Demographics are destiny.
The foundations of the European Monetary Union, which provides the financial underpinning for the European Union, and its central bank, the European Central Bank, are increasingly fragile. Without significant structural reforms in its member countries, the EMU will unravel.
Across the currency union, public spending on pensions hovers around 12% of GDP. The contrasting rate in the United States is about 6%. To compound the challenge, total age-related spending is around 25% of current-year GDP. By contrast, the U.S. spends about 8% of GDP on the elderly. Because the populations of the region are aging rapidly, the burden of caring for the elderly will only increase.
Moreover, economists say that pension and related obligations for the countries that are members of the common currency union range between 200% and 500% of their national GDP, vastly overshadowing their explicit sovereign debt figures, which in some cases exceed 100% of GDP. In plain language, several of the most important countries of the EMU are broke.
Spain’s long-term fiscal challenge is especially daunting: its “promises” exceed 500% of GDP. Italy (438%) and France (400%) also have made fiscal promises that cannot be satisfied. In truth, there is no legitimate way out of the EMU’s fiscal black hole.
Economic growth across the region is stagnant. Optimists argue that the countries of Europe can grow at sustainable rates of around 1.5%. But given very low productivity growth rates and declining populations, even growing at 1% will prove challenging.
Spain is held up as the poster child of modern Europe, but economic growth in the country is completely dependent on immigration and fiscal transfers from Europe’s wealthy countries, principally Germany. Spain’s record on productivity growth is dismal.
To make matters worse, Europe is experiencing a high level of brain drain. The “best and brightest” Europeans— engineers, AI researchers, and entrepreneurs—are leaving. Confiscatory tax rates, coupled with stifling regulatory regimes and anti-capitalist cultures, compel the ambitious to migrate to pro-growth regions.
To compound the productivity challenges that European countries face, Spain and other large European countries welcome low-skilled immigrants. Many of these immigrants are functionally illiterate and innumerate. With significant brain drain and the influx of very low-skilled labor, Europe is falling farther and farther behind the U.S. and China in the technologies essential to the AI Revolution.
Now, Europe faces the challenge of social unrest. France, Spain, and even Germany have experienced violent protests in recent weeks.
All that stands between fiscal collapse in Europe or default on sovereign debt is the European Central Bank, which has the authority to purchase the debt of countries like France. In 2012, Mario Draghi, president of the ECB, said that the central bank would do “whatever it takes” to preserve the euro, the common currency. But given the unsustainable liabilities of countries such as France, Spain, and Italy, what happens when the global financial community begins to question the creditworthiness of the ECB?
The truth is that the solvency of the ECB rests on the German economy, which, by a wide margin, is the largest economy in the currency union. But Germany faces long-term economic stagnation. Energy for its industries is too expensive, German bureaucracy suffocates the private sector, and for decades the country has been plagued by low productivity growth.
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Today, Germany faces the bleak future of an aging workforce and shortages of skilled labor. Moreover, German businesses are completely noncompetitive in advanced technology and artificial intelligence.
The bottom line is that the foundation of the EMU rests on an economy in terminal decline.
James Rogan is a former U.S. diplomat who later worked in law and finance for over 30 years. He writes a subscription-based daily note on markets, economics, politics, and social issues. His email is [email protected].