01 October 2019

Project Syndicate: Are Europe’s economic prospects brighter than they appear?

Despite all the headlines about the trade war causing a recession in the US or some kind of collapse in China, recent economic data reveal a very different picture: the main victim has been Europe. But, fortunately for the European economy, overdependence on foreign trade is not the whole story.

The unexpected distribution of damage can be clearly seen in the International Monetary Fund’s quarterly revisions of its economic projections. The latest revisions, published in late July, forecast 3.2% global growth in 2019, down from 3.7% in the IMF’s October 2018 projection. But this downward revision was attributable to neither the US nor China. [...]

The IMF now expects eurozone growth to reach 1.3% this year, down 0.6 percentage points from its forecast a year ago, and German growth is expected to amount to just 0.7%, compared to the 1.9% rate predicted a year ago. Thus, if any region will soon pull the world into recession, it is Europe, and specifically Germany, not the US, China, or Asia.

There are three reasons why the European economy has suffered far more this year than either of the belligerents in the US-China conflict. For starters, Europe is extremely vulnerable to collateral damage from a trade war, because it is more dependent on trade. Exports account for 28% of the eurozone’s GDP, compared to only 12% for the US and 19% for China.

 

Moreover, Europe’s policy response to economic shocks is almost always wrong. [...]

Third, Europe has been hit by two internal political shocks that were even more damaging than the US-China trade war. Last summer’s budget clash between the European Commission and Italy’s new populist government revived fears of a currency and banking collapse even worse than the euro crisis that erupted a decade ago. And in March, just as the Italian risk subsided, a no-deal Brexit suddenly emerged as a serious threat. Because the EU exports almost twice as much to the United Kingdom as it does to China, a sudden stop in commercial relations with the UK could be as damaging as the sudden stop in finance that occurred in 2008.

Now for the good news. Two of the three reasons for Europe’s poor performance – misguided macroeconomic policies and conflict with Italy or Britain – are moving toward resolution. And although excessive exposure to global trade – especially in Germany – continues, at least Europe’s overdependence on exports is starting to be recognized as a structural vulnerability, not a sign of “competitiveness” or fundamental economic health. [...]

The ECB’s recent decision to resume quantitative easing and maintain negative interest rates without any time limit guarantees that debt-service costs will fall drastically for highly indebted governments such as those in Italy, Spain, Belgium, and France.  [...]

With the political and macroeconomic climate improving, Europe should be able to overcome the structural handicap of excessive exports and avoid recession. Germany may be less fortunate, because it cannot be cured of its export addiction until it abandons its misguided budget consolidation. Until then, Germany will be stuck in its unfamiliar new role as the laggard of Europe. [...]

Full article on Project Syndicate

© Project Syndicate