Christopher Smallwood: To keep its place in the world, Europe must open its doors to immigrants

The latest clutch of economic statistics for the eurozone bring into sharp focus the extent of Europe's economic crisis. It had been predicted, following three years in which growth had scarcely managed to nudge above 1 per cent, that 2004 would finally be the year of the long-heralded upturn.

The latest clutch of economic statistics for the eurozone bring into sharp focus the extent of Europe's economic crisis. It had been predicted, following three years in which growth had scarcely managed to nudge above 1 per cent, that 2004 would finally be the year of the long-heralded upturn.

This year, after all, is witnessing a vigorous international recovery, with the US growing at more than 4 per cent per annum, and China, spearheading expansion across the Far East, clocking up growth in the region of 9 per cent. The hope was that, given such a favourable context, the economies of the eurozone could not fail to shrug off at least some of the torpor which has afflicted them over the last decade or so.

But it was not to be. After a promising start to the year, growth in the eurozone has fallen back to just 0.3 per cent in the three months to September. Germany and France, the two largest economies, grew by only 0.1 per cent. Forward-looking indicators suggest there is worse to come. The question is unavoidable: if the eurozone can't rekindle growth in an environment as favourable as this, when can it? Have Europe's economic problems become entirely intractable, or is it still possible to chart a path through them leading to economic renewal?

The answer depends partly on how far ahead one looks. The disappointed hopes of the latter part of 2004 are put down to a combination of high oil prices and the sliding dollar. The hope had been that a surge of exports to booming markets in the US and the Far East would kick-start growth especially in Germany and France, boosting consumer confidence and leading in turn to a sustained rise in consumer spending. Unfortunately, as in previous "upturns", the pick-up in growth was not sufficiently long lasting to encourage German and French households to reduce their (extraordinarily high) rates of saving and start consuming more like their Anglo-Saxon counterparts. As for external demand, this too may now subside as the US and China become more subdued, and the dollar's weakness curbs demand for European exports. In the short term, therefore, no significant pick-up in growth is in sight.

But these problems will not last forever. In the next two or three years, it will be difficult to prevent a further decline in the value of the dollar against the euro, or to reduce the excessive propensity to save which keeps demand weak, especially since the reform effort which reduces job security and pension entitlements leaves people feeling insecure and cautious. But looking further ahead, a major development is in prospect, so far largely overlooked, which should provide a sustained boost to the European Union's growth prospects. As the population continues to age, household savings in Europe - as they have done in Japan in recent years, where the ageing process is more advanced - will begin a steady decline, leading the problem of sluggish demand to cure itself.

This could provide the basis for a more encouraging economic performance a few years from now. The challenge above all is to improve the performance of Germany and France where markets are inflexible and savings chronically high. If in those two countries reform programmes could be carried through to deliver more flexible labour markets, so that it becomes possible to start drawing the "reserve army of labour" - the 10 per cent unemployment pool in those countries - back into employment as household demand rises, there could be a sustained boost to growth lasting several years.

Looking further ahead, however, Europe faces a still more formidable problem. Even if, over the next five or 10 years, "demand-side" problems, such as misaligned exchange rates, budget deficits and even inappropriate savings ratios sort themselves out, leaving long-term growth rates to be determined by "the fundamentals" - growth in the workforce and the growth of productivity - the Eurozone still looks notably disadvantaged compared with the US.

The first chart shows the marked difference in the projected growth of the workforce in the US and the EU which is expected in coming decades by the US Census Bureau and the European Commission. Whereas the working population of the US continues to grow, from now on the European workforce will shrink and the rate of decline will accelerate. This reflects Europe's low birth rate and its meagre rate of immigration when compared with the US. The result is that the US economy is likely to expand at least 1 per cent per annum faster on average, even if Europe catches up on the productivity side.

And as far as productivity is concerned, the picture isn't comforting. Productivity growth in the EU has been declining for many years and has been particularly low this decade. By contrast, it has been accelerating in the US as a result of the spread of new technologies and is currently rising at about double the European rate, as the second chart shows.

Adding employment to productivity growth, the European Commission expects that, in the absence of fundamental policy changes, US growth is likely to be double Europe's on average for decades to come. The consequences are stark. Whereas the US share of world GDP rises from 23 per cent to 26 per cent in 40 years' time, Europe's drops from 18 to 10 per cent, with all the loss of international significance and clout which that implies (the third chart). And within Europe, the pecking order turns around remarkably. Over the next 35 years, the populations of Germany, Italy and Spain are expected to fall by one-third; while in 20 years' time - even assuming that the Chancellor Gerhard Schröder's reforms succeed in raising German productivity growth to more normal levels - the 20 per cent fall in Germany's workforce expected by then leaves Britain with the largest economy in Europe.

Can the eurozone do anything to transform this dismal prospect? Although progress is slow, reform measures being pursued by some EU governments - aimed at more flexible labour markets, more competition and more incentivising tax systems - should eventually enhance productivity growth, making it possible for new technologies to be diffused through the economy at the US rate. But what is to be done about the falling working population?

Policies to encourage higher participation in the workforce could achieve a great deal for up to a decade if they were vigorously pursued. Increasing the participation of women, raising retirement ages to keep people in the workforce for longer, and reabsorbing the unemployed, could stabilise the workforce for some years ahead. But when these adjustments have been made, the underlying demographic trends will reassert themselves, with Europe losing ground rapidly and continuously against the US thereafter.

When that stage is reached, only one solution to falling numbers remains. Europe will maintain its relative economic weight only insofar as it is prepared to throw open its doors to economic migrants on the scale required to keep employment growing. This will only happen if there is a revolution in attitudes towards immigration, which may be difficult to achieve. After all, the earlier members of the EU, with the exception of Britain, refuse to admit citizens even from the new Eastern European member states, and many do not want to admit Turkey. And the current tensions in the Netherlands indicate the strains which can be associated with immigration from Islamic countries. But the fact is that it is only a union which remains true to its liberal values, which presents an open, welcoming and generous face to outsiders, which will be able to maintain its place in the world.

Christopher Smallwood is economic adviser to Barclays plc. This is a personal view.