That sinking feeling (again)

If Germany, France and Italy cannot find a way to refloat Europe’s economy, the euro may yet be doomed

JUST a few months ago the eurozone’s leaders believed that, having weathered the stor m, they were set fair at last. Buoyed by the promise of Mario Draghi, the president of the European Central Bank, to do “whatever it takes” to support the currency, confidence had seeped back into the continent. Growth seemed to be retur ning, albeit at a slow pace. Troubled peripheral countries were recovering, after bail-outs and painful measures to cut budget deficits and improve competitiveness. Unemployment, especially among the young, was still desperately high, but at least in most countries it was falling. And bond spreads had narrowed sharply, as financial markets stopped betting that the euro would fall apart.

It was an illusion. In recent weeks the countries of the eurozone have begun to take in water once again. Their collective GDP stagnated in the second quarter: Italy fell back into outright recession, French GDP was flat and even mighty Germany saw an unexpectedly large fall in output. The third quarter looks pretty unhealthy, partly because the eurozone will suffer an extra drag from Western sanctions on Russia. Meanwhile, inflation has fallen perilously low, to around 0.4%, far below the near-2% target of the European Central Bank, raising fears that the zone as a whole could fall prey to en- trenched deflation. Ger man bond yields are hovering below 1%, another harbinger of falling prices. The eurozone stands (or wobbles) in stark contrast with America and Britain, whose economies are enjoying sustained growth.

What started more than four years ago as a banking and sovereign-debt crisis has decayed into a growth crisis that is now enveloping the three biggest economies. Germany is teetering on the edge of recession. France is mired in stagnation. Italy’s GDP is barely above its level when the single currency came in 15 years ago. Since these three countries account for two-thirds of eurozone GDP, growth in places like Spain and the Netherlands cannot make up for their torpor.

The underlying causes of Europe’s new ills are three very familiar and interrelated problems. First, there is a shortage of political leaders with the courage and conviction to push through structural refor ms to improve competitiveness and, eventually, reignite growth: the big countries have wasted the two years bought by Draghi’s “whatever it takes” commitment. Second, public opinion is not convinced of the urgent need for deep and radical changes. And third, despite Draghi’s efforts, the monetary and fiscal framework is too tight, throttling growth—which makes structural refor ms harder.

Clouseaunomics

Different manifestations of these problems can be seen across the eurozone. But the country that most dramatically epitomises all three is France. This week its embattled Socialist president, Francois Hollande, was forced to reshuffle his gover nment to eject Ar naud Montebourg who, despite being economy minister, was his own side’s most persistent critic from the left. Hollande, who came to office in 2012 promising a painless future, is hardly a Thatcherite refor mer. But since he appointed Manuel Valls as prime minister in March, he has at least embraced the principle of publicspending cuts, lower taxes and structural refor ms.

In theory a new and more cohesive refor ming gover nment could make progress, but public opinion is not remotely prepared for that. Hollande is not just deeply unpopular; unlike Italy’s Matteo Renzi, who has bravely made the case for (as yet undelivered) tough refor ms, the French president has failed to convince voters that painful change, including a reduction in the size of the state, is inevitable. Instead, Montebourg and his chums offer the be- guiling notion that, if only the eurozone scraps its rules and allows bigger budget deficits and generous enough public spending, no more painful refor ms will be needed, because the economy will miraculously lift itself out of danger by its own bootstraps.

Montebourg’s argument is all the more seductive because he is right about Europe’s third problem: excessive austerity, largely forced on the continent by Germany. Draghi has just implicitly conceded that fiscal and monetary policy in the eurozone is too tight at the annual economics jamboree in Jackson Hole. He hinted that he was in favour of quantitative easing, which both America and Britain have used, and he called for fiscal policy to do more to encourage growth—a message plainly aimed at Germany’s chancellor, Angela Merkel. She is the leader who insists most fir mly on sticking to the eurozone’s rules on fiscal discipline, just as it is the German Bundesbank that is most strongly against quantitative easing.

Angie, we can say you never tried

Despite the gloom, there should be scope here for a bargain. If Hol-

So it will be hard. But without a new push from the continent’s leaders, growth will not revive and deflation could take hold. Japan suffered a decade of lost growth in the 1990s, and is still struggling. But, unlike Japan, Europe is not a single cohesive country. If the currency union brings nothing but stagnation, joblessness and deflation, then some people will eventually vote to leave the euro. Thanks to Draghi’s promise to put a floor under gover nment debt, the market risk that financial pressures could trigger a break-up has receded. But the political risk that one or more countries decide to stor m out of the single currency is rising all the time. The euro crisis has not gone away; it is just waiting over the horizon.

The Economist

Illustration: ROHNIT PHORE