Flashback to Western Europe, circa 1994. It's the era of "Eurosclerosis"—a chronic malaise of anemic growth, high unemployment and a political class in deep denial about the continent's problems. The EU's official jobless rate was 10.5 percent, versus only 6.1 percent in the United States and 2.9 percent in Japan. The "official" numbers didn't even include tens of millions of Europeans who'd dropped out of the work force altogether, or were sloshing around in the continent's vast labyrinth of government make-work and often useless re-education programs. In its 1994 Jobs Report, an alarmed OECD warned that Europe's mass unemployment threatened to "unravel the social fabric [and undermine] the authority of the democratic system."
You'd have been called insane then to predict that one day Europe would create jobs far faster than America and be close to eliminating mass unemployment. Yet thanks to what Allianz chief economist Michael Heise calls Europe's "jobs miracle," that is precisely what's been happening. As a result of a decade of labor reform, wage moderation and booming markets for its products, the EU has created 17 million jobs since 2000, outpacing the United States over the same period. Even the economic downturn emanating from the United States hasn't stemmed the tide. Despite the World Bank's slashing of its 2008 eurozone growth forecast from 2.8 to 1.7 percent, Europe is still churning out jobs. According to last week's Employment Outlook Survey by Manpower, employers in the four biggest EU economies—Germany, France, Italy and Britain—say they expect to keep up their pace of hiring through the third quarter, while U.S. and Japanese companies are cutting back. At 6.7 percent, Europe's jobless rate is now the lowest it's been in a quarter century, and barely 1 point higher than America's 5.5. "I'm shocked," says Michael Burda, an American economist at Berlin's Humboldt University who remembers the 1990s. "All my students are getting jobs."
All this has happened while masses of new workers—women, older people, the previously discouraged—have been flooding the job market, raising the labor-participation rate from just 61 percent of working-age Europeans in 1994 to almost 70 percent today. By all accounts, Europe's biggest and most intractable social and economic scourge on its way to defeat.
You might think Europeans would be rejoicing—and politicians falling over themselves to take credit for the turnaround—but you'd be wrong. A wave of discontent has spread across Europe. In many countries, the reforms that helped kick-start the jobs miracle have been put on hold or reversed. In Germany, Chancellor Angela Merkel's coalition government has not only frozen economic reform but has begun to reregulate the labor market with new minimum wages and higher jobless benefits. That hasn't stopped 15 percent of German voters from supporting the radical-left Linkspartei, which vows to undo reform. In Italy, voters just kicked out Mario Prodi, under whose watch Italy created 430,000 jobs. He joins a long list of leaders—including Spain's José María Aznar, Austria's Wolfgang Schüssel and Germany's Gerhard Schröder—who lost their jobs after passing reforms. As a result, Burda warns, Europe's turnaround is on the verge of stalling.
The discontent is due in part to reform fatigue. Labor reforms, and the cuts in welfare benefits that made it more attractive to look for work, continue to be deeply unpopular. And Europe has seen a lot of radical reforms since the late 1990s, as more and more countries finally have become serious about battling mass unemployment. Tito Boeri, labor economist at Bocconi University in Milan, counted 304 unpopular labor reforms (those involving a decrease in employment protection or benefits) from 1996 to 2005 in the major EU economies, versus just 77 the decade before. Now that the employment numbers have improved, he says, politicians are reverting to form.
With economic headwinds growing, voters are even less eager to hear about reform. But the main problem with Europe's labor reform is that it has been haphazard and incomplete. A two-tier system exists: even though Germany, Italy and France have allowed more flexibility in hiring temp workers, it's still nearly impossible to hire and fire permanent staff.
That's the main reason Boeri estimates that more than half of the 21 million jobs created since 1994 have been fixed-term or other nonpermanent work.
The question now is whether politicians will have the courage to finish the job. Unions and their lobbyists in Brussels are pushing for further reform rollbacks. But there are some signs that leaders are willing to move forward. In France, President Nicolas Sarkozy has taken up labor-market reform again after a failed start last year. Germany, though it has stalled for now on labor reform, is finally starting to get serious about improving an education system that has dramatically failed to provide lower-class kids with even the most basic employable skills.
The risks of not continuing on the path with reform are clear. Unemployment has not fallen as much in the big Continental economies as in star performers like Denmark, Britain or the Netherlands. That means fewer people contributing to the economy, and unemployment spending that could better be used for pro-growth programs like education. As the economic picture darkens, economists say, unfinished reforms put the continent at a higher risk of wage-price spirals and even stagflation. Reregulating back to the 1990s, as the anti-reformers want, is even less of an option. In today's era of global competition, the fallout would make 1994 look kind by comparison.