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POLITICAL ECONOMY
Walker's World: EU - from acute to chronic
by Martin Walker
Paris (UPI) Jan 14, 2013


disclaimer: image is for illustration purposes only

In medical terms, an acute illness is short, sharp and nasty. A chronic illness is one that lasts a long term and the patient has to learn to live with it. The euro crisis has just gone from its acute to its chronic phase.

Throughout the last year there seemed to be two likely triggers for the kind of crisis that could force countries out of the euro. The first was that Greece could become bankrupt, unable to raise any more funds. That was resolved when the other eurozone countries, led by Germany, agreed to take over Greece's financing needs -- in return from some onerous conditions.

The second potential trigger was the much higher interest rates that Spain and Italy had to pay to sell their bonds, 5 and 6 percent more than Germany. This threatened to become unsustainable. It was resolved when Mario Draghi of the European Central Bank said he would do "whatever it takes" to save the euro and make unlimited funds available to buy Spanish and Italian bonds.

But if the acute crisis has passed, the chronic state in which Europe finds itself may be worse. Europe is now condemned to several years of, at best, very slow growth and possible to something that feels like a semi-permanent recession. This will mean high unemployment, particularly for young people, high taxes and a constant squeeze on government spending.

At some point, the current alleviating factor of very low interest rates will have to end, since this is causing real problems for pension funds and insurers and people on fixed incomes.

It is because the acute phase of the crisis has passed that European leaders like Commission President Jose Maria Barroso can say "the worst is over" and Draghi spoke last week of "positive contagion" in the eurozone economy, adding that the financial situation is improving and growth is set to return in the second half of the year.

Maybe, but some of the key signs aren't good. The German locomotive that hauls the European economy has stalled, with slight contraction in the final quarter of 2012. Stefan Schneider, an analyst with Deutsche Bank, last week forecast that German gross domestic product should rise a miniscule 0.3 percent in 2013, compared with the very feeble increase of 0.8 percent in 2012.

"For Germany, whose exports make up roughly 50 percent of GDP, subdued global growth constitutes a considerable economic headwind," Schneider noted. "It has also already weighed heavily on corporate investments in machinery and equipment. These probably fell by around 5 percent in 2012, and another decline on an annualized basis is also expected for the current year despite a gradual recovery. This is suggested in any case by the decline in domestic capital goods orders and the below-average level of capacity utilization."

So if there is little to be expected from Germany in the coming year, what is the source of the public optimism of so many European leaders? It is that that the wages are being driven down so hard in the weaker peripheral eurozone countries like Greece and Spain that their labor costs are starting to look competitive again. Combine that with the labor market, pension and welfare reforms that had to be enacted as the price of German support, and a transformed future starts to emerge.

It won't be a pretty future for many, perhaps most people in the southern European countries. Wages will be low, working hours longer with less job security. Pensions will be paid later and in smaller amounts. There will be less welfare, higher healthcare contributions and higher taxes and probably less free education.

But there should be more jobs. These have been the reforms to improve European competitiveness that the EU Commission has been promoting for the last decade and more, and which governments could postpone because it was easier to borrow -- until the crisis hit.

This is now official EU doctrine. Olli Rehn, EU economic affairs commissioner, said Friday that the criticisms by the International Monetary Fund of Europe's austerity policies fails to take into account the positive effect it has on market confidence. (IMF economists caused a stir last year with a new research paper that said the growth-cutting effects of spending cuts had been underestimated.)

"In the political debate, what has often been forgotten is that we have not only the quantifiable effect -- which is something that economists like to emphasize -- we also have the confidence effect," Rehn said.

Citing Italy as an example, he said spending cuts introduced in November 2011, by the new Prime Minister Mario Monti had convinced the bond markets that Italy was embarked on serious reforms and they were more ready to lend money to Italy as a result.

"From November onwards, we have seen more consistent and prudent fiscal consolidation by Italy and we are seeing much lower bond yield for Italy, which brings savings to Italian tax payers and facilitates return to economic recovery," Rehn said.

But he went on to admit that "the coming months will see tough times and social tensions," because EU citizens will see improvements in their day-to-day lives "only with some delay."

The social and political implications of that delay, and of prolonged mass unemployment for young people, will define the progress of Europe's chronic phase.

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