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Analysis: Europe puts its head in sand over growth crisis

Sep 5, 2011, 1:19 a.m.
European Union flags are seen outside the European Commission headquarters in Brussels ahead of an EU heads of state summit, October 27, 2010. REUTERS/Francois Lenoir

By Alan Wheatley, Global Economics Correspondent

LONDON (Reuters) - Japanization is shorthand for slouching toward that country's noxious mix of low growth and high debt. Euro zone governments will find it tough to keep the ugly new word out of their lexicon.

Concern is mounting over a deterioration in Europe's long-term growth prospects that, unaddressed, will make it even harder to tackle the banking and debt problems underlying the current life-or-death struggle over the euro.

The financial crisis that has been rocking the global economy since 2008 has permanently reduced trend growth across the industrial world. The Organization for Economic Cooperation and Development in Paris reckons the potential output of its 34 member countries has dropped by about 2.5 percent.

"A lot of countries are going to take a permanent hit to their trend rate of growth. This is not an ordinary recession and so we're not going to see countries bouncing back to pre-crisis rates of growth," said Philip Whyte, a senior research fellow at the Center for European Reform, a London think-tank.

As firms have gone bust, capacity has been lost for good. With demand subdued, profitable companies are not replacing old plants.

And as high unemployment persists, skills atrophy. This weakens productivity and shuts people out of the job market for longer and longer periods -- a danger stressed by Federal Reserve Chairman Ben Bernanke at the U.S. central bank's Jackson Hole symposium last month.

Apart from sapping animal spirits and forcing governments to raise taxes or cut spending, diminished growth closes off one route for lowering the high sovereign debt to gross domestic product ratios that have locked Greece, Ireland and Portugal out of the bond markets and are unnerving investors in Italian and Spanish debt.

Against this background, and with the scope for fiscal and monetary stimulus all but exhausted, politicians might be expected to grasp the nettle and push through reforms to improve the supply side of the economy -- policies such as making it easier to hire and fire, promoting greater competition and investing more in training.

Far from it. Pier Carlo Padoan, the OECD's chief economist, says he is less optimistic about the prospects for deep-seated change than he was at the start of the year.

"I see that measures are being announced. I would like to see them being implemented," Padoan said.

With policy ammunition running desperately short, he said it was time for governments to overcome their squeamishness about confronting vested interests opposed to change. "This is a luxury that many countries cannot afford any more. The situation does not allow it."

SOUTHERN DISCOMFORT

The vicious circle of rising debt and falling growth is made worse by the fact that those countries drowning in debt on the periphery of the euro zone are also the ones that have dragged their feet on freeing up their product and labor markets or modernizing their education systems.

"They're going through some truly horrible times. I'm very worried about the whole southern European fringe, not just on an 18-month to 2-year view but looking out a decade or longer," said Whyte with the Center for European Reform.

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