Ageing, Debt and Immigration in the Euro-Zone

2

SCUSA 63

Thinking Beyond Boundaries:

Contemporary Challenges to U.S. Foreign Policy

Wither Europe?

Ageing, Debt and Immigration in the Euro-Zone

The transatlantic relationship is America’s most enduring and arguably most important. The 62-year-old cornerstone of the relationship is the North Atlantic Treaty Organization (NATO), which has evolved from a collective defense arrangement into a mechanism for attaining transatlantic goals globally, as seen most recently in operations in Afghanistan and Libya. But NATO and US national interests in the region intersect in complex ways with Europe’s grand experiment in continental economic integration, the European Union. Twenty of the twenty-eight members of NATO are also members of the European Union. Indeed, the continent’s economic integration is an essential pillar of its regional security strategy. Through the purposeful blurring of national economic boundaries, Europe has sought to diminish the risks of the inter-state conflict that plagued the continent for much of its modern history. This deep connection between regional security and economic integration raises the stakes for U.S. foreign policy in the region. How does the United States delimit its own national interests in a situation of such complexity?

The most urgent item on the transatlantic agenda is Europe’s debt crisis, with its origins in the unsustainable fiscal policies of Greece and a handful of other Euro-Zone countries. The crisis directly threatens the viability of Europe’s monetary union, the stability of one of the world’s most important currencies, and decades of hard-fought institution-building. The successful resolution of this crisis holds huge economic and political repercussions for the United States. Yet, few agree on what a “successful resolution” would look like. In addition, diminished fiscal capacity across the EU and the United States holds significant challenges for managing not just the debt crisis but near-term challenges on the geo-political front, like fomenting economic growth and democracy in North Africa. Already, NATO partners are showing reluctance to invest in the alliance’s military capacity, arousing concern over burden-sharing across member-countries. Fears of a “two-tiered” NATO, in which some countries can contribute effectively to combat operations while others cannot (or will not) have been voiced at the highest levels.[1]

Exacerbating the fiscal positions of the EU countries is a major demographic trend: the ageing of Europe’s populations. The social contracts prevailing across the European Union include generous retirement benefits, which imply growing fiscal liabilities for these countries into the foreseeable future. An ageing population also makes it more difficult for Europe to grow its way out of its fiscal maladies, since an elderly person tends to be less productive and also to work fewer hours. A central conundrum for the European Union, and thus the United States as its major economic partner, is how to balance the rights of sovereign states to manage demographic change through internal policy decisions while recognizing the collective impact of those decisions on its partner countries.

One time-honored way to augment the available labor force and improve long-run growth prospects is encouraging immigration. A broader and more competitive labor market across Europe would reduce costs of hiring workers across the continent, making its products more competitive in world markets. Yet, immigration poses its own challenges to social cohesion and to European identity. It also raises questions about state security if terrorists can enter European countries more easily, if large and resentful groups second-class citizens emerge, or if an ultranationalist or ethnocentric backlash occurs.

How Europe’s leaders address the questions of ageing, debt, and immigration will shape the continent’s interaction with America and the world in the years to come.

Europe’s Debt Question

Europe’s sovereign debt crisis began in the spring of 2010, when Greece revealed that previous estimates of its budgetary deficit were inaccurate. New estimates for 2009, which were released in April 2010 and November 2010, put Greece’s deficit as a proportion of its Gross Domestic Product (GDP) at 13.6%[2] and 15.4%[3] respectively, well over the 3% level required for membership in the Euro-Zone and well over the 12.7% previously reported. The country’s debt-to-GDP ratio is projected to rise above 150% by 2012. This information led Standard & Poor’s to downgrade Greece’s debt to “junk” status,[4] forcing interest rates on Greek bonds to rise to over 15% to compensate investors for the increased risk of holding these assets.[5] In the vicious cycle that can seize financial markets, the extremely high cost of borrowing further undermines faith in Greece’s ability to repay its bondholders, relentlessly raising the threat of a sovereign default and thus the cost of borrowing continues to rise.

As a member of the Euro-Zone, Greece has no national currency to devalue in an effort to reduce its national debt burden. Its only options are a default, a loan or transfer from Euro members to Greece, or a new financial instrument, such as a Eurobond, that would allow for a consolidation of national debt instruments into a single EU-backed bond.[6] All the options hold perils for the European Union and are proving politically unpalatable in big Euro-Zone economies, particularly Germany. To date, Euro-Zone leaders have managed a €110 billion loan to Greece at a rate averaging around 5%, which is substantially lower than the prevailing market rate for Greek debt.[7] In addition, they have set up the European Financial Stability Facility (EFSF) in order to raise funds to support ailing Euro-Zone members.[8] None of these steps has stemmed the crisis. From a policy standpoint, however, one thing is painfully clear: every solution requires fiscal austerity,[9] as the markets and demographics exert their inexorable pressures on Euro members to live within their means.[10]

This fall, bond yields in both Italy and Spain have climbed to rates widely seen as unsustainable.[11] Widening gaps between the interest rates on Spanish and Italian bonds and those on German bunds pose a severe risk to the continuity of the single currency, the monetary union, and the fiscal solvency of EU members. While the crisis began in Europe’s periphery, it is now boring into the Euro-Zone’s core. New rumors of a downgrade of France’s credit rating have plagued the European debt market,[12] and analysts are noting that the EFSF simply cannot absorb the volume of Italy’s sovereign debt if it becomes the next country to fall. The widening of the crisis has prompted Euro-Zone leaders to consider a restructuring, or partial default, for Greece.[13] Such a restructuring would involve bondholders taking a “haircut,” which means accepting late or partial repayment of Greece’s debts. This step entails costs to bondholders and clearly has repercussions throughout global financial markets.

The policy implications of the Euro-Zone’s debt challenges are immense. Their dilemma is stark: deepen their economic union by accepting a degree of fiscal harmonization and sacrificing a degree of national sovereignty[14]or loosen their union by allowing for the exit of countries from the Euro-Zone and opening the door to further exits that bring an end to Europe’s grand experiment. In which direction does the bulk of U.S.national interests lie?

Is Growth Possible for an Ageing Continent?

In order for European states to carry their share of the transatlantic political and security burden as well as manage the fiscal demands of the debt crisis, Europe must put itself back on the path to economic growth. Yet, Europe is the world’s oldest continent.[15] Although some studies indicate that an ageing population may have a positive impact on output per capita through the mechanism of increased saving and investment,[16] the preponderant view is that ageing populations will impede economic growth in Europe going forward. Addressing the demographic trend must be part of the economic policy solutions.

The ageing of Europe’s population directly affects its dependency ratio, which is the ratio of the economically dependent population (such as children, the disabled, and the elderly) to the economically active population. Europe’s high dependency ratio comes mainly from the high ratio of retired workers to working age adults and not from the number of children (who would enter the labor force in the near future). In other words, in Europe, older dependents represent a higher proportion of society than any other major geographic area on the planet.

Europe’s high dependency ratio has and will continue to have economic consequences. Increases in labor supply are a major component of output growth, accounting for almost half of the EU 15’s output growth through 2010.[17] Thus, in the absence of employment growth, which is the logical consequence of Europe’s population aging and its dependency ratio rising, Europe’s output is likely to stagnate or decline. In addition, the rising dependency ratio means that future workers will bear a larger and larger burden for the cherished social welfare programs, the bulk of which are used by the elderly in the form of generous pensions and state-provided health care. As Europe’s dependency ratio increases, intergenerational fairness becomes a challenging issue for European governments.[18]

The simplest way to reduce dependency ratios in ageing societies is for workers to continue to be employed productively for longer and to reduce any incentives for able-bodied individuals not to work. To do so would require changes in retirement and employment policies, which inevitably create social and political difficulties as labor unions rail against governements advocating increases in the legal retirement age or decreases in unemployment compensation.[19] How can the United States, with its own ageing population and fiscal challenges, best support the fiscal reforms required in Europe to meet its challenges?

Immigration – Costs and Benefits

Another way to relieve the strain of increasing dependency ratios is through migration of labor. Current migration into the EU is not sufficient to compensate for projected declines in the working-age population.[20] A United Nations population study concluded that, “to offset the projected population decline in Europe, the average annual net inflow of international migrants would need to be about twice as high during 2000-2050 (about 1.8 million) as that during 1995-2000 (approximately 950,000).”[21]

But immigration represents a political and social challenge for many European states, many of which have strong national identities and vital local cultures. Indeed, immigration calls into question one of the deepest purposes of a national boundary. In the first decade of the 21st century, Europe experienced a political backlash against the continent’s notion of “multiculturalism.” In 2007, French President Nicolas Sarkozy instituted a “ministry of national identity and immigration” that later proposed regional quotas on immigration.[22] Other European states have been even harsher, often even on migrants from within the EU-27. In Italy, Romano Prodi’s government approved a 2007 decree making it easier to expel EU citizens deemed to be a threat to public security.[23] In late 2010, German Chancellor Angela Merkel controversially proclaimed an end to Germany’s “multiculturalist” approach to immigration.[24] Spain, whose population was four years ago among the most open to immigration,[25] recently banned jobless Romanians from entering the country, a controversial measure that was ultimately upheld by the European Commission.[26] The Spanish case highlighted not only the challenge to national governments, but to EU institutions and their commitment to full labor and capital mobility.

Immigration policy has also sown discord within core members of the EU. Recent waves of immigration into Italy provoked conflict with France over whether such migrants can subsequently move elsewhere in Europe.[27] The July 2011 mass killings in Norway, whose suspected perpetrator penned a 1,500 page manifesto expressing many anti-immigration sentiments, have colored Europe’s immigration debate, with right-wing political parties becoming more circumspect about anti-immigration rhetoric.[28] In addition, unrestricted immigration may leave European countries more vulnerable to terrorist attacks launched from within their boundaries.

European leaders must evaluate the costs and benefits of increasing the arrival of non-European and intra-European migrants. A consensus seems likely to form around the importance of immigration to economic growth, but the modalities of managing population flows will be contested for some time to come. In the debate over international labor mobility, where do U.S. national interests lie?

Going Forward

Europe’s grand experiment in economic integration, and its significant implications for regional security, is being sorely tested. At its core, the current crisis follows from a fundamental lack of fiscal policy coordination across all members of the Euro-Zone combined with fiscal policy mismanagement within a few member-states. The crisis now threatens the viability of the entire monetary union and the stability of the world’s financial system. Europe’s fiscal woes at the national and supranational levels do not bode well for the region’s ability to manage long-term demographic trends and generate more robust growth in its labor force, in part through some immigration. Europe’s capacity to manage this troika of challenges will impact the EU’s capacity to act effectively on transatlantic and global issues going forward. As the relative weight of “The West” in the planet’s economic and military league tables declines, the collective capacity of the transatlantic community to meet emerging fiscal, monetary, and demographic challenges becomes increasingly important to both Europe’s and the US’s ability to maintain global influence.

Recommended Readings

Eichengreen, B. The European Economy Since 1945: Coordinated Capitalism and Beyond. Princeton: Princeton University Press, 2007.

Eichengreen, B., Obstfeld, M., & Spaventa, L. “One Money for Europe? Lessons from the US Currency Union.” Economic Policy 5, No. 10 (April 1990): 117-187.

Sloan, S. Permanent Alliance? NATO and the Transatlantic Bargain from Truman to Obama. London: Continuum, 2010.

Tett, G. Fool's Gold: The Inside Story of J.P. Morgan and How Wall St. Greed Corrupted Its Bold Dream and Created a Financial Catastrophe. New York: Free Press, 2009.

[1] Gates, Robert. "The Security and Defense Agenda (Future of NATO)." Brussels: United States Department of Defense, June 10, 2011.

[2] Bloomberg. "Papandreou Faces Bond Rout as Budget Worsens, Workers Strike." bloomberg.com. April 22, 2010. http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aUi3XLUwIIVA (accessed August 11, 2011).

[3] The Economist. "Europe's Debt Crisis: The Cost of Europe's Dithering." The Economist. July 11, 2011. http://www.economist.com/blogs/freeexchange/2011/07/europes-debt-crisis-0/print (accessed August 11, 2011).

[4] Ewing, Jack, and Jack Healy. New York Times. April 27, 2010. http://www.nytimes.com/2010/04/28/business/global/28drachma.html?adxnnl=1&adxnnlx=1313100101-S4mNnoIP9VpsophTqGrQrg (accessed August 11, 2011).