Europe Misses The Point.

Heise is chief economist for the Allianz Group and Dresdner Bank in Frankfurt.

Once upon a time, the governments of Germany, France or Italy could revel in their considerable accomplishments--the creation of a single market, a common currency, a bigger and bolder Union. But lately the celebratory champagne has gone more than a little flat.

For starters, there's last week's warning that Europe's vaunted "single market" is not living up to its potential. Sluggish growth and slackening productivity threaten to widen the economic gap between Europe and the United States, according to a survey by the European Commission. The report also warned of a developing "two tier" Europe, where some countries and regions (Scandinavia, for instance) will markedly outpace others, such as Greece, Italy and France. Worst, reforms are lagging on all fronts--putting in question Europe's self- declared goal of becoming the world's most competitive economy by 2010.

Then there are the troubles brewing on the fiscal front. Devised in 1997 to enforce financial discipline across the 12-member monetary union, the EU's Stability and Growth Pact imposes a ceiling on annual borrowing of 3 percent of GDP. Budgets must be balanced in the medium term, subject to heavy fines. These days the newspapers are full of reports about how these strictures are increasingly observed in the breach, as one EU member after another struggles to comply in a fast- deteriorating economic climate. First came Portugal (2001 deficit: 4.1 percent). Then came Germany, whose shortfall spiraled to an estimated 3.7 percent last year. A formal early warning has been issued to France, and Italy follows not far behind.

This flap misses the crucial point. The real threat to Europe's finances--and to monetary union--isn't the relatively small fiscal changes of the past year. (Will this or that country's deficit be 3.1 percent or a mere 2.8?) It's the fact that the Stability and Growth Pact no longer positions Europe to meet critical future challenges.

The biggest of those challenges is demographic. In a nutshell, the populations of the large European countries are (or will soon be) shrinking and aging. Over time, fewer and fewer workers will have to support more and more older people. This demographic time bomb threatens to make today's budget gaps look tiny.

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