early 1990s was based on (1)
the elimination of the 1980s dollar overvaluation, (2) the much greater
computerisation of the American than the European economies, (3) the much
more extensive spread of computer-assisted design and computer-assisted
manufacturing in the US economy based on its unsurpassed superiority in
software, and (4) the much greater restructuring of the US economy than
European economies during the 1980s and early 1990s. It may be that the United
States is gaining competitively with respect to Europe, but the trade data up to
1995 does not seem to show it.
The European Union did lose in competitiveness with respect to Japan from 1980
to 1990, but since then it seems to have more than recaptured its lost ground. This
can be seen from the fact that the EUs net trade balance in high-technology
products with respect to Japan as a percentage of its total manufactured exports
worsened from !4.17 in 1980 to !5.54 in 1990, but then improved to !2.74 in 1995
(see Table 2). Only with respect to Asian economies other than Japan (mostly
DAEs), did the European Union lose in relative competitiveness continuously from
1980 to 1995. As shown in Table 2, the EUs positive trade balance in hightechnology goods with respect to Asian economies other than Japan as a per centage
of the EUs total manufactured exports declined from 3.62 in 1980 to 1.63 in 1990
and 1.48 in 1995. That is, the European Union still has a revealed comparative
advantage in high-technology goods with respect to the dynamic Asian economies
but it is shrinking (DAndrea Tyson, 1992; Hall and Jones, 1996; Krugman, 1994;
Porter, 1990; Rausch, 1995; and Salvatore, 1990 and 1997a).

4. EUROPES EMPLOYMENT PROBLEM

The major problem facing Europe today is its double-digit unemployment rate.
This is the result of inadequate growth of employment (Dreze and Malinvaud,
1994; Bean, 1994; Layard, Nickell and Jackman, 1994; Lindbeck, 1996; and
Phelps, 1994). Table 3 gives data on the average growth of employment in the
European Union during the decades of the 1970s, 1980s and 1990s and compares
these average growth rates to those of the United States, Japan, and all industrial
(OECD) countries together. The table shows that the average growth of
employment in the European Union was less than one quarter that of the United
States and about one third that of Japan and all OECD countries between 1970
and 1989 and was in fact negative from 1990 to 1996. It is also not true that most
new jobs in the United States are low-paying jobs more than three-quarters of
them pay higher than average wages.
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TABLE 3
Employment Growth
(Average Annual Percentage Change)

OECD
United States
Japan
European Union

19701979

19801989

19901996

1.4
2.6
1.2
0.4

1.1
1.7
1.1
0.4

0.7
1.1
0.8
!0.1

19701996
1.1
1.9
1.1
0.3

Source: OECD, OECD Economic Outlook (Paris: OECD, June 1997 and various earlier issues).

Even though the average growth of the labour force in the European Union was
less than one-half that of the United States over the 1970"1996 period, the average
growth of employment was less than one-quarter that of the United States, with the
result that the rate of unemployment increased sharply in the European Union but
remained the same, on average, in the United States between the first and the last
period under examination. Table 4 shows that the average rate of unemployment
between 1970 and 1979 was 3.8 per cent in the European Union as compared with
6.5 per cent in the United States, 1.7 per cent in Japan, and 4.6 per cent for all OECD
countries. For the 1980#1989 period, the corresponding rates (in percentages) were,
respectively, 8.9, 7.3, 2.5 and 7.1. For the most recent period (i.e. 1990#1996), the
average rate of unemployment was 10.2 per cent in the European Union as
compared with 6.3 per cent for the United States, 2.6 per cent for Japan, and 6.8 per
cent for all OECD countries (OECD, 1996b and 1997b).
Although the overall average rate of unemployment for the entire 19701996
period was very similar for the United States and the European Union, it was
much lower in the European Union than in the United States in the earliest period
(i.e. 19701979) and much higher in the most recent period (19901996). Indeed,
if we compared the unemployment rate in the year 1970 with that in 1996, we
find an even more startling difference. In 1970, the rate of unemployment was
about 2.5 per cent for the European Union as compared to 5.4 per cent for the
United States. In 1996, the rate of unemployment had more than quadrupled to
11.3 per cent in the European Union while it was the same at 5.4 per cent in the
TABLE 4
Unemployment Rates
(Average Annual Percentages)

OECD
United States
Japan
European Union

19701979

19801989

4.6
6.5
1.7
3.8

7.1
7.3
2.5
8.9

19901996
6.8
6.3
2.6
10.2

Source: OECD, OECD Economic Outlook (Paris: OECD, June 1997 and various earlier issues).
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19701996
6.1
6.7
2.2
7.3

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DOMINICK SALVATORE

United States. From being more than double the European unemployment rate in
1970, the US unemployment rate became less than half in 1996. What accounted
for this dramatic reversal?

5. CAUSES OF THE EMPLOYMENT AND UNEMPLOYMENT PROBLEMS IN EUROPE

Until a few years ago if was fashionable to prescribe higher growth and more
investments to cure Europes employment and unemployment problems. That
these policies would not have been effective, however, should have been very
clear even then. As Table 1 showed, the average rate of growth of real GDP was
not much less in Europe than in the United States and yet the United States
created over 30 million jobs from 1970 to 1996 while the European Union only a
few millions. Of course, a much faster rate of growth would have created more
jobs in Europe, but inadequate growth was not the major cause of stagnant
employment in the European Union during the past quarter of a century. Nor was
the problem inadequate investments. In fact, as Table 5 shows, the European
Union invested a greater proportion of its GDP than the United States in every
time period, with average annual investments as a percentage of GDP equal to
20.7 per cent in the European Union, as compared with 19.1 per cent in the
United States over the entire 19701996 period. Thus, the cause of the European
employment and unemployment problems must be found elsewhere.
A closer look at the data reveals that investments in Europe were used
primarily to increase the capital-labour ratio (i.e. for capital deepening), which
increased labour productivity and real wages, while in the United States
investments were capital widening, which increased employment very much but
not labour productivity and wages. This can be seen in Tables 6 and 7. Table 6
shows that average labour productivity (defined as output per employed person)
grew much faster in the European Union than in the United States. It grew by 2.7
per cent in the European Union as compared with 0.4 per cent in the United States
TABLE 5
Gross Investments* as a Percentage of GDP
(Average Annual Percentages)
19751982#
OECD
United States
Japan
European Union

22.7
20.3
31.5
22.0

19831990
21.6
19.5
29.3
20.5

19911996

19751996

20.8
16.9
30.0
19.4

21.8
19.1
30.3
20.7

Notes:
* Include private and public, domestic and foreign.
# The different time breakdown than in previous tables is due to data availability.
Source: IMF, World Economic Outlook (Washington, DC: IMF, May 1997, p. 200).
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TABLE 6
Growth of Labour Productivity
(Average Annual Percentage Changes)

OECD
United States
Japan
European Union

19731979#

19801989

19901995

19731995

1.9
0.4
2.8
2.7

1.7
1.0
2.6
1.8

1.2
0.5
1.5
2.1

1.6
0.7
2.3
2.1

Note:
# The different time breakdown is due to data availability.
Source: OECD, OECD Economic Outlook (Paris: OECD, December 1996, pp. 19 and A68).

TABLE 7
Growth of Real Labour Compensation
(Average Annual Percentage Changes)
19701979
OECD
United States
Japan
European Union

2.3
1.0
4.7
3.4

19801989
!0.3
0.3
1.3
5.3

19901996

19701996

!0.6
0.4
0.9
2.2

0.6
0.6
2.6
4.2

Source: OECD, OECD Economic Outlook (Paris: OECD, December 1996, pp. A15 and A18).

from 1973 to 1979, 1.8 per cent as compared with 1.0 per cent during 19801989,
and 2.1 per cent as compared with 0.5 per cent during 19901996, for an overall
annual average growth over the 19731995 period of 2.1 per cent in the European
Union as compared with 0.7 per cent in the United States.
Table 7 shows that this much greater increase in labour productivity in the
European Union than in the United States resulted in much higher increases in
real wages in the European Union than in the United States in each time period
and for the entire 19701996 time period. Thus, new investments in the European
Union were used primarily for capital deepening and these raised labour
productivity and real wages but created very few new jobs. By contrast, most
investments in the United States were capital widening, which created many new
jobs without, however, increasing labour productivity and real wages very much.
The crucial question is why?

6. EUROPES INFLEXIBLE LABOUR MARKETS

The major reason for the slow growth of employment and rapid rise in
unemployment in the European Union as compared with the United States is the
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inflexibility of labour markets in the former. The European Union has a social
welfare system and worker protection which makes labour not only very costly
but also makes labour markets rather inflexible. Once hired, it is practically
impossible for a European firm to fire a worker even when the firm no longer
needs the worker. But if firms cannot fire workers easily when their demand for
labour declines, they are much less likely to hire new workers when firms
demand for labour increases.
In many EU countries, more than 50 per cent of the labour force is unionised,
as compared with less than 15 per cent in the United States, and labour unions are
notoriously more interested in protecting the jobs of union members and
bargaining for high wages for their members than with creating new jobs (see
Salvatore, 1996). EU countries also provide much more generous social security
benefits to unemployed workers than the United States and this discourages
workers from finding jobs. For example, while unemployment benefits are about
50 per cent of wages in the United States and are provided for only 26 weeks, in
the European Union they exceed 75 per cent of wages and are often provided for
as long as three years (and sometimes even longer). It has been found (Economic
Report of the President of the United States, 1993, p. 107) that each additional
week of unemployment benefits will increase the expected duration of
unemployment in the United States by about half a week and that the longer
the benefit period the less is the likelihood that unemployed workers will shift to
other industries. Katz and Meyer (1990) found that the probability of finding a
job doubled when unemployment benefits ran out.
The most disturbing feature of the high overall and long-term unemployment
rates in EU countries is the slow adjustment toward a long-run equilibrium in
EUs labour markets since the early 1970s. This is clearly apparent from the
tendency for the unemployment rate, after rising during a cyclical downturn, to
decline only slowly when economic activity picks up again and never returning to
its previous lower level. This occurred after all the four recessions that the EU
countries faced over the past quarter of a century. In other words, EU
unemployment rates seem to fluctuate during the course of successive business
cycles along a rising time trend. This suggests that while there are many causes of
rising unemployment in EU countries, unemployment persistence and slow
labour market adjustment can best be regarded as the result of labour market
inflexibility.
Slow labour market adjustment also means that the response of EU countries to
the strong movement toward the globalisation of economic activities that has
been taking place in the world economy as a result of the revolution in
telecommunications did not create many new jobs in the European Union.
Globalisation creates many opportunities for new jobs in expanding sectors, but
somehow EU countries were unable to take full advantage of these new
opportunities. With labour markets and real wages more much flexible than in the
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European Union, the United States has been able to adjust much more rapidly and
effectively to these momentous changes in the world economy and succeeded in
creating millions of new jobs during the past two decades. Higher European
unemployment can also not be attributed to the pace of technological change,
since that has occurred even more rapidly in the United States (and, in any event,
there is no reason to believe that technological change necessarily destroys more
jobs than it creates). What technological change did do is destroy unskilled jobs
while creating skilled jobs. It is only by possibly increasing the mismatch
between labour demand and labour supply in various skills that technological
change can be said to be related to higher unemployment. But this has occurred in
both Europe and the United States and does not explain the much higher longterm unemployment rate in the former than in the latter. In any event, the solution
to the unemployment problem is not to slow down the pace of technological
change, but rather to increase job training and labour mobility to fill the new high
skilled jobs being created.

7.POLICIES TO OVERCOME EUROPES EMPLOYMENT AND UNEMPLOYMENT

PROBLEMS

The 1994 and 1995 OECD Job Study classifies policies to reduce unemployment into two broad categories: those that involve the removal of existing
impediments to hiring and those that actively seek to improve the operation of
labour markets and encourage hiring. Among the first type of policies are the
reduction in the amount and duration of unemployment benefits (which, as we
have seen discourage workers from seeking jobs), lowering non-wage labour
costs such as employers social security contributions, reducing real minimum
wages (by keeping nominal minimum wages constant in the face of some price
inflation), remove or weaken the automatic indexation of wages to prices, relax
firms anti-firing rules, remove the restrictions imposed by unions and
professional associations on entry in certain occupations, and allow temporary
work arrangements. Most European countries have already begun to adopt some
of these policies, but much more needs to be done. The United Kingdom and the
Netherlands are two EU members that succeeded in increasing labour market
flexibility and have much lower unemployment rates than the rest (McKinsey
Global Institute, 1997; and OECD, 1996a).
The OECD also advocates active labour market policies (ALMPs) to provide
job training and skills, job-search assistance and counselling, and subsidies to
help long-term unemployed workers pay the cost of relocating to areas where
jobs are available and thus help them become fruitfully employed. In fact, nations
should shift more of their resources from passive labour policies (such as
unemployment benefits) to ALMPs. While in the short term there is no substitute
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for flexible wages, in the long term providing job training and skills are most
important (CEPR, 1995).
No country has gone further in adopting and implementing these ALMPs than
Sweden, whose relatively low rate of unemployment, despite the highest rate of
labour force unionisation in OECD countries, demonstrates that these
programmes can be effective if they are carefully targeted and monitored and
if they are undertaken on a large scale (Calmfors and Skendinger, 1995; and
Scarpetta, 1996). Although most other European countries have started some new
such programmes in recent years, they are generally not on a sufficiently large
scale to have a major overall impact in enhancing the employment prospects of
long-term unemployed unskilled workers, even if successful. In the final analysis,
reducing the rate of unemployment in Europe is to a large extent a political
decision on how much those who hold jobs are willing to sacrifice (in the form of
reduced job security and above equilibrium wages) for the sake of increasing
employment of long-term unemployed workers.
Many policies that are sometimes advocated to reduce the unemployment
problem now facing most OECD countries would simply not work. Reducing
technological progress would only reduce the growth of standards of living in the
long run without increasing employment much, if at all, even in the short run.
Restricting exports from the newly industrialising countries would also not have
much effect on employment in OECD countries because these exports represent
less than 2 per cent of the goods and services consumed by OECD countries.
Such trade restrictions would only interfere with international specialisation,
efficiency, and growth in developed and developing countries alike (Salvatore,
1993 and 1996a). The same is true of policies to protect the nation from the
globalisation of economic activity that is taking place in the world economy
today. Trying to reduce the length of the work week in order to share work
without at the same time proportionately reducing salaries would only increase
labour costs and reduce employment. Encouraging early retirement would also
tend to make the nation poorer. The secret is to find fruitful employment for all
those who are willing and able to work rather than reducing the size of the labour
force in a vane attempt to reduce unemployment.

8. THE EURO AND EUROPES EMPLOYMENT AND UNEMPLOYMENT PROBLEMS

The general benefits from the establishment of the euro are well known and
include: (1) the elimination of the need to exchange currencies of EU members
(this has been estimated to save as much as $30 billion per year); (2) the
elimination of excessive volatility among EU currencies (fluctuations will only
occur between the euro and the dollar, the yen, and the currencies of non-EU
nations); (3) more rapid economic and financial integration among EU members;
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(4) a European Central Bank which may conduct a more expansionary monetary
policy than the generally more restrictive one now practically imposed on other
EU members by the Bundesbank; and finally (5) greater economic discipline for
countries, such as Italy and Greece, that seem unwilling or unable to bring their
house in order without externally-imposed conditions. But will the movement and
actual establishment of the euro in January 1999 help resolve or at least
ameliorate the serious employment and unemployment problems now widespread
in the European Union?
A single market with one currency will certainly make the EU countries more
competitive globally in the long run and this will certainly be good for
employment.1 The effort currently under way to meet the Maastricht criteria is
only forcing EU member nations to restructure their economies more quickly or
at least making them more painfully aware of the need to do so. EU nations now
understand the need to change their pension and welfare systems, slash budgets,
reduce subsidies, and privatise the economy with a view towards containing
labour costs and increasing labour market flexibility. The prospect of much
greater competition when the euro arrives is also inducing companies to cut costs
and, whenever possible, jobs, and payrolls so as to become more internationally
competitive.
But it is the globalisation process now proceeding rapidly as a result of the
revolution in telecommunications and transportation that is requiring nations and
companies throughout the world to restructure so as to meet the global
competitiveness challenge. The Maastricht Treaty and the movement towards the
euro is only making EU member nations more aware of the need to restructure
their economies and speeding such a process on a coordinated EU-wide scale. It
is now becoming painfully clear that the enviable social welfare system that EU
members have so painstakingly put together since the end of World War II (and
of which they are justifiably very proud) is no longer sustainable in the present
form in a world of global competition. Benefits such as job security rules, high
unemployment pay, paid medical care, and early retirement are hard-won
achievements that EU labour is not going to give up easily.
It is global competition and not the coming of the euro, however, that is
creating the need to restructure and increase efficiency for all nations and
companies throughout the world. What the Maastricht Treaty and the
movement towards the euro is doing is to stimulate the process by making
EU members face up to the need to restructure and actually introduce the
required changes. It is true that for nations to slash budgets to meet the
Maastricht criteria and for companies to restructure and shed labour at a time
when most EU member nations face huge unemployment is very painful. But
these changes are necessary if Europe is to be fully part of and to adequately
1

Not everyone agrees with this. See, for example, Greenaway (1995).

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DOMINICK SALVATORE

benefit from the dynamic globalisation process now in progress. The very fact
that labour is now rebelling (e.g. the results of the recent French election)
against the drastic changes and restructuring required is proof that without the
Maastricht Treaty and the move toward the euro, European countries would be
much more reluctant and much less willing to introduce the drastic changes
that increased globalisation and world competition require.
If Europe fails to face up to the challenge it risks falling behind in the global
competitiveness race and becoming a backwater to the United States, Japan, and
even some of the larger and more dynamic Asian economies (DAEs). The United
States went through such a painful restructuring during the 1980s and is now the
most competitive nation in the world (see World Economic Forum, 1997). While
Japan faces many similar restructuring problems to Europe, it remains the second
most competitive nation in the world among the G-7 countries, and is well ahead
of Europe. Even the DAEs are moving up very rapidly. Thus, it is crucial for
Europe to rise up to the challenge and not delay the required restructuring. This
does not necessarily mean dismantling its entire social welfare system or
switching completely to a more liberal or market-oriented model of the AngloSaxon type, but to the realisation that any social welfare benefit over and above
those received by people and workers in the United States and Japan, but also in
the United Kingdom and the Netherlands, is expensive in terms of government
finances and international competitiveness. The danger now is that labour
rebellion against social welfare cuts and revising the common postwar social
contract will force governments to delay and will water down the restructuring
process.

9. ASYMMETRIC SHOCKS AND THE EURO

One serious unresolved problem that the establishment of a European Central

Bank (ECB) and the euro may create is how an EU member will respond to an
asymmetric shock. It is practically inevitable that a large and diverse single
currency area such as the European Union will face periodic asymmetric shocks
that will affect various member nations differently and drive their economies out
of alignment. In such a case, there is practically nothing that a nation so adversely
affected can do. It is clear that the nation cannot change the exchange rate or use
monetary policy to overcome its problem because of the existence of a single
currency, and fiscal discipline will also prevent it from using this policy to deal
with the problem (Baldassarri, Imbriani and Salvatore, 1996; Fratianni and
Salvatore, 1993; and Fratianni, Salvatore and von Hagen, 1997).
A single currency works well in the United States because if a region suffers an
asymmetric shock, workers move quickly and in great numbers out of the region
adversely affected by the shock and towards areas of greater employment
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opportunities. In fact, the Organisation for Economic Cooperation and

Development (1986) and the European Commission (1990) found that labour
mobility among EU members is from two to three times lower than among US
regions. In addition, in the United States there is a great deal of federal fiscal
redistribution in favour of the adversely affected region. In the European Union,
on the other hand, fiscal redistribution cannot be of much help because the EU
budget is only about one per cent of the EUs GDP and more than half of it is
devoted to its Common Agricultural Policy (Salvatore, 1997b). Furthermore, real
wages are also somewhat more flexible downward in the United States than in the
European Union. It should be clear that none of these escape valves are available
to an EU member adversely affected by a negative asymmetric shock. Otherwise,
how could we account for the persistence of much higher unemployment rates
among EU nations and regions than among US regions?
Facing such a predicament, the United Kingdom and Italy opted for leaving the
Exchange Rate Mechanism (ERM) of the European Monetary System (EMS) in
September 1992 and, by allowing their currencies to depreciate, were able to
move out of the deep recession in which they found themselves. With a single
currency this would have been impossible. Remaining in the ERM of the EMS in
September 1992 would have meant Britain and Italy standing idly by and
watching their unemployment rate increase from already very high levels until
the recession came to an end naturally and gradually over time. No government
can afford to do this. In any event, massive speculation against the pound and the
lira forced a depreciation of those currencies. It is true that the establishment of a
single currency will prevent such speculative attacks. But that also means that
with a single currency the nation will have no policy choice available. It will
simply have to wait out for the recession to be cured by itself (see Salvatore,
1996b).
Supporters reply that the requirements for the establishment of single currency
will necessarily increase labour market flexibility and, by promoting greater
intra-EU trade, a single currency will also dampen nationally differentiated
business cycles. Furthermore, it is pointed out that highly integrated EU capital
markets can make up for low labour market flexibility and provide the automatic
response to asymmetric shocks in the European Union. While these automatic
responses to asymmetric shocks may in fact be present, they may not be adequate.
It is true that meeting the Maastricht parameters will increase labour market
flexibility. But this may be a slow process and may not be allowed to take place
to a sufficient degree if EU labour insists on retaining many of its present benefits
(such as job security and high unemployment pay). Furthermore, excessive
capital flows may also work perversely by reducing the incentive for fundamental
adjustment measures and may even produce supply shocks of their own by
pushing up the exchange rate of the EU member adversely affected by an
asymmetric shock.
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10. PERIPHERAL AREAS AND THE EURO

The move to the euro is also likely to create serious problems for peripheral
EU regions and nations. That is, the greater economic and financial integration
that the move toward the euro will entail and encourage is likely to increase the
geographical concentration of economic activities at the core of the EU area and
lead to increased economic inequalities between the centre and the periphery.
Southern Italy, Scotland, Northern Sweden, and even entire peripheral countries,
such as Greece and Portugal, are likely to become poorer as a result of a process
of cumulative causation so aptly discussed by Gunnar Myrdal in 1957. That is,
peripheral areas and countries are likely to lose their best trained people who
might be attracted by the higher salaries and the better career opportunities in EU
core areas. Similarly, the savings of the peripheral areas may flow to and be
invested in the EU core regions, attracted by the smaller risks and the likely
higher returns there. Finally, it is difficult for industries in peripheral areas to
effectively compete with EU-core industries.
Such progressive impoverishment of peripheral areas is evident within many
EU member nations, but the process is likely to gain steam as the European
Union moves toward a truly integrated economy. The experience with prior
economic integration at the national level of many EU member nations clearly
points in that direction. And EU regional policies to help peripheral areas are not
likely to be sufficient to reverse the trend toward greater interregional inequality.
For example, after 50 years of a massive effort by the national government to
help the Italian South, the gap in real per capita income of the Mezzogiorno
relative to the North is as wide, if not wider today, as it was in 1950. Despite
accusations of waste, the Italian government tried almost everything imaginable
to help the South narrow differences with the more industrialised North. It tried a
land reform, it built infrastructures, it built massive industries such as the steel
industry at Taranto, it tried incentives to small firms, and introduced programmes
to train labour all seemingly to no avail.
It is wrong, however, to infer from this that the special effort to help the South
was entirely ineffective. The effectiveness of such a programme can only be
measured by counterfactual simulation. That is, what would the North-South
difference have been without the massive effort to help the South? Unless the
programme was a complete waste, the North-South difference would have been
greater without the governments programme to help the South. The point is that
the unhampered operation of the market mechanism can be expected to increase
peripheral-centre inequalities and even a massive government effort to reverse
this trend may not be sufficient to prevent regional inequalities from increasing.
Despite an even more massive and concentrated effort by Germany to help the
Eastern portion of the country restructure its economy after decades of
communism, West-East differences remain very large today. And peripheral
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regions can certainly not expect the same degree of effort from the EU Regional
Development Fund. Thus, the move towards the euro is likely to lead to even
greater concentration of economic wealth at the EU core and result in widening
inequalities of peripheral areas.

11. SUMMARY AND CONCLUSIONS

The European Union grew only slightly less than the United States during the
19701996 period. Trade data also shows that while the EUs competitiveness in
high-technology goods worsened with respect to Japan from 1980 to 1990 and
with respect to Asian countries other than Japan from 1980 to 1995, it did not
with respect to the United States from 1980 to 1995, and especially since 1990.
To be sure, the European Union still has a large trade deficit in high-technology
goods with respect to the United States, but as a percentage of its total manufactured exports, the EUs position has improved significantly since 1990. The
major economic problem facing the European Union today is that so few new
jobs are being created. This resulted in a big increase in the unemployment rate,
despite the fact that the EU labour force grew very slowly during the past quarter
of the century.
The EUs employment and unemployment problem was not due to inadequate
growth of real GDP and investments but resulted because most investments were
capital deepening and increased the capital-labour ratio, labour productivity, and
real wages without creating many new jobs, while they were capital-widening
and sharply increased employment in the United States without, however,
increasing wages very much. The reason for this sharp difference is to be found in
the EUs inflexible labour markets. The OECD correctly advocates both policies
to remove impediments to work (such as reducing unemployment benefits and
minimum wages) and active labour market policies (ALMPs) to provide job
training and skills for long-term unskilled unemployed workers to help them
become fruitfully employed. Most European nations have adopted some of these
policies but much more needs to be done.
A single market with one currency will certainly make the EU countries more
competitive globally in the long run and this will certainly be good for
employment. But it is the globalisation revolution that is requiring nations and
companies throughout the world to restructure in order to meet the global
competitiveness challenge. The Maastricht Treaty and the movement towards the
euro is only making EU member nations more painfully aware of the need to
restructure their economies and to speed such a process on a coordinated EUwide basis. To that extent, the move toward the euro will stimulate EU
competitiveness and shorten the time before the restructuring process will lead to
significant new job creation. The creation of a European Central Bank and move
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towards the euro will, however, result in significantly greater adjustment costs for
EU members affected by asymmetric shocks and will exacerbate the economic
problems of peripheral EU nations and regions and increase their inequalities
with EU core areas.

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