Protesters against a draft amendment to French labor law clash with police during a demonstration in Paris on May 17 (XINHUA)

The EU economy is in trouble, with new uncertainties brought by Britain's exit, Italy's upcoming referendum, and growing risks in banking.

EU policymakers are vexed by the current plight, but they have yet to come up with an effective solution. To extricate the EU from its economic mire, the bloc's leaders must not only choose correct policies, but also take bold steps to solve deeply rooted systemic problems.

Comprehensive social welfare provision, disproportionate to current levels of economic development, has become a drag on EU economic growth. A broad cross-section of EU society agrees that maintaining the social welfare status quo is difficult but that pushing through even comparatively small reforms of the system is challenging because of vested interests. Yet, high social welfare costs continue to negatively affect economic performance.

The first consequence is high unemployment. When laying people off is difficult, employers are less willing to hire in the first place. Such reluctance largely derives from overly protective welfare provisions regarding workers' rights and complex redundancy procedures.

The second outcome is constraints on innovation. In today's world of globalization, companies must treat their capacity for innovation as critical to their survival. By soaking up a sizeable fraction of business profits, Europe's social welfare system inhibits development of the region's capacity to innovate, which in turn undermines its economy. In the Lisbon Agenda issued in 2000, the EU proposed that research and development expenditure should account for 3 percent of GDP. In practice, however, the proportion remains only 2 percent.

Welfare reform among continental European states presents such a challenge that it became one of the reasons for Brexit. Britain joined the then European Community in the 1970s, attracted mainly by continental Europe's economic vitality. Brexit, conversely, can be attributed to the decline in regional economic vitality. In late 2015, the British Government attached four conditions to the UK continuing its EU membership, one of which was a proposal to implement effective structural reforms to raise the EU's global competitiveness. But the proposal had little influence over other EU states, which stimulated to some extent Britain's EU departure.

Furthermore, the rigid political system hinders the taking of even miniscule reform measures. Under the Western governance model, politicians are relatively unmotivated to drive change, constrained by the maxim, "the person who conducts reform will have to resign."

But as time passes, EU nations face so many accumulated problems that they have no choice but to implement changes. Italy, which held a referendum on constitutional reform on December 4, is a case in point. Prime Minister Matteo Renzi has promoted change at the risk of losing his position, yet he cannot guarantee bright prospects under the new arrangement. At its core, Italy's constitutional reform referendum is about reducing the number of senators and simplifying legislative procedures in order to bolster the government's legislative power to gain approval for reform measures to expand the country's economy.

These days, as populism sweeps across Europe, staging referenda to make essential decisions on issues with major influence on national development has become the norm. Unfortunately, though, people tend to vote according to their everyday personal experiences rather than what's in their nation's best interests. Average citizens, after all, can hardly be expected to grasp highly complex issues and the ramifications of selecting among the various possible solutions. Thus, when it comes to a popular vote, the choice that best suits national interests typically goes unmade. It is time, therefore, for EU states to profoundly reflect on their political systems.

President of the European Central Bank (ECB) Mario Draghi (right) and Vice President Vítor Constancio attend a press conference at ECB headquarters in Frankfurt on October 20 (XINHUA)

The defects of eurozone governance have brought about a plethora of major problems in a comparatively short space of time. The eurozone has a single currency and is still under development. In this context, the Deutsche Bank crisis appears to be the most prominent of the various problems. Given Deutsche Bank's huge 6.2-billion-euro ($6.5 billion) deficit in the third quarter of 2015 and the whopping $14-billion fine imposed by the U.S. Department of Justice this September, the bank is now considered to be "the riskiest financial institution in the world as a potential source of external shocks to the financial system," comparable to Lehman Brothers in the United States in 2008, according to The Wall Street Journal.

Europe has failed to come up with an effective solution. European Central Bank policy primarily aims at controlling inflation, and the institution is neither obliged nor empowered to act as a "lender of last resort" during a time of crisis. So, although the central bank is willing to support Deutsche Bank, its ability to render assistance is restricted.

The European Central Bank is not alone in having difficulty coming to the rescue. The German Government sees the need for action, but bailing out Deutsche Bank would not only contravene its principle of "no more aid for ailing banks," but also cause two problems. First, such assistance would conflict with the position on financial aid for Greece which Germany adhered to in the past. Second, the support could set a precedent for other member states to follow, leading to a wave of governments assuming bank debts and raising the specter of a new round of crisis. After the euro debt crisis broke out in 2009, the eurozone began to address systemic defects in its financial system mainly with a view to accelerating banking and capital integration. While this benefited the eurozone, it provoked opposition in Britain and elsewhere.

In conclusion, Europe must struggle to achieve substantial progress on institutional reform—an arduous process full of uncertainty—in order to surmount obstacles and restore economic vitality. The EU economy, therefore, still has a considerably long, hard road ahead before it may glimpse light at the end of the tunnel.

The article was originally published in Chinese in People's Daily

Copyedited by Chris Surtees

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