Some economists believe that this summer could mark themoment when some of the eurozone’s peripheralmembers may begin to be forced out; others think that such a scenario is inconceivable. All agree that, at least in theshort term, a eurozone breakup would be disastrousfor jobs and growth.

But, because the outcome is unknowable, and depends on politics as much as oneconomics, let us leave that frightening prospect to one side and look insteadat what we know about the underlying performance of the European Union economy.In short, how competitive is Europe in thesummer of 2012?

If we compare theEU-15 (the membership before the enlargements of 2004 and 2007) with the US, the most obvious point is that GDP percapita in Europe is almost 25% lower, adifference of around $11,000 ayear. Furthermore, per capita EU productivity, which had been converging on the US level for 20 years up to1995, when Europe was only about 5% below the US, lost ten percentage points inrelative terms in the decade preceding theeurozone crisis. Europe was unable to match America’s significant productivityboost from the information-technology revolution.

But Europe managed tohold its share of global exports during that period more effectively than didthe US.European companies have been more successful, on average, at maintaining theirshare of emerging-market demand than have US companies.

Moreover, Europeanjob creation has not been as bad as many think. An analysis by McKinsey &Company of new jobs in the USand the EU from 1995 to 2008 suggests that, while the US created 20million new jobs, 19 million of them were attributable to population growth.The EU-15 created about 24 million new jobs during the same period, with onlynine million due to rising population.

This job creation wasnot evenly spread across Europe, but ithappened. That means that the EU now has successful employment models that canbe emulated.

There is also solidevidence that Europe’s big companies have beencompeting relatively well globally. The number of Fortune 500 companiesheadquartered in the EU has grown over the last decade, while the number ofthose based in the UShas fallen. Moreover, big European companies’ profits have grown 50% morerapidly than those of their American counterparts.

Few deny the need forfiscal consolidation in many EU countries, especially in the south (andincluding France).But fiscal adjustment must be accompanied by structural reform. It is clearthat the labor-market reforms undertaken by Germany a decade ago, painful asthey were, have put the German economy in a far stronger position to competeglobally. Similar reforms are urgently needed in countries like Italy and Spain.

Service-sectorreform is vital as well. Manufacturing productivity per hour in Europe comparesquite well with the US,but Europeans work significantly fewer hours per year, which explains theannual per capita difference. But European countries lag badly inservices, where restrictive practices, protectionism, and inefficiency holdthem back.

Spanish PrimeMinister Mariano Rajoy and Italian Prime Minister Mario Monti seem tounderstand these points, but the reform programs that they have unveiled are not adequate to the challenge.Although Italian employers have dismissed the proposed employment-law reform asfar too modest, Monti’s government has retreated in the face of trade-unionopposition and protests from assorted interest groups (like taxi drivers) eagerto defend their privileges.

Governments areinhibited by the knowledge that labor-market reform may well result in ashort-term increase in unemployment (and thus further fiscal deterioration),because employers will find it cheaper to fire personnel. The hope is thatgreater flexibility would also translate into a greater willingness to hire inan economic upturn.

For EU politicians,however, the long term will be reached only after a series of short-termelectoral challenges, so pro-reform governments may well not survive to reapthe benefits. As Luxembourg’sPrime Minister Jean-Claude Juncker remarked,all EU governments know what must be done; what they don’t know is how to getre-elected once they have done it.

Is there a way out ofthis dilemma?

Countries like Germanyare adamantly opposed to a fiscal union,with a central EU budget for responding to asymmetricshocks, because they would be the chief contributors. But a variant that might elicit greater support would link fiscal supportto labor-market reform. If Italyor Spainintroduced changes that led to a short-term increase in joblessness, the fiscalcosts would be met from a central EU budget to ease the pain. This “investment”by wealthier countries should pay off if it leads to more flexible labormarkets and higher productivity in the recipientcountries.

Another proposal is acentral-budget subsidy to reduce employment taxes in the EU’s most economicallychallenged countries. The logic is that a country like Greece needsdevaluation to enhance its competitiveness, but that leaving the euro wouldpose major problems. The alternative would be to cut nominal wages (“internal”devaluation), which is hard to do (though it has been achieved in Latvia and Ireland).

Reducing taxes onlabor, perhaps for a defined period, would have a similar effect. That would becostly for governments in the short term, though an increase in output andemployment might well justify the “tax expenditure” involved; here, too, an EUsubsidy might be a worthwhile investment.

If Europewants to revive sustainable growth and highemployment, it must replicate what has worked in those countries that haveperformed successfully. Doing so will cost money. Governments must be preparedto persuade their electorates that it wouldbe money well spent.