Europe's risk aversion comes with consequences

As I watch Europe's deepening existential crisis over its grim growth prospects, I often think back to a speech I heard 16 years ago in Paris.

I was a lowly consultant for the Organization of Economic Cooperation and Development, but for some reason they had let me in to a fancy lunchtime reception, where I listened to a senior staff member describe how the financial crisis proved the validity of the European economic model.

Slow, steady and highly regulated growth, she explained, was superior to the American boom-and-bust version of capitalism.

What a difference a decade and a half makes.

Last year Mario Draghi, the former president of the European Central Bank, released his now infamous "Draghi report," which blames excessive and fragmented European regulations for strangling growth. Business owners in countries such as Germany must comply not only with their own country's regulations, but also with the EU's.

As a result, and they spend too many hours dealing with red tape, and the costs are unduly felt by smaller businesses.

According to the report, 55% of small- and medium-sized businesses cite regulatory obstacles as their greatest challenge. The General Data Protection Regulation, for example, has made it nearly impossible for small technology firms to compete.

This is a drag on European growth because smaller businesses are both more innovative and more likely to adopt new technology. The European Union was meant to spur growth by offering national economies access to a bigger market and more stable financial conditions. But all they've gotten is more financial and regulatory fragmentation. A lot needs to change - and lifting some regulations is a good place to start.

This will not be easy, however, and the Draghi report shows why. It's not just the many cautious references to ensuring safety and stability, or the explicit goal of an "industrial strategy" for Europe. The report reflects a much deeper issue that undermines growth: extreme risk aversion, especially in Germany.

To some extent, European regulations are designed to slow growth and increase certainty. European culture is just more risk-averse than America's. There is a reason stock ownership is lower and welfare states are bigger in Europe. Relatively speaking, the US is less regulated and more open to risk (which is one reason it has better growth prospects).

Remarkably, for all their differences, the US and Europe - as well as many developing nations - do agree on one thing: the need for deregulation. Some of the explanation is related to domestic politics, as in the US, where President Donald Trump's administration is banking on deregulation to unleash much higher growth rates to pay for its tax cuts and spending plans. But there are larger forces at play.

First, nations are realizing they need more economic growth to pay down debt and continue the rise in living standards their citizens demand. Growth will be especially critical for countries needing to pay for the care of aging populations. Second, new technology such as AI is transforming economies around the world.

This demands a rethinking of regulatory structures, not only so regulations can be more effective, but also to ensure countries can take advantage of the new opportunities a major transformation offers.

Whether these deregulatory initiatives will translate into more growth depends on how they play out. After a crisis, there are always calls for more regulation - and during periods of stagnation, there are often calls for less regulation. In both cases, however, what's actually needed is better regulation: Rules that update regulatory structures and institutions to fit the new economy.

In this case, that means giving them simpler and more flexible ways to meet the changing and unpredictable needs the adoption of AI will require.

Some leaders still don't get it. They promise that this economic transformation can be managed to the benefit of everyone. But technology-driven growth is inherently unpredictable and creates winners and losers. The most realistic hope for regulation is to limit externalities and fraud, not to ensure stability and predictability.

None of this is to say that regulatory reform - or, if you prefer, deregulatory reform - is doomed. It's only to say that finding the right balance between reducing risk and encouraging growth is as much about values as about economics. The purpose of government is to balance risk and reward for its citizens. The problem is that Europeans want more safety than they can afford.

And Americans may well get more disruption than they anticipate.

(COMMENT, BELOW)

Allison Schrager, a Bloomberg columnist, is a senior fellow at the Manhattan Institute and a contributing editor of City Journal.

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