Rebooting Europe

McKinsey Global Institute Prize Essay Competition: Opportunity for Europe, 2016

12 Pages Posted: 14 Oct 2016 Last revised: 17 Oct 2016

Dan Ciuriak

Ciuriak Consulting Inc.; C.D. Howe Institute; Centre for International Governance Innovation (CIGI); BKP Development Research & Consulting GmbH

Date Written: October 12, 2016

Abstract

The European Union is mired in a bad economic equilibrium of stagnation and deflation – stag-deflation. While the problem is excess supply and inadequate demand, current policy, premised on private-sector-investment-led growth, aims to expand supply further through ultra-low interest rates. This is demonstrably not working. The reason is that it raises the cost of labour relative to capital, thereby destroying jobs and demand, which negates the incentive for private sector investment. The next interest rate cut simply intensifies the deflationary pressures. At the same time, this policy is generating a debt burden that is a tinderbox for crisis. Incremental reforms will not work. Europe’s policy settings need to be reset to a configuration that has worked in the past. This involves the following: (a) re-price labour: recognizing that monetary stimulus, including quantitative easing, has not triggered interest-sensitive consumption and investment but has priced labour out of factor markets (as interest rates fall, the ratio of wage rates to cost of capital rises), remove the subsidy for investment and price labour back into the market by normalizing interest rates; (b) defuse the debt bomb: since raising interest rates in the context of a debt bubble would lead to a crisis, have the European Central Bank buy up excess public sector debt and cancel it. This would remove the tourniquet on fiscal policy, allowing a return to the job-creating expansions of the Keynesian era. Moral hazard? In crisis, ignore; and (c) redefine industrial policy by addressing the problem of adverse selection of investment opportunities: the current consensus supports investments with risk/return metrics that appeal to the private investor, leaving on the table investments that do not, but that may have strong public good characteristics. There is money on the table; Europe should seize it to restore growth, using its new-found fiscal room to manoeuvre.

Keywords: Europe, stag-deflation, paradigm shift, factor markets, debt jubilee, innovation, moral hazard

JEL Classification: E10, E31, E50, E60, F44, J23, O30

Suggested Citation

Ciuriak, Dan, Rebooting Europe (October 12, 2016). McKinsey Global Institute Prize Essay Competition: Opportunity for Europe, 2016. Available at SSRN: https://ssrn.com/abstract=2851329

Dan Ciuriak (Contact Author)

Ciuriak Consulting Inc. ( email )

83 Stewart St.
Ottawa, Ontario K1N 6H9
Canada

C.D. Howe Institute ( email )

67 Yonge St., Suite 300
Toronto, Ontario M5E 1J8
Canada

Centre for International Governance Innovation (CIGI) ( email )

57 Erb Street West
Waterloo, Ontario N2L 6C2
Canada

BKP Development Research & Consulting GmbH ( email )

Romanstrasse 74
München, 80639
Germany

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