Is this really the end of the road for Europe's 'tax and spend' economies?

'The issue is whether the next European generation will be forced to adopt the US government model'
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If a week is a long time in politics, a fortnight is a long time in economics. Here in Britain we have been preoccupied by the political implications of the fuel crisis, which has in one week utterly changed the political landscape. Across Europe the last two weeks have seen a similar tax revolt, which is helping to depress the euro to yet new lows and is raising grave questions about the sustainability of the continental European "tax and spend" economic model.

If a week is a long time in politics, a fortnight is a long time in economics. Here in Britain we have been preoccupied by the political implications of the fuel crisis, which has in one week utterly changed the political landscape. Across Europe the last two weeks have seen a similar tax revolt, which is helping to depress the euro to yet new lows and is raising grave questions about the sustainability of the continental European "tax and spend" economic model.

The past two weeks have seen a big shift in mood across Europe - something that we have not noticed much here because of the fun and games we have been having at the expense of Messrs Blair and Brown. The petrol protests in Europe have been less dramatic, partly because that have been more localised in their effects and partly because several governments have made immediate concessions. But in terms of a general loss of confidence in the ability of governments to meet voters' long-term aspirations, the European situation is even more serious than our own. One reflection of that is the continued plunge of the euro.

On Tuesday the economic adviser of the International Monetary Fund, Michael Mussa, suggested that there would have to be an international rescue package for the euro. Its continued weakness was, in his view, threatening to undermine confidence not just in Europe but in the global economy. He wanted co-ordinated intervention on the foreign exchanges by the Group of Seven countries. In other words the non-euro members of the G7 - the US, Japan, the UK and Canada - would join with the European Central Bank and buy euros on the exchanges. The hope would be that this buying would change the market mood. Something on these lines may well be discussed at the G7 meeting this weekend in Prague, but it would depend crucially on support from the US. Currently the US does not seem interested, but we will see.

The trouble is not just lack of US support. The wider difficulty is that such intervention might well fail if it were not coupled with structural reforms in Europe, especially deregulation and cuts in taxation. The weakness of the euro stems principally from European investors preferring to put their money into deregulated, low-tax America because they feel that the US economy will grow faster than the European one during the early years of this century, just as it did during the 1990s.

In an ideal world, the Europeans would simply cut taxes towards US levels and deregulate. Trouble is, there are profound political limits to this. Both Germany and France have tax cuts planned, but these would still leave personal taxation higher than in the US. Like the UK, they are also under profound pressure to cut taxation on goods and services too, particularly on fuel. But to give meaningful tax cuts requires cuts in spending, and that is not on either.

The pressure not to cut back on spending is widespread across Europe. One of the things the Danish government has promised, just last week, is that there would be no cuts in state pensions were Denmark to join the euro-zone. The Danes are understandably unenthusiastic about the idea of financing the pensioners of countries, such as Italy, that have an even more adverse demographic pattern that Denmark.

Here in Britain you can see similar pressure, though the focus is on the need to raise our meagre old age pensions rather than maintain more lavish ones. One of the things now being used to beat Gordon Brown about the head is his decision in the last Budget to raise the pension by only 75 pence a week. But our Chancellor does have several advantages over his Continental counterparts. The UK public is more aware of the impact of an ageing population; we have a very high proportion of people in jobs; we have an extensive private pension network; and we are ageing less quickly than any other EU nation, bar Ireland.

So while all governments are caught in the pincer movement between the need to cut taxation to boost economic growth and the greater demands of an ageing population, the squeeze is much tighter on the Continent than it is here or in the US. The only place in the world facing an even more serious squeeze is Japan, now in a seemingly permanent slump.

Until the last few weeks, the prevailing attitude in much of continental Europe towards this squeeze was to believe that the region could muddle though with modest tax-tweaking and modest cutbacks in the welfare state. For example, three years ago Germany introduced a so-called environment levy on its petrol, and has used the money to shore up its pension deficit. It also made some very modest cuts in pension entitlement. But there is still a projected deficit, and now the petrol levy may be politically unsustainable. Some 80 per cent of the population is against it.

In the last couple of weeks it has suddenly become apparent that tweaking may not work. People will not be prepared to pay for the services that they themselves demand. They will take to the streets if the price of petrol rises; but they will also take to the streets if their pensions are cut.

If tweaking won't work, what then?

Well, the issue is whether the next generation of continental Europeans will have to accept something closer to the US model of government than the one they have now. Taxes would be lower but services would be much leaner. The state would still supply a safety net - hopefully a more complete one than the US does - but most people who could afford to pay for what are now publicly-funded services would have to do so.

We now know that continental Europe is being forced to adopt many aspects of the US/UK economic model: the importance of securities markets and shareholders, deregulation of labour markets, the abandonment of state-owned industries and so on. Could it be that it will also be forced to adopt many aspects of the US government model?

In so far as the UK government is something of a halfway house between the US and continental Europe, maybe the long-term lesson of the past couple of weeks is that European governments will have to become more like ours. Only they will have to be a bit cleverer at listening to the public on little matters like fuel tax.

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