Roads to recovery, chapter 7: Europe: challenges and risks

• Europe faces the challenges of redeploying its unused labour potential and tapping further growth potential out of structural reforms.
• The need for households, firms and governments to deleverage may hamper growth.
• Low inflation in Europe intensifies the setbacks from deleveraging.

The European economy can grow in the next decade. Increasing spending, falling unemployment and gradually growing income and inflation can reinforce each other in a virtuous circle. Structural reforms can increase production. Moreover, the available capacity can be better utilised. After six years of crisis, unemployment in many EU member states is high and the productive capacity underused. The recovery is threatened by the postponement of consumption and government spending and a negative spiral of low inflation and delayed growth.

Structural reforms in financial markets, the labour market, product markets and the internal market for services can increase productive capacity in EU member states. An increase in the productive capacity by more than 10% (compared to a situation without reform) may be possible, part of which could be realised in the next ten years. At present, however, there are still many people without work. Even without reform unemployment may fall without leading to tension in the labour market and rapidly rising wages.

Postponed spending is a major threat to the economy and recovery in the labour market. The Great Recession has had a major impact on the financial positions of households. As such, in a large number of Member States, including the Netherlands, the mortgages of many households are underwater. The debt burden of governments has increased sharply due to both bank bailouts and expansionary fiscal policy at the beginning of the Great Recession. A negative spiral of stagnation, low inflation, high debt and high savings rates may threaten the potential recovery.