Could employment-focused policies spearhead economic recovery in Europe?

In Development Viewpoint #66 we assessed the performance of two contrasting strategies for debt reduction in the US: a ‘fiscal-contraction’ versus a ‘fiscal-expansion’ approach. In this Policy Brief we apply a similar ‘fiscal-expansion’ approach to economic recovery in Europe, focusing here on the need, first and foremost, to foster rapid growth in employment. Employment generation should be a high priority for European policymakers, particularly because of secular declines in the size of the working-age population across the continent. Moreover, unemployment levels (especially among young workers) are unbearably high in many countries in the aftermath of the global financial crisis. So getting people back to work represents, indeed, one of the best strategies for debt reduction currently available. As in past exercises, we use the State of the World Economy global macroeconomic model to gauge the impact of such a strategy. In this case, we construct a model scenario that programs changes in macroeconomic policies that are designed to stimulate an employment-focused economic recovery in Europe (as well as in the US). We then compare this scenario’s results with those of a ‘baseline’ scenario (based on no change in policies). We are not interested in gauging short-term impacts alone so we extend our assessment through 2030. We present our results for blocs of countries (except for the UK and the US) because data in the model are aggregated in this fashion. We start with the policy lever that has the most immediate potential to stimulate Europe’s economies—i.e., an increase in government expenditures. We also assume that these expenditures will help promote private investment. For example, they could be public investments in infrastructure, skills training or new cutting-edge technology. In order to reinforce the desired increase in private investment, we also assume a modest stimulus to bank lending. Both public expenditures and private investment are marshalled to target an increase in employment, not economic growth alone. This target is based on the ratio of the number of employed to the number of people of working age. We calibrate the size of the stimulus in order to achieve a desirable, but also feasible, level of this ratio for each European bloc