In the latest years the European project has faced several big threats to their future, among others the Brexit (first time any country leaves the EU) and the sovereign debt crisis in 2011. Taking this into account, many policymakers have discussed how the Eurozone can become more credible and how long term growth can sustain inside it.
In order to understand what drives long-term growth, we can use the Solow Model; a model that explains the reasons for GDP growth in the long run. The Solow Model considers labor growth, capital accumulation and technological progress as the main drivers for growth. Technological progress is the key driver for growth and is named TFP (Total Factor Productivity), data shows that it has a strong correlation with GDP growth.
Unfortunately, in the last few years the Eurozone TFP has been growing less than that of the US and other advanced economies which, by consequence, affects GDP growth massively and shows an underwhelming performance of the Eurozone.
Furthermore, innovation contributes a lot to TFP growth and the data shows the EU is behind the US in this parameter. Furthermore, the EU with its lack of innovation will not achieve the goal of investing 3% of GDP on R&D which is supposed to be reached by 2020.
Baring all of this in mind, policymakers should think about ways of increasing TFP growth, labor and capital productivity. To achieve TFP growth we should focus on technology, fiscal policy and better legislation inside the European Union. Technology should be increased by focusing on stimulating R&D investment by the private sector. This should be achieved by making patent registration more agile with less bureaucracy and more efficiency, creating fiscal benefits for firms which invest in R&D inside the Eurozone. Besides this, we should also take care of the massive bureaucracy problem that the Eurozone has by uniformizing labor and corporate legislation. This will allow higher mobility of both capital and labor within the Euro Area, making the creation and insolvency processes easier and faster for firms, as well as increasing the conditions for firms to not leave the Euro Area.
The Eurozone has shown difficulties in managing asymmetric shocks between countries and monetary policy is not enough to smooth these shocks, creating massive disparities from country to country. If we really want an European project from now on, fiscal policy should be more and more similar from country to country. A mechanism should be created in which countries have more tax harmonization and in which corporate taxes should be reduced to compete with other advanced economies in order to attract investment. Besides this, to offset asymmetric shocks from member state to member state and the for southern countries disastrous fiscal policy after the 2008 crisis, there should be a mechanism where countries that are in expansionary macroeconomic cycles should make fiscal transfers to countries that are in the recession path of the cycle.
In addition to these fiscal policies, there should be an immediate resolution fund to bail out banks in the Eurozone that are struggling to make the banking system more equal between countries and avoid extra public budgetary costs for each country (which happened a lot in southern economies).
These measures should help a lot in achieving long term growth, but it’s not enough considering the huge problems that we may have regarding labor participation. The European population is becoming older and older with low fertility rates and less ability to keep workers inside the Eurozone. This will harm long-term growth if we don’t do something. This can be done creating a mechanism in which students have their higher studies for free in Europe, but only if they work in the Eurozone for 10 years. Additionally, we should promote more immigration and make countries receive them if these countries have a very low fertility rate which will smooth shocks to population growth and decrease the possible risks of decreasing labor participation rates.
To sum up, all these measures require a huge amount of collaboration inside Europe and will only be possible if we move towards a Federation in the future. Despite the success that these measures may promote to the European Economy, we should take in account that reaching consensus over most major issues regarding economic decisions (divided by northern European creditor states and southern debtors) will be very difficult, because of cultural differences and the loss of sovereignty that each country will face if we move for a Federal Europe, which, right now, it’s not desirable for the majority of the member states.