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Reprieve or Reform in Europe?

MILAN – The first round of the French election turned out much as expected: the centrist Emmanuel Macron finished first, with 24% of the vote, rather narrowly beating the right-wing National Front’s Marine Le Pen, who won 21.3%. Barring a political accident of the type that befell the former frontrunner, conservative François Fillon, Macron will almost certainly win the second-round runoff against Le Pen on May 7. The European Union seems safe – for now.

With the pro-EU Macron seemingly headed toward the Élysée Palace – the establishment candidates on the right and the left who lost in the first round have already endorsed him – the immediate threat to the EU and the eurozone seems to have subsided. But this is no time for complacency. Unless Europe addresses flaws in growth patterns and pursues urgent reforms, the longer-term risks to its survival will almost certainly continue to mount.

And, as has often been noted, the French election, like other key votes over the past year, represents a rejection of establishment political parties: the Republicans’ Fillon came in third, with about 20% of the vote, and the Socialist Party’s Benoît Hamon finished fifth, with less than 6.5%. Meanwhile, the left-wing Euroskeptic Jean-Luc Mélenchon won 19.5%, putting the total share of voters who chose candidates of non-traditional parties – Le Pen, Macron, and Mélenchon – at nearly 65%.

Unlike last year’s votes for Brexit in the United Kingdom and Donald Trump in the United States, which were driven by middle-class, middle-aged voters, in France, the young led the way in rejecting the establishment. Among 18-34-year-olds, Mélenchon – who has so far declined to endorse Macron for the second round – received roughly 27% of the vote. Le Pen was the second most popular candidate among young voters, especially the less educated.

This trend is not exclusive to France. In Italy, the anti-establishment, Euroskeptic Five Star Movement has surpassed the center-left Democratic Party in recent polls, with the young comprising a significant share of that support. Likewise, in last December’s Italian referendum, younger voters formed a substantial share of the vote against the constitutional reforms – essentially a vote against then-Prime Minister Matteo Renzi, who had staked his political survival on their adoption.

Of course, even in the face of weak and declining economic performance, there may be an upper limit to the support that populist parties can muster – a level that falls short of a governing mandate. But the fact that parties and candidates that reject the status quo are gaining ground, particularly among young people, reflects profound political polarization, which generates governance challenges that could impede reform.

Yet reform is precisely what is needed to address these trends, which reflect fundamental problems with today’s prevailing growth patterns. In France, Italy, and Spain, growth is too slow, unemployment is high, and youth unemployment is even higher. In France, the youth-unemployment rate is in the neighborhood of 24%, and trending downward only slowly. Youth unemployment in Italy stands at 35%, and exceeds 40% in Spain.

These are countries with substantial social-security systems. But those systems protect labor-market incumbents much more than new entrants. And the reforms that have been implemented, in order to ease entry into work, are not sufficient in the context of weak overall growth.

Without deeper reform, the demographic arithmetic suggests that the disenfranchised and anti-establishment share of the population may grow (unless today’s young people change their stripes as they age). The question is whether this trend will lead to a genuine disruption of the status quo or merely to political polarization that weakens government effectiveness.

The solution to European economies’ woes seems clear: a set of reforms that encourages more vigorous and much more inclusive growth patterns. After all, while globalization and technology lead to job displacement, sufficient growth can ensure that overall employment is sustained. To that end, reforms are needed at both the national and EU levels.

While each EU country has its own specific features, some common reform imperatives stand out. In particular, all countries need to reduce structural rigidity, which deters investment and hampers growth. To boost flexibility, social-security systems have to be largely disconnected from specific jobs, companies, and sectors, and rebuilt around individuals and families, income, and human capital.

The remainder of the domestic reform agenda is complex, but its goal is simple: enhance private-sector investment. Under this heading are items like regulatory reform, anti-corruption measures, and public-sector investment, especially in education and research.

At the European level, the most important recent development is the weakening of the euro relative to most major currencies, especially the US dollar, since mid-2014. This has caused the eurozone to run a substantial surplus and helped to restore some competitiveness in the tradable sectors in France, Spain, and Italy. In all three countries, tourism is an important sector for employment and the balance of payments, and expenditures have been rising when measured in euros.

Of course, the weaker euro has fueled large surpluses in Germany and northern Europe, where unit labor costs are lower, relative to productivity. In the longer term, convergence of unit labor costs is needed. But that will take time, especially in a low-inflation environment. In the meantime, the weak euro may help to spur growth.

EU-level action is also needed on immigration, which has emerged as a major economic and political issue. Faced with inflows of huge numbers of refugees from the Middle East and Africa – inflows that exceed many countries’ absorptive capacity – the EU may need to modify the free movement of people for a period of time.

After Germany, France is the most important country in the eurozone. If a Macron victory is treated as an opportunity to pursue aggressive reforms targeted at boosting growth and employment, the French election may amount to an important turning point for Europe. If, however, it is treated as a validation of the status quo, it will produce only a short reprieve for a besieged EU.

Now watch this video on the challenges facing France’s President-elect Emmanuel Macron: