PARIS: The 1990s have been Europe’s Janus decade. Having dispatched communism, much of the Europe that rests east of the Elbe faces strong growth and a brighter future. Europe’s western half, however, is facing darkness. Economic growth is at its lowest since World War II, averaging a scant 1.3% since the decade began. Prolonged slump imposes not only mass unemployment, but stagnant wages, increased poverty, and rising inequality. Europe’s bright hopes for the future have dimmed.

Aggravating the Continent’s defeatist outlook is a realization that the proposed cures seem as bad as the disease. All imply that Europe can no longer build on the legacy of its glorious postwar decades, that time when its peoples secured both economic growth and high social equality. Today, Europe is told it must choose between one or the other. The path to the future, it is said, starts by marching backwards.

Europe’s future, however, may not be as dark as is feared. Achieving growth rates equal to those of the postwar decades may be unrealistic, but resigning oneself to a sterile status quo is an unnecessary surrender. It is also dangerous to social cohesion and democracy. To really cure Europe’s ills, policies must attack the source of infection: the dominance that lenders now hold over borrowers in financial markets.

This dominance was established over the the last 16 years. As globalization of financial markets and the emergence of newly industrialized countries fueled demand for credit, the anti-inflationary monetary policies implemented in the early 1980s restricted its supply. This put lenders in the driver’s seat. They could push up interest rates, hence profits, without fear. As a result, real interest rates are stuck at unprecedentedly high levels for the longest duration in the history of Western capitalism.

High interest rates imposed adjustments that, in Europe, caused years of low growth. Firms that traditionally borrowed on the financial markets avoided these high rates by relying on their own profits. To secure profits high enough to do this, however, bosses aggressively cut back on labor costs and investment. So successful were they at this gambit that some firm’s find themselves, for the first time since WWII, able to act as lenders in their own right.

A firm’s decision to lend, not consume capital to expand its market share, results in unemployment as well as growing pressures on those still in the labor force. Employees must work harder for equal or lower pay. This vicious cycle particularly affects recent college graduates and low skilled workers. It also incites insecurity in the middle class because it signals that the risks of falling down the social ladder are increasing at the very moment an upward climb becomes more difficult.

For the poor and unemployed, the public sector once provided a last refuge. But today’s public sector is not immune from the effects of high interest rates. A sluggish economy depresses tax revenues and increases social expenditures, leading to high public deficits. Because a big slice of these deficits must be financed through borrowing at high interest rates, a growing public debt relative to income results. The sheer scale of public borrowing precludes interest rates from falling despite the presence of new lenders on the scene. So a firm’s success in decreasing its private debts leads to an increase in the public debt. One victim is substituted for another.

Beleaguered by pressures to finance their deficits, governments try to create conditions favorable to lenders by keeping inflation rates low and debt to income ratios stable. To do this, they restrict monetary and budgetary policies. But this policy mix is counterproductive. It cuts social expenditures at a time when they are most needed, and fails to provide a strategy for dealing with ongoing high real rates of interest.

In order to begin to cure today’s maladies, incentives are needed for firms to borrow and to expand their operations. But this requires a vastly different policy mix than practiced in Europe today. It demands an expansionary monetary policy coupled with a restrictive budgetary policy.

An expansionary monetary policy will lower interest rates, making it cheaper to finance public debt and inducing firms to invest in the "real," as opposed to the financial, sectors of the economy. A restrictive budgetary policy lowers public expenditure, reducing public deficits and thus reliance on financial markets for government finance. Curtail the state’s appetite for credit and interest rates will begin to fall, as has been the recent American experience.

Wielding a knife to budgets, however, is not enough. To lower public expenditure without exacerbating the inequalities which slow growth imposes on society, public sector structural reforms are demanded. First among these is a drive to increase public sector efficiency dramatically. This will assure that social benefits can still be delivered despite budget cuts.

Such a change in the policy mix is beginning to be implemented, as Europe takes a lead from the United States. Policies of the type pioneered by President Clinton (a huge drop in America’s budget deficit followed by falling interest rates) increased employment without inciting inflation. Great Britain and Italy traveled much the same path in 1992, also happily. Now France and Germany seem, at last, to be going down this road.

The question is whether European policymakers can muster the political determination to adhere to the new course long enough for the economy to gain momentum. Because Europe has been profoundly afflicted by its slump, the change in policy regime will take time for the Continent’s economy to get wind in its sails.

In determining the precise policy mix to follow and whether or not structural reforms will be introduced, policymakers must first decide whether the haughty dominance of lenders over wage earners is to be perpetuated. Economic policies always arbitrate between different social groups. If the political determination to follow a new course can be mustered, economic growth will once again be within Europe’s grasp.