Last month, former Dutch prime minister Wim Kok presented to European leaders his midterm review of the Lisbon reform agenda.¹ He concluded—surprise, surprise—that Europe will not, after all, become the most dynamic and competitive knowledge-based economy in the world by 2010.

As Mr. Kok told the leaders, their governments simply have failed to implement the necessary economic reforms to achieve the Lisbon goals. But he did not help to focus attention on the things that matter most. Instead, he presented no fewer than 22 "key recommendations," spanning from greening public procurement to the formation of new standing committees in the European Parliament. No social partner or interest group was left behind.

European leaders must focus their attention on raising productivity growth and employment, which are complementary, not conflicting, objectives. The way to get there is through increased competitive pressure on companies, greater labor market flexibility, and better work incentives. These are Europe's three big challenges at the moment.

The need for greater labor market flexibility and better working incentives, particularly by scaling back early retirement opportunities, is widely recognized, and some limited progress has been made. Our focus here is on one important policy prescription that would both increase competitive intensity and help create jobs: changing Europe's land-use policies.

Within its relatively small borders, Europe contains immense historical and natural beauty, and it is understandable that Europeans want to preserve the quality of life that comes with these treasures. But very few people realize the extent to which excessive and irrational restrictions on land use are discouraging productivity and employment growth.

Productivity and employment growth require a dynamic economy, and in fact Europe has plenty of new companies starting up; there is no shortage of business initiative, despite a belief to the contrary. However, new, small companies in Europe are much less likely to prosper than those in the United States. The high price and lack of available land in Europe, as well as other regulatory barriers, are a constraint on the growth of new companies and on the creation of new operations for existing companies. The lack of space for new residential construction raises housing costs and makes workers less mobile if they need to relocate in order to find new jobs.

Examples include the inability of retail companies to find locations for new large stores, a barrier that holds back productivity and employment throughout Europe—notably in Germany where complex licensing is required even to convert an existing building for retail use. In France it takes ten administrative procedures and nearly 200 days just to register any sizable business property, even when no rezoning is required. This contrasts with Sweden, where such registration takes only two days. Even though most European policy makers say they want to increase jobs in manufacturing, in practice it can take months or even years to get permission to build a new factory, and the costs of construction are often inflated by a variety of regulations.

The right goal for zoning decisions is to encourage both economic growth and a livable environment and to make a sensible trade-off when these two elements conflict. At present, land-use decisions are too skewed against development, and one reason is that the officials in charge of building permits frequently have little or no incentive to encourage investment and jobs. The way taxes are collected and distributed often means that local authorities bear higher costs and get no extra revenue if they green-light new projects. These incentives must be changed. In some jurisdictions, permits are effectively blocked by incumbent firms that do not want to face new competition.

Regional policies in Europe compound the problem. Such policies often take it as a given that expansion must be held back in big cities and dynamic regions by taxes and land-use restrictions and that money should be sent to stagnant or dying regions. By building roads and residential housing, it is argued, the declining regions will revitalize and people will move back there. In those poorer regions, land-use policies are often more permissive and subsidies are sometimes paid to encourage private investment. But these policies usually fail because the real problem is that the underlying economic base of these regions has disappeared. There are areas in Eastern Germany and the north of England where large sums of money produced only limited benefits or none at all. At the same time, growth in dynamic regions, such as the southeastern region of England or Bavaria in Germany, is discouraged.

Countries are not companies, but there are parallels. If you were a CEO, would you take profits from your best-performing divisions and use them to invest heavily in the businesses that are contracting and losing money? Making such a comparison does not mean we put the needs of business ahead of the needs of people. Instead, what we are proposing would actually help the European economy to move faster—and this is now the top social priority in Europe.

In terms of regional policies, people show a strong preference for living in dynamic cities. The selection of jobs, operas, movies, shops, and theaters is wider and often of better quality. Big cities are very productive. No one should be forced to leave the town or village where he or she now lives, but we do think that policy should not stand in the way of the evolution and change that is inevitable in market economies. If that process is hurting people, assist them directly—with financial support for migration or help with finding a new job. If growth creates congestion, then provide better public transportation and use congestion pricing for roads, as is done in London and Singapore.

European reforms are not a left- or right-wing issue; nor are they a business-minded versus a socially responsible agenda. They are simply necessary.