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Weakness In Europe

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There Maybe Worse To Come

In the case of Europe, the financial crisis - that's to say, the extent to which the problems were rooted in the banking system - was particularly acute in the case of Spain and Ireland. Booms in lending and property prices were followed by sharp retrenchments and bank failures. But across the Eurozone banks were hit by investments in flawed financial assets or by lending to financially-stressed governments.

What this means is that some degree of weakness was to be expected in Europe. But has it been aggravated by austerity, the spending and taxation policies pursued by many European governments seeking to reduce their borrowing needs? Professor Paul de Grauwe, of the London School of Economics, says the Eurozone is in a "double-dip recession which is entirely self-made". He blames what he calls "excessive austerity in southern countries".

The idea that the austerity has deepened Europe's downturn is widely shared. It is another question whether there is a realistic alternative. Several Eurozone governments have debt burdens that are rising unsustainably. There is a debate to be had, however, over how rapidly they should do that.

The International Monetary Fund has suggested there is a case for moderating the pace of cuts. The countries in the most acute financial and economic difficulty also have problems with competitiveness. Membership of the euro means they don't have the option of allowing their currency to depreciate to readdress that problem. Instead, they have been hoping that reforming their economies, notably their labour markets, would do the job. There are signs of progress in that area.

In the case of Greece, the EU's commissioner for economic affairs, Olli Rehn, recently said "by the end of this year, all of the competitiveness loss experienced by Greece between 2001 and 2009, relative to the rest of the euro area, will have been recouped". It is nonetheless a process that takes time, much more time than a currency depreciation.

Looking ahead, many economists expect worse to come. Surveys of business have suggested a further deterioration is likely, even in Germany. Growth there has already slowed. The most recent figure was a decidedly sluggish 0.2% in three months. If Germany were to slip into recession, that would be a powerful symbol of the Eurozone's problems. It would also be another headwind to recovery. As well as being an exporting powerhouse, Germany is also a major buyer of goods and services from the rest of the Eurozone. It is, then, a very overcast outlook.

To take one example, the London-based consultants Capital Economics forecasts a contraction of 2.5% for the Eurozone next year. The European Commission is less pessimistic. Its recent forecast has the Eurozone growing in 2013 year. But the figure is a frankly pitiful 0.1%, followed by a still rather lacklustre 1.4% the following year. Even if the Commission turns out to be right, that would be a very long period of sub-par performance.

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