Understanding All the Changes Europe’s New Euro Can Buy

The news from Europe seems confusing. As the 15 countries of the European Union move toward a single currency, called the euro, the people of Europe tell pollsters they don’t want the euro to replace their brightly colored francs, marks, pounds, lire and other notes.

In elections they vote for Socialist and other left-wing parties, as if to turn back the clock on economic reform. Yet politicians on both the right and left campaign to cut taxes and privatize state industries, hoping to qualify their economies for inclusion in the new single-currency system--and also in some way torelieve unemployment, which is running at 11% to 13% in Germany, France, Italy and other countries.

And progress continues toward monetary union Jan. 1, 1999, when the euro will become the official currency for government and business use--with euro coins and bills scheduled to enter general circulation in 2002.

A single currency, of course, means that all economies must be aligned, with similar discipline as to inflation and budget deficits. Thus the euro is to governments what a blackboard pointer was to schoolteachers of old--a means of enforcing discipline.

What it all means is that economic change is coming to the European Union, a grouping of 370 million people with $7 trillion in annual output of goods and services--a union as large in economic output as the United States and with 100 million more people.

And there are consequences for the U.S. economy and world markets. So we should try to understand the realities beneath the troubled surface of Europe’s economies.

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We should ask, for example, why the European countries tolerate such high rates of unemployment. We should also understand that a new Europe-wide currency could lead to a reduced value for the U.S. dollar and to higher interest rates--unless the U.S. government can balance its budget before 2002. Indeed, Germany’s attempt to revalue the gold reserves in its central bank--the Bundesbank--could affect U.S. interest rates, so interlinked are the world’s major economies.

Interlinked, yet different. The reason European countries tolerate such high rates of unemployment is that they operate with different priorities. One clue lies in Europe’s relatively low rates of labor force participation by women.

In Germany, the Netherlands, Italy and other countries, roughly 42% of the female population is active in the employed labor force. In the United States, 59% of women work at cash-paying jobs. Male labor participation rates are comparable at roughly 80% on both continents.

What those figures indicate is that European countries still have predominately male-breadwinner economies. They make jobs for heads of households and tax their incomes heavily--typically more than 60% in income and value-added taxes--to pay for children’s allowances, subsidies on milk and food, and prolonged unemployment benefits for those who do not get jobs.

The U.S. economy makes jobs for as many people as it can, but there are fewer social benefits available. Women’s labor force participation rates have been rising for two decades.

And the U.S. record of 12 million jobs created in the last five years stands in sharp contrast to that of Europe, where the major economies have created no new jobs.

Each side of the Atlantic defends it economic philosophy. European officials praise their economies as being pro-family and criticize the U.S. system as harsh and unfeeling. American economists respond with words like “eurosclerosis” and fears that the old continent will be a permanent also-ran in the global economy.

The characterizations are overblown in both cases, but, significantly, it is Europe that is being forced to change. All European governments now are trying to cut social programs in order to rein in budget deficits.

That’s why the issues in Europe’s many elections are about economic reform, not left and right. Britain’s new prime minister, Tony Blair, is openly following U.S. policy with regard to tax cuts and free trade. In Ireland, both major parties in next Friday’s election are promising to cut taxes because the country’s young middle-class workers don’t like paying 48% income rates.

France may vote Socialist again in today’s runoff election, but that’s because voters trust that party to adapt the economy without raising taxes.

The Netherlands is the model for reform in Europe today, having cut its unemployment rate to less than 6% through numerous agreements to cut wages while slightly reducing the average workweek to spread jobs around. Dependent on foreign trade for 55% of its economy, the Netherlands “must adapt to the world,” says a government economist.

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Even the biggest economies must adapt. A warning signal was sent to Germany’s highly paid workers recently when Daimler-Benz began producing a Mercedes sport-utility vehicle in Tuscaloosa, Ala. If a Mercedes can be successfully produced in Alabama, then “there is nothing so particular about the skills of Germany’s workers that would justify paying them” roughly three times the going rate in Alabama, says Stefan Richter, head of TransAtlantic Futures, a Washington research organization.

New challenges to Western Europe also loom from next door. Poland, the Czech Republic and Hungary, with lower-cost food and manufactures to export, will soon gain entry to the European Union.

So the traditional economies, however family-friendly, will adapt or fossilize. The struggles of France, Germany and Italy to qualify for the single currency say they will adapt.

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But lest Americans feel smug, they should understand what effect the coming of the euro will have.

“It will be held in official reserves by European central banks that now hold mainly dollars,” explains economist John Mueller of Lehrman Bell Mueller Cannon, a research firm in Arlington, Va.

“To the extent they hold euros, they will dispose of dollar holdings,” Mueller goes on. “And that will reduce liquidity in U.S. markets.” That means higher interest rates.

Foreign central banks invest their dollar holdings in U.S. Treasury securities. Such investments swelled total foreign holdings of Treasuries to more than $600 billion last year. That money helped the U.S. economy run a budget deficit and still have low interest rates to finance expansion and job creation.

In an interlinked world, in other words, Americans have benefited from Europe’s economic weaknesses. But that day may be drawing to a close.

The news from Europe is not really confusing; it’s ironic and thought-provoking.