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Debt crisis pushes Europe toward economic reforms

world Updated: Jul 02, 2010 16:18 IST

AP
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In the ashes of Europe's debt crisis, some see the seeds of long-term hope. That's because the threat of bankruptcy is forcing governments to implement reforms that economists argue are necessary to help Europe prosper in a globalized world but were long viewed as being politically impossible because of entrenched social attitudes.

Changes such as making it easier for companies to fire workers or stare down unions were until recently dismissed as simply not being the "European way." Similarly, many were skeptical that European governments would or could tackle bloated public payrolls, trim entitlements or force people to retire later.

When it became clear earlier this year that Greece's debt crisis was rattling markets everywhere and dragging down Europe's common currency, it was business as usual: European governments seemed to dither, disunited.

Germany came in for particular criticism, appearing to hold up a bailout of Greece because it was unpopular with German voters. But over two months of hectic activity a new narrative has started to settle in, to the surprise of many a euro-skeptic: When the chips were truly down, the countries of the European Union found a way to strike hard and fast- and together.

European leaders first joined with the International Monetary Fund in May and agreed on a $1 trillion rescue fund for financially troubled countries. Then Greece announced deep budget cuts, Spain cut employer costs and France raised its retirement age. France also joined Germany and the U.K in imposing harsh budget cuts. To Marco Annunziata, the London-based chief economist for Unicredit, those are signs that Europe is finally facing the reality that it must make structural changes.

"Governments are reluctantly acknowledging that reforms are needed and there is no more room for delays and excuses," he said. "It looks like perhaps we are past the longest stage of denial, which in Europe has lasted at least 20 years."

Annunziata said governments now face a crucial test of political will: Can they implement the reforms they have announced? Already in Italy, Premier Silvio Berlusconi has suggested he will reconsider some of the austerity measures he announced last month to trim the deficit after facing opposition and seeing his popularity dip. And France will have to steel itself for strikes. Still, there are signs that Europe may muster passing grades. In Spain, employers had long moaned that laying off workers is so expensive that they were wary of hiring in the first place. Political leaders felt no urgency as the economy grew at a healthy clip, buoyed by a construction boom and cheap credit. Nor did they when the boom ended and the jobless rate soared to 20 percent. Then came the May 28 decision by the credit rating agency Fitch to downgrade Spanish debt.

Facing a growing risk of a debt default, the Spanish parliament quickly passed measures that make firing cheaper and even let companies talk their way out of collective bargaining agreements if times go bad.

The changes were imposed by Prime Minister Jose Luis Rodriguez Zapatero's government almost overnight, after nearly two years of state-sponsored talks between unions and management finally collapsed a few weeks ago.

Sandalio Gomez, a professor of management at IESE Business School in Madrid, noted that the government also has enacted euro15 billion ($18.7 billion) in spending cuts to slash the deficit. The cuts reduce civil servants' wages and public investment and freeze retirement pensions.

"If we were not in the midst of a sovereign debt crisis they wouldn't be doing it," said Stephen Lewis, chief economist at Monument Securities. "They wouldn't be inviting the negative reaction from their own labor forces."

Spain's workplace package was passed as a fast-track decree and is now subject to amendments by Parliament over the next month or so.

Under the old law, many workers have contracts that give 45 days of severance pay per year worked. These will remain for old contracts, but for new ones the figure goes down to 33 days of severance per year of work.

Also, companies in economic trouble can now negotiate with workers to lower salaries and reduce shifts or other terms of employment, and call in an arbitrator for a binding ruling if the talks hit a deadlock. That's still generous, compared with practices in the U.S. and other less regulated economies, but a start. Spanish unions are furious and have called a general strike, but not until Sept. 29, after the sacrosanct monthlong summer vacation ends.

Like Spain, Greece is shaking up its stodgy, rule-bound practices on hiring and firing. The hope is to encourage hiring and stimulate economic growth that will be needed to help pay down a swollen debt load.

In December, the government revealed it had fudged its deficit numbers. Prohibitively high interest rates soon followed, forcing Greece to accept a euro110 billion ($138 billion) EU and IMF bailout, with policed austerity as the price.

This month, Greece announced that companies could lay off more people and make lower severance payments. The maximum notice period was reduced from 24 months to four months. The short-term response to those moves has been a wave of strikes and riots.

Demonstrations also have been held in Spain and France. In fact, such measures were called for by the European Union in its Lisbon Strategy, an ambitious blueprint adopted in 2000 whose goal was to make Europe the world's most competitive economic bloc. Little got done.

One reason: the courage to enact change can be costly. Then-Chancellor Gerhard Schroeder loosened Germany's heavily regulated labor market as part of social spending reforms he undertook in 2003 and implemented for the most part by 2005. Economists say the changes helped get the German economy on track before the recent financial crisis. But they hurt Schroeder and his Social Democrats politically. In 2005, voters dumped him and Angela Merkel became chancellor.

Not everyone has the same sense of urgency. While Italy's debt totals 115 percent of gross domestic product, higher than Spain's, few structural reforms are being discussed there. One reason is that its unemployment rate of 8 percent is far better than in Spain, thanks to government-sponsored jobs support programs. Interest rates on Italy's long-term debt also haven't spiked as they did in Spain and Greece- at least not yet.