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The Reform Game

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.