If it's broken, fix it!

Europeans are right to worry about their economy. Forecasters think that the eurozone economy will grow by a paltry 0.5 per cent this year. But the real problem is that Europe's sluggish performance is part of a long-term trend. An economic powerhouse in the post-war years, Europe has gradually run out of steam. Most economists think that Europe can only manage a growth rate of around 2 per cent a year.

This is well below the EU's own growth target of 3 per cent, set at the Lisbon summit in 2000. Then, EU leaders resolved to turn Europe into the world's most innovative and competitive economy by 2010. However, the EU is failing to deliver on its economic objectives. The drive towards creating a single market has slowed. The Lisbon reform process has not lived up to expectations. The European Central Bank (ECB) stands accused of being too strict, too slow and too opaque recent reform efforts notwithstanding. The Stability and Growth Pact, the eurozone's fiscal rulebook, has lost all credibility.

Nevertheless, there is little fundamental debate about how to fix the EU's economic policy framework. One welcome exception is a recent report from an expert panel set up by Commission President Romano Prodi and chaired by André Sapir, a Brussels-based economics professor. The report contains a host of useful policy recommendations, many of which the CER has long advocated, such as establishing an independent EU trustbuster and shifting the Stability Pact's focus from deficits to debt. However, what sets the report apart from similar exercises is that it returns to first principles.

After a thorough look at the EU's economic policy machinery, Sapir and his colleagues conclude that the picture is one of 'tension and confusion'. Confusion because within the EU's institutional machinery it is nearly impossible to tell who does what and how. This is bad for efficiency and accountability. And tension because member-states have given the EU ever more responsibilities for growth, jobs, competition and social justice without also handing it the power or the cash to deliver. As a result, policy failure has become almost inevitable.

To start with, says the Sapir report, the EU needs to be more realistic and more focused in its objectives. Economic growth should be the top priority. Here, the EU has a good track record see the growth-boosting effects of trade liberalisation and the single market. The agenda has changed, however. Tearing down national barriers to doing business was great for big industrial enterprises that could exploit economies of scale in a larger market.

But in today's fast-changing, globalised economy, Europe needs nimble, gutsy and tech-savvy enterprises. For these companies to succeed, the EU needs to put much more money into research and higher education. But it must move away from the 'shower principle' with which it now distributes grants. Funding should be based on peer review and channelled into 'centres of excellence' European versions of America's Massachusetts Institute of Technology (MIT).

To kick-start its economy, the EU also needs to make life easier for small start-ups and encourage more competition across the board. But, as the report admits, faster change also means more pain. Rather than keeping industrial behemoths in business through subsidies, EU governments should concentrate on making labour and product markets flexible enough to adjust quickly. The EU could help by setting up a restructuring fund that assists laid-off workers to relocate, retrain or start their own business.

The EU's other big challenge over coming years will be eastward enlargement. The old member-states fear that large income gaps between East and West will complicate decision-making, encourage mass migration and play havoc with EU policies for farmers and poorer regions.

The EU should therefore do its utmost to help the new members catch up. But the EU's system of regional subsidies, which finances a plethora of small projects across the EU, is not up to the job. Sapir and his co-panellists suggest a new catch-up fund that would invest in better bureaucracies and improved infrastructure both human and physical in the poorest member-states.

The EU should stop attaching multiple, often contradictory, objectives to its policies, so that it ends up with a neater and more focused economic toolbox. The member-states would retain responsibility for structural reforms, employment and social policies. In these areas, the EU would play a 'facilitating' role, for example through spreading international best practice. Independent regulators could take on tasks such as supervising electricity markets and other aspects of the single market. The EU's core institutions could focus on creating a growth-friendly macro-economic environment and helping the new members catch up.

Sapir's frank and radical report has received a mixed response. Some Brussels commissioners were hostile, not least because the report calls for the abolition of such EU staples as the Common Agricultural Policy.

But member-state governments may well be more receptive. They know that the EU cannot muddle through indefinitely, and that they need to reform the Union's economic rules and institutions sooner or later. The European Convention saw remarkably little discussion about economics partly because national finance ministries and central banks were jealously guarding their turf. This is unfortunate. Europe's long jobless queues and the widening gap with the US serve as reminders that economics is too important to be left to economists alone.