international analysis and commentary

The EU’s economy: still in the trap?


Entering the eighth year of the Great Recession, Europe’s economic outlook is still gloomy. While the US is on a rather solid path of growth (having added an average of more than 150,000 new jobs per month over the last three years and a half, with an unemployment rate of 5.9% as of last September), the Eurozone and the EU as a whole are facing a much different situation with unemployment rates, respectively, of 12% and 10.7%.

Moreover, forecasts for next year show only few and very vulnerable signs of improvement: the IMF’s World Economic Outlook, released in October, assigns only a 1.3% GDP growth rate to the Eurozone and a slightly better 1.7% to the EU; with this slow pace of recovery the 18 euro countries will return to the pre-crisis level of production (2008) only in 2016. Even this sluggish recovery is now threatened by a very low dynamic of prices, far from the 2% ECB target and in some cases below zero, which is both a sign of weakness in consumption and investments in the area and a burden for national debts – as it automatically raises debt/GDP ratios. The list of European countries with a debt/GDP ratio close to or over 100% is long: France, Spain, Belgium, Cyprus, Portugal, Ireland, Italy and Greece.

Despite the willingness shown by Mario Draghi’s ECB to take down the “spread crisis” in 2012 – when the clever combination of firm statements (“whatever it takes to preserve the euro”) and the institution of OMT (Outright Monetary Transactions) stopped the run from some countries’ bonds – there are little signs that the central bank could undertake new adequate actions to revive the dynamic.

At the moment, the ECB will continue to operate through exceptionally low interest rates, while the long announced Asset-Backed Securities Purchase Program will hopefully restore liquidity in the credit market, especially in the vulnerable peripheral countries like Greece and Cyprus, and, to a lesser extent, Italy and Spain. The Program has, in any case, raised strong concerns and outright opposition in German political and financial circles, in spite of Chancellor Angela Merkel’s effort to avoid a public spat.

Meanwhile, fiscal policy is still a major concern in the Union: in fact, despite scarce investments and high unemployment, the EU members are committed, through the Stability and Growth Pact and the Fiscal Compact, to restore balanced budgets and cut national debts. Since, at the same time, the EU budget (due to the fierce opposition of conservative and euro-skeptic political parties) is not going to increase, the continental reduction of public expenditures will restrain aggregate demand; unlike the USA, the European Union is still lacking any “federal” automatic stabilizer, such as a European unemployment insurance, that would boost countries suffering a negative shock.

The new €300 billion investment plan, proposed by Jean-Claude Juncker, the new President of the European Commission, appears as a weak response to the challenges facing the continental economies: major concerns arise from the sources of funding also because – with a flat EU budget – the European Investment Bank is unwilling to be the pivotal partner in the collection private financing. In any case the magnitude of this triennial plan (€100 billion a year) is far from closing the “investment gap” created by the crisis: the amount of investment that should have happened if the recession had not occurred is around €800 billion for 2014.

In this very difficult context even the stronger EU economy, Germany, could face severe downturns: the economic performance of Germany during the last years was mainly driven by the huge demand for investments and machineries in emerging countries, primarily China and Russia. Now, the Ukraine crisis, the general reduction of growth rates in the BRIC countries, and the enduring consumption slump in several EU countries are a threat to a German prosperity which is over-reliant on exports.

We will see if this scenario and a rise in the unemployment rate from the current level of 4.9% (exceptionally low for a European country) will change the German attitude towards fiscal austerity. In particular it will test the compromise between Chancellor Merkel’s CDU and the allies of the SPD in the Grosse Koalition. The terms of a deal could be that, while imposing a strict fiscal discipline in the European context, thanks to the low interest on public debt and a moderate but steady growth, more resources will be pumped into the already generous welfare state, introducing for the first time a minimum wage and decreasing the retirement age.

The German economic slowdown could also heavily affect its eastern neighbors: Poland, Hungary and Czech Republic’s good performance in the last decade was strictly correlated with their integration with German manufacturing that has outsourced increasing portions of labor-intensive productions there. Now these countries face a new challenge: reductions in demand by their main commercial partner and the possible appreciation of their currencies, against the ECB’s relatively expansive monetary policy, could pose a threat to their growing economies.

The prospects for Southern Europe remain dim, although to varying degrees and with national differences: Italy, Spain, Portugal, Greece, Cyprus and now also France are struggling within high unemployment and a steadily increasing public debt – despite the implementation of some structural reforms, especially in the labor market, as indicated by the EU Commission. The long awaited publication of banking stress-tests by the ECB in recent days is revealing: the huge amount of public resources poured in the financial systems of these countries was only sufficient to support half of the 25 European banks that present the highest risk level; 12 of them still have to cover €10 billion in capital shortfall, in order to prevent another potential continental meltdown.

Among the Northern countries, the United Kingdom is the economy with the strongest momentum. After avoiding the inevitable fallout that would have followed a successful Scottish independence referendum, the British economy is back on a solid growth path. This is characterized by the full recovery of the real estate sector and, despite the rhetoric of the Cameron government, by a softened fiscal discipline, coupled with a constant expansionary monetary policy by the Bank of England – whose activism during the entire Great Recession has been at least equal to the FED’s.

Against this backdrop, the growing conflict between national governments and the European Commission, in its transition from Barroso’s leadership to Juncker’s, is a signal of the urgent need for new instruments to solve the European economic puzzle before nationalisms endanger the whole political Union. It is far from certain that Junker’s investments plan, after winning him the decisive support of the S&D party in the European Parliament, will be enough to pursue such an ambitious agenda.