With Greek banks nearly forced to fund their government, the Greek banking system is on the verge of collapse and a sudden bank run with foreign and domestic capital leaving overnight is a possibility.
British and French treasury officials are silently preparing for the possibility of a sovereign debt crisis in their country.
Europe struggles with such high levels of public debt that given the weak level of future growth, the considerable future social security and retirement benefits payments, most southern European countries, including France, will not be able to pay their debt service without borrowing heavily.
A number of European countries will have to default selectively on their debt before the end of decade.
Default will imply lower public spending, lower public employment and wages, and higher taxes.
Governments will be tempted to protect their companies by resorting to protectionism and distortions of free and fair competition.
So, is this the decline of European economic power?
Europe can survive the debt crisis in the long run if it sustains sufficiently high growth — that can, in turn, generate government revenue through taxation. In Europe two key long-term assets drive growth: The skill of its work force and the quality of its legal and institutional environment.
Europe has one of the most educated workforces in the world — and this translates into real economic gains: Economists estimate that increasing the number of years of education of the overall active population by one year increases productivity per worker by six percent.
The high level of education of the European workforce is also key to innovation and the production of high quality differentiated goods bought by the upper end of the market — cars and luxury products, high-quality machinery for manufacturing, planes, and high-speed rail, among others.
Europe also has a very high quality legal and institutional environment, with a relatively fairer and more transparent judiciary than in many emerging markets.
There, fear of expropriation and substantial institutional uncertainty is hindering prospects for foreign direct investment and economic growth.
One of the most cited examples is the rocky Anglo-Russian partnership between Rosneft and British Petroleum.
But there are still significant worries for Europe’s long-term growth.
In both dimensions — education and the quality of the legal environment — Europe’s governments are under pressure to favor short-term remedies over long-term investments.
Europe’s basic education system desperately needs more investment per student and a larger role for private funding.
In the UK and in France, about 100,000 students leave school every year without any qualification, thus relying on welfare benefits — publicly funded — or working in low-paying jobs that are most likely to be exposed to international competition and trade.
Nevertheless, both countries are cutting expenditures in basic education.
In higher education too, Europe needs more investment per student and a larger role for private funding.
Italian and French universities’ international ranking in science is falling year on year.
David Cameron’s government, in the UK, lifted the cap on university students’ tuition fees.
Also, governments in France and Italy are tempted to disrupt free and fair competition in public tenders.
President Nicolas Sarkozy intervened in the purchase of new carriages for its French high-speed lines — disgruntled that the French national railways chose to buy carriages from a foreign competitor rather than from the local French supplier.
Italian President Silvio Berlusconi’s party erupted in anger when the French group Lactalis attempted a takeover of the Italian group Parmalat.
If European governments do not invest in their educational system, do not preserve their legal and institutional environment, and are forced into default by the debt crisis, Europe’s gradual decline will pave the way for the emergence of a new world economic order.
A recent study of educational systems by the Organization for Economic Cooperation and Development (OECD) put many Asian countries at the top of the ranking: Korea is first in the OECD digital literacy study, Shanghai — a population like a mid-sized European country — is first in general academic achievement for 15-year olds, and Singapore ranks at very top of the list.
More worryingly for Europe, in some sectors, emerging markets do not rely on European technology any more: The latest high-speed train carriages connecting Beijing and Shanghai do not come from European design offices.
Airbus and Boeing are not the aircraft industry’s sole players anymore on the segment of mid-sized jets.
The most pressing issue for many emerging markets is the quality of their legal and institutional environment.
A highly predictable legal system, with low levels of corruption, and the legal enforcement of property rights, where companies can reasonably count on the rules of the market rather than on government interference and cronyism, is the key to economic development.
Timothy Besley, professor at the London School of Economics and member of the Bank of England Monetary Policy Committee, highlighted the role of property rights as the key to long-term economic development in his recent address to the European Economic Association.
Ilian Mihov and Antonio Fatas, my colleagues at INSEAD, show the strong link between growth and economic and political institutions.
Without significant improvement in the skill of their workforce, and improvements in their legal and institutional environment, emerging markets will not be able to seize the opportunity of the European debt crisis to leverage their growth and capture new markets.
The sovereign debt crisis could just be a transitory episode in Europe’s economic history.
 
— Amine Ouazad is assistant professor of economics and political science at INSEAD Business School