How Europe's New Goals Will Pay Off

The Parthenon atop the Acropolis hill. Greece is being forced to change. Aris Messinis / AFP-Getty Images

Call it Greece's China moment. Like an economy run into the ground by decades of socialism, as China's was before the country began reforms in 1978, Greece's political and economic order had failed. Greece wasn't crushed by Maoism but by its $400 billion national debt. When the market for Greek bonds dramatically collapsed in the spring of 2010, the country's prime minister, George Papandreou, managed to secure a $140 billion credit line from the European Union and the International Monetary Fund—under the strict condition that he slash public spending, raise taxes, and reform the Greek economy.

Much of the world—probably including most Greeks themselves—snickered at the idea that this most profligate and corrupt of Western nations could ever change its ways. Yet that is exactly what Papandreou has set out to do. He has faced down strikes and protests to start abolishing the tight controls on many sectors of the Greek economy, unleashing competition for the very first time. Ranked on the World Economic Forum's Competitiveness Index as one of the most inhospitable places to do business in the Western world, Greece now has a fast-track law to push through investment projects, and is setting up one-stop offices for starting a business. An education reform modeled after that of Sweden, where Papandreou once lived, will cede central control over universities and force them to compete for students. A radical new transparency law—aimed at rooting out corruption and the Soviet-style statistical fakery that obscured the true extent of the country's debt—could soon make Greece's the most open government in Europe. Once the Diavgeia ("clarity") law is fully in force in 2011, no government contract, expenditure, or administrative decision will be legally binding unless it has been made public on the Web.

If Greece stands for one of the darkest days of the world's debt crisis, it also stands for its silver lining. One after another, the overindebted countries of Europe have been forced by the crisis to address problems their leaders ignored in rosier times. Deep reforms and deficit cuts have become unavoidable in order for countries such as Greece, Spain, Britain, and Ireland to reduce their debts and regain the trust of markets. While in the United States politicians and economists still argue over whether austerity or spending is the best path to economic health, a growing number of European countries not only have embraced deficit cutting, but they are also looking for ways to boost long-term growth—so crucial for creating sustainable jobs, for financing government, and for paying off debt. Some of these reforms, like Greece's new transparency laws, are revolutionary and could redefine the way government operates. Others are straight out of the market--liberalization textbook, contradicting the widespread view in the West that the crisis would lead to a rejection of the market economy and usher in a new era of big government. Instead, governments are finding that without growth they cannot finance their debt, and without expanding markets they cannot achieve growth.

From the view of the year 2020, says Centre for European Reform director Charles Grant, this crisis—more than all the countless agendas drawn up by Brussels bureaucrats—may well have been the turning point that restored competitiveness and unleashed new economic dynamism in many parts of Europe. Overindebted and overspending governments (state spending averages 51 percent of GDP in the European Union versus 40 percent in the United States) will have no choice but to downsize permanently, vacating many niches of the economy that can be taken up by innovative, job--creating entrepreneurs. Budget rigor will force them to become more efficient, finding better and cheaper ways to provide services to their citizens.

Until then, however, the push to restore growth is a race that Greece—and Europe—could very easily lose. Without a sustained economic recovery, public finances will remain in crisis. Slashing public spending when the economy is already weak often pushes a country into recession. That, in turn, depresses incomes and tax receipts, making it ever harder to service the debt. To avoid this debt trap, the question for Papandreou and other leaders is therefore whether pro-growth reforms can kick in fast enough or are overwhelmed by the slowdown that comes from cutbacks in spending. Greece, whose debt is still rising and whose GDP was contracting by 4 percent in 2010, could yet fall into such a debt trap and be forced to default, as it did five times between 1826 and 1932 (though both Papandreou and his IMF watchers insist Greece is on track to make all its payments). Ireland, Spain, and Portugal are also struggling to boost growth quickly enough to avoid the trap.

Making it worse—some economists say intractable—is that they have to do this at a time when there are few locomotives elsewhere to pull them out of their slump. Many of their main trading partners in Europe aren't growing, either—or, in the case of Germany, are growing only their exports, which doesn't help others grow their economies. "The problems are without precedent," says CER's Grant, who predicts five years of "ghastly mess" for Europe, fraught with further political and financial tensions over debt, before the continent's economic renaissance emerges.

Today, the budget cutters and reformers include countries from every corner of the continent, every twist of the European social model. They include Mediterranean countries long considered irredeemably spendthrift. Italy, which has the highest debt as a proportion of GDP (120 percent) of any large economy after Japan, cut its budget by $30 billion in 2009—a small number but a giant first step for a debt-addicted country. Spain, struggling with an uncompetitive economy, a real-estate crash, and 20 percent unemployment, is deregulating its labor market to create new incentives for companies to hire workers. Britain and Ireland have slashed state spending, while Germany has passed a constitutional amendment—called Schuldenbremse, or debt brake—that outlaws deficits in the national budget beginning in 2016. Even in France the realization is slowly sinking in that the country's current welfare state, which produces the youngest pensioners in the OECD countries, is an increasingly unaffordable and unfair burden on the productive economy that sustains it. When President Nicolas Sarkozy took the first small step of raising the minimum pension age from 60 to 62 in October, it was one of the first times a French government has not pulled back (or watered down) a necessary reform in the face of public protest. "Real reform starts when the government money stops," says Valdis Dombrovskis, the 39-year-old prime minister of Latvia, another hard-hit country.

That the deepest reforms of all are taking place in Greece is only apt for that singularly dysfunctional country. But it's also proof of what even the most unreformable nation can do. The country is downsizing the number of politicians and civil servants with an administrative reform that slashes the number of municipal governments from 1,034 to 325, and of regional prefectures from 67 to 13. Collective bargaining has been de facto abolished, and companies are now free to set their own wages, which will help Greek companies become flexible and competitive. The massively loss-making state railway company, whose debt alone adds up to 5 percent of Greek GDP, will be overhauled.

Key sectors of the Greek economy, such as transport, tourism, and agriculture, are becoming more open to foreign investment. China is investing $7 billion in Greece's main port of Piraeus, slated to become Asia's new hub for all of Southeast Europe. Qatari investors have lined up for real-estate deals that used to be blocked by the bureaucracy. When all the reforms eventually kick in, Greece's GDP could benefit by as much as 17 percent, estimates Yannis Stournaras, director of the Foundation for Economic and Industrial Research in Athens. Deregulating trucking companies alone, says Stournaras, will generate one extra point of GDP by cutting transport costs, decreasing shipping times, and creating new jobs in the sector. If Stournaras is right, a new growth story is about to emerge from the Hellenic rubble.

For a similar growth dynamic to be unleashed elsewhere in Europe, however, the current reforms can only be a start. So far, politicians have focused more on the rigors of budget cutting than on the economic reforms needed to create growth, says Ann Mettler, director of the Lisbon Council, an economics think tank in Brussels. Although the EU Commission is trying to pursue Europe's lowest-hanging fruit—the opening up of its vast, 500-million—consumer economy by creating a truly single EU-wide market—that idea is not getting much support these days from the protectionists in the ministries of Paris and Berlin. Digital services, from broadband to Internet shopping, are hopelessly fragmented along national lines, as are energy, transport, and almost the entire service economy, where productivity gains and job growth have lagged far behind comparable economies like the U.S.'s. Nor has Europe acknowledged that the more competitive economies, such as Germany's, are part of the problem facing Greece, Spain, and the other countries that depend on growth to get out of debt. Although Germany's dynamic export com-panies are among the world's most competitive, its limpid and overregulated domestic economy has been stagnant, starved of investment, and acting as a drag on the rest of Europe's growth.

In the past, crises have created opportunities for countries and societies to reinvent themselves, just as now—booming China and India did after decades of stifling socialism and bitter poverty. Europe's recent history suggests that its leaders begin to push for reforms only when their backs are against the wall. Papandreou says his country's debt crisis, for all its very real pain, has made it possible to drive through changes that would not be politically possible in normal times. Europe may be still only in the middle of its debt crisis. But in struggling economies such as Greece's, the seeds of a revival are being sown.