Why the apostles of euro gloom have got it wrong again
Like Germany after 2005: euro area reaping rewards of reform
by Holger Schmieding
Tue 28 Jan 2014
Financial markets are, rightly, starting to give the euro area the benefit of the doubt. The systemic euro crisis is over for almost all practical purposes. Although the German Constitutional Court, in its long-awaited judgment on the European Central Bank’s (ECB) Outright Monetary Transactions (OMT) programme could still trigger a nasty surprise, this is no more than a tail risk.
Generally, the outlook for the euro area is positive. As in 2012 and 2013, the apostles of doom and gloom are likely to be proven wrong again this year. Instead of collapsing, most of the erstwhile problem countries on the euro periphery are already starting to reap the rewards of their painful reforms.
As a multinational currency, the euro has encountered some unique problems. But contrary to widespread perceptions, the euro bloc has been quite successful. Despite setbacks during the euro crisis, the euro area’s job performance over the 15 years of the euro’s existence matches that of the US. The major reason why the unemployment rate in the euro area with 12.1% is now far above that of the US with 7.1% while it was below the US rate earlier on is simple. In the US, almost 10m discouraged workers have withdrawn from the labour market, whereas the participation rate has risen in the euro area.
The US has an edge over the euro area in terms of total GDP growth. But the US paid a high price for that. During the 15 years of the euro, the ratio of public debt to GDP has risen by roughly 23 percentage points in the euro area, with the entire increase happening in the wake of the post-Lehman recession. In the US, artificial life-support for aggregate demand has boosted the debt ratio by around 43 points at the same time. According to the IMF, the US ratio of general government gross debt to GDP now exceeds that of the euro area by 10 points.
Being a euro member can be tough. The common currency denies its members the easy but ultimately futile escape route of devaluation. Instead, the euro forces its members to tackle problems the hard but lasting way, through sweeping structural reforms. With the reforms brought in by Chancellor Gerhard Schröder in 2004-05, Germany turned itself from the sick man of Europe into the continent's growth engine. Spain, Portugal and Ireland are following suit.
Even recalcitrant France has started to embrace some reforms. Following entitlement cuts, almost all national pension and welfare systems in the euro area are now more sustainable than the US Medicare and Medicaid programmes despite Europe's less favourable demographics.
The euro area's macroeconomic management has been less disastrous than that of the US in the last 15 years. When the US faced a financial crisis in September 2008, it mishandled matters so badly that it pushed the west into its worst recession in 80 years. When the euro area faced financial problems in 2011, it caused only a mild recession in the region, with limited repercussions for the rest of the world.
Initially, the euro area was slow to react to the panic triggered by difficulties in Greece. But since the ECB promised that it would behave like other major central banks and intervene with full force if needed to stop a market panic, the euro crisis has faded away.
Nine months after the ECB deterred rampant speculation against the euro in mid-2012, the euro area economy returned to modest growth in spring 2013. Leading indicators project a gradual firming of growth towards its trend rate of around 1.7% by the second half of 2014. With the exception of stagnant Greece, GDP is now expanding again in the euro periphery. With the usual lag, the labour market is turning the corner. Unemployment is already falling in Ireland, Portugal and Spain.
The credit crunch for small enterprises in parts of the periphery remains a problem. But we have to put it into context. Across most of the euro area, lending is falling mainly because cash-rich companies do not need to borrow.
Statistics show a clear drop in the rates charged by banks on company loans in Spain and Italy, the two major countries suffering to some degree from a genuine credit crunch. The ECB’s asset quality review and stress tests are likely to reveal some further capital shortfalls. Once these are dealt with, the credit crunch will probably be over for good.
Holger Schmieding is Chief Economist at Berenberg
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