Reform, when long discussed but never implemented, can do far more harm than good. Anticipation of a reform – say, of pension rules, the health system, or unemployment benefits – worries everyone who might feel the impact. In response, they cut consumption and save more, expecting that sooner or later they will have to start paying for some of the services they had been used to getting free or at subsidized rates.

But because reform in Europe is usually only discussed, the benefits fail to materialize: people work harder only when they are sure that tax rates are actually cut, and in financial markets the positive effects of lower government spending do not come before any reform is approved. In the meantime, as politicians debate and do nothing, consumer confidence falls, economic performance worsens, and the consensus needed to get reforms approved in the first place vanishes. Still the talk does not stop, nor does the fall in consumer confidence.

Germany’s recent experience provides a worrying example of this vicious circle. Reform of Germany’s generous social system has claimed the front pages for German papers for more than ten years. Some timid measures have been implemented, but the general feeling among Germans is best described by the following answer to a survey conducted two months ago by the newspaper Die Welt : “47% of those interviewed plan to cut consumption due to the uncertainty about pensions and health reform.”

The result has been a sharp fall in consumer confidence: the German index of consumer sentiment was small but positive in November 2000; it has since fallen to -20, the sharpest decline in the euro area.

Out on the street, pessimism runs rampant. For two years now, the growth rate of private consumption (measured at constant prices) has been negative: - 1% in 2002, -0.5% in 2003. Similar declines in real consumption are rare in industrial countries, as in bad years consumers typically draw on their savings to keep their consumption relatively constant. In the case of Germany, one has to go back to the early 1980’s to see similar negative numbers in consumption growth. As a result, rather than falling, the household saving rate has increased, rising from 9.7% of disposable income in 2000 to 11.8% last year.

Depressed consumption and higher savings have affected all age groups, but the relatively old have been more prone to the trend than the relatively young. The only positive signs in consumption are seen among the youngest households, those headed by people in their early twenties, who evidently hope that sooner or later the reforms will be approved and their tax burden reduced. But the saving rate even in households in their thirties has risen along with concern about reforms.

Not surprisingly, elderly people cut consumption more. With retirement, they have lost almost all options: they can no longer work more, nor can they sign up for private health plans – the insurance premiums at their age are too high. So they are forced to rely on their savings, and virtually stop consuming. Put this in the context of a rapidly aging population and the effects on overall consumption are dramatic.

Interestingly, France is the only large Euro area country where consumer confidence is growing (from -24 a year ago to -13 today). The reason is simple: as the 2006 elections approach, reforms have been shifted off the political agenda.

If a government does not have the will to adopt a reform program, then the best thing it can do is stop talking about reform altogether. This may start happening in Germany and for the same reason: consumer confidence remains lackluster.

Europe’s economy grew at an anemic 1.8% annual rate in 2004, and the OECD has recently revised downward its growth forecast for next year, from 2.5 to 1.9%, owing to the rising euro and the fall in exports – so far the only driver of the euro area economies. The common wisdom is that to faster European growth requires a boost from domestic demand. But this will not happen as long as politicians keep talking about reforms, while doing virtually nothing to realize them. On the contrary, all they are doing is spreading pessimism.

Europe has two ways ahead. It can forget about reform and enjoy the four or five decades it will take for its per capita income to fall below the level of, say, Chile, or it can deeply change its social model and start growing like the US. Doing nothing but talking, which is Europe’s current model of inaction, is the worst possible course.