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Analysis
The consequences of Europe’s growth drought

The consequences of Europe’s growth drought

Predictions of better times dashed again

by David Marsh

Mon 18 Aug 2014

For the third year in a row, the seemingly perpetually sickly European economy appears to be heading for a nasty case of déjà vu. A prime witness is the hapless Olli Rehn, formerly in charge of economic and monetary affairs in the outgoing European Commission.

Presiding over Brussels’ largely disappointing budgetary consolidation strategy, Rehn has been permanently on the lookout for silver linings in otherwise black clouds. His predictions during the growth drought of better times ahead have regularly been dashed. The bitter truth is that, over the 2009-14 period, starting with the year of the world recession, the euro area will have contracted 0.1% a year on average, compared with growth of 1.5% annually in the US and 0.4% in the UK, outside the now 18-nation currency bloc.

In France, President François Hollande awaits a tide of political and economic challenges upon return from holiday today. In six of the nine quarters since Hollande became president in May 2012, France has registered nil growth or an economic contraction.

French politicians preach confidence for an international audience, despair when speaking to a domestic constituency. Only two weeks after saying in a joint Handelsblatt interview with German counterpart Wolfgang Schäuble that France would meet its budgetary targets, Michel Sapin, the French finance minister, told Le Monde last week that the deficit would be above 4% this year, exceeding the 3.8% target – and that France had no intention to raise taxes to keep to the 3% objective for 2015.

Rehn has left the Commission to join the European parliament. So he was not on hand to comment on last week’s latest set of depressing GDP figures. Germany, France and Italy, making up two-thirds of the euro bloc’s economy, all failed to show any growth in the second quarter. The only good news was that some of the previously slow-growing countries of the periphery, such as Spain and Portugal, turned in much better performances, with second quarter growth of 0.6%.

Rehn’s replacement at the Commission, fellow Finn Jyrki Katainen, the country’s former prime minister, doesn’t seem yet to have acquired the Panglossian philosophical style. Here are some sound-bites that Katainen may need to practice. ‘Europe’s recovery in the real economy has taken hold and is becoming self-sustaining,’ Rehn wrote in January 2011. ‘Our most pressing priority is to break the vicious circle of unsustainable debt, financial turbulence and sub-optimal growth. Europe needs a comprehensive strategy that restores sustainable public finances through budgetary adjustment, financial repair and growth-enhancing structural reforms.’

Rehn was in similar vein in December 2012. ‘The eurozone is living through lean times, but there is light at the end of the tunnel. On the one hand, the short-term economic outlook remains weak. On the other hand, there are signs that confidence is returning.’ And in August last year, when the single currency area at last emerged from an 18-month recession, Rehn was at it again. ‘The data … supports… a policy mix where building a stability culture and pursuing structural reforms supportive of growth and jobs go hand in hand.’

In fact, that optimistic picture remains an illusion. The latest statistics illustrate Europe’s sensitivity to perturbations beyond its borders, above all the turbulence between Russia and Ukraine. Even when the direct effect – for example, of Russian sanctions and counter-sanctions – remains limited, Europe shows extreme vulnerability to psychological setbacks. All this is paradoxical, given that one of the main objectives of setting up the euro was to increase Europe’s self-sufficiency and make it less prone to external shocks.

The petering out of the euro area recovery will have three consequences.

First, it reinforces pressure from France and Italy for Germany to take action through tax cuts and spending measures to boost public and private investment in Germany itself – something the Berlin government is loath to do. Such action would blow off course the German government’s balanced budget objectives – and would lower its ability to take the moral high ground in lecturing other EU states over missed budgetary plans.

Second, it delays still further the budgetary consolidation favoured by Germany and the European Commission – where Katainen while Finnish prime minister was an adherent of German chancellor Angela Merkel’s hard-line budgetary stance. The International Monetary Fund, along with many foreign economic commentators, has been sniping at Europe’s consolidation efforts for several years. So far, the only perceptible impact has been to increase obduracy along the Berlin-Frankfurt-Brussels axis.

Third, and most ominously, the growth setback adds to calls for the European Central Bank (ECB) to bring forward a discussion on full-blown quantitative easing that it hoped to postpone until the New Year. This increases the probability that the Bundesbank might eventually be outvoted by other members of the ECB council over the need to start full-scale purchases of German government bonds, which would anchor 10-year Bund yields semi-permanently below 1%. That would be a sure way of signalling a much-denied development: that Japanese-style deflation has reached the euro area – and of resurrecting still-considerable Franco-German tension about the future of the euro. 

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