Progressive Alternative Policies Are Essential Now

This is a year of crucial national elections in key European countries. In all these countries, right–wing populism raises its ugly head, even though it will hopefully be defeated.

A key, though not only, reason for the rise of these extreme right-wing parties is disillusion due to the fairly anemic recovery from the Eurozone debt crisis. This is accompanied by ever-widening divergences in levels of growth and unemployment between the more successful “Northern” countries and the weak performing “Southern “ ones, where unemployment – especially of the young – is still unacceptably high. Furthermore, income inequality is very high in most countries, and often rising, whilst levels of investment, even in very successful Germany, are fairly low.

Not only are economic prospects poor in much of the European Union, but also many people have lost hope that the economy will improve, and their children will have a better living standard in future than they have.

This state of affairs is by no means inevitable. On the contrary, there are alternative policies that can lead to far better economic outcomes, both in terms of higher growth and employment, as well as better income distribution. It is key for progressive parties throughout Europe to provide such a comprehensive policy package, which they alone can formulate and deliver properly. Conservative parties have broadly failed in this endeavor, both because their policy design has been based on incorrect theoretical frameworks and they are often captured by vested interests; extreme right-wing parties would make matters far, far worse.

An alternative economic package would include, amongst others, the following elements: an increase in both public and private investment, greater symmetry of adjustment between current account surplus and deficit countries, and strengthening of workers’ bargaining rights leading to higher real wages.

The increase in investment is highly necessary, to facilitate greater innovation and more sustainable infrastructure; this would help make the European economies increase their productivity, thus enabling them to be more competitive as well as greener in the medium term, whilst providing additional aggregate demand in the short–term to encourage more growth and higher employment now.

It is essential to increase public investment, very valuable in itself, but also having the virtue of helping – in current circumstances – crowd in private investment, as leading economists like Joe Stiglitz have shown. As the International Monetary Fund has forcefully argued, the German, Dutch or other creditworthy Governments can borrow funds so cheaply, and these resources, if well invested, will have yields well above the cost of borrowing. As a result, future debt to GDP levels would fall, rather than rise, as growth would increase. More generally, all EU countries should be allowed – by making the current Growth and Stability Pact more flexible – to increase their deficits, by say 1% of GDP, provided the resources are channeled into forward-looking productive investment, as suggested by the well-known economist, Peter Bofinger, who called this a Lighthouse Initiative.

This Lighthouse Initiative should be complemented by a further expansion and improvement of the European Fund for Strategic Investment (EFSI), also known as the Juncker Plan, which helps finance private investment, both in strategic sectors, like innovation, green and digital economy, as well as funding the better small and medium enterprises, which will help increase employment. For this purpose, the paid-in capital of the European Investment Bank could be increased by European member states.

The EFSI initiative will work best if it collaborates very closely with well-run national public development banks, like Germany’s KfW, which has been very effective in helping catalyze private investment in renewables, as well as financing SMEs. Development banks can channel long-term funds into productive investment. Governments only fund the banks’ capital; resources for lending are raised on capital markets, allowing large leverage of public funds. Government ownership encourages credit to be channeled to priority sectors, benefitting the majority of citizens. It would be desirable to increase the capital of existing national development banks, and create development banks, in countries where they do not exist, such as Greece.

After the Eurozone debt crisis, spending fell sharply in current account deficit countries forced to adjust, whilst there was insufficient offsetting expansionary policy in current account surplus countries, so the net policy effect was deflationary for the EU as a whole. This combination has been a very important reason for low Eurozone growth.

Since 2011, Germany has become the world’s major surplus economy, with a current account surplus likely to be 8.6% of GDP in 2016; Holland’s current account surplus is even higher, at around 10% of GDP. This is very problematic as, by not providing additional aggregate demand, and taking higher imports from the rest of Europe, it implies lower growth in those countries.

Relatively higher wage adjustments of surplus economies as well as more expansionary fiscal policies, particularly for increased investment, should be an essential part of future policy packages for more dynamic Eurozone growth. The resulting expansion, via both higher wage growth and some growth of fiscal spending (for more public investment), would be beneficial for surplus countries themselves. They would enjoy higher growth and better income distribution, as real wages rise – as well as crucially generating positive spillovers for neighboring, especially deficit, countries. These measures would thus be positive for all countries, and for all citizens.

As in much of the rest of the developed world, the share of wages in the EU within total income has been falling; this is very negative, both because it worsens income distribution, and reduces aggregate demand, and thus growth, as poorer people consume more than richer ones. Therefore, measures to strengthen workers’ bargaining rights and increase wages, will be good both for growth and for a better income distribution. For example, the introduction of the minimum wage in Germany was a very positive step. Much more needs to be done in all EU countries to increase the incomes of the relatively poorer citizens of these societies.