Europe’s economic weaknesses risk becoming new crises

EUROPE’S leaders have failed to solve the structural problems revealed by the crisis of 2008. Nor have they grappled with issues that have emerged in recent years. Examples include high public debt, the stock market bubble and distorted risk perceptions caused by the eurozone’s artificially low interest rates, writes World Review expert Professor Enrico Colombatto. For now, the situation has stabilized. Financial markets are headed into a period of high volatility, but panic has been averted. The question is whether this calm will last or if the European Union’s economic challenges will erupt into new, full-blown crises. Policymaking at the EU level has been disappointing recently. After years of recession and stagnation, most leaders were planning to grow their way out of the public-finance and banking crises. They hoped that relatively fast rates of economic growth would cut their countries’ debt and budget-deficit ratios, make higher interest rates and debt servicing costs tolerable, and alleviate the pressure of nonperforming loans on banks’ balance sheets. This looked good on paper, but it required gross domestic product to grow at an annual rate of between 2 percent and 3 percent. Europe’s actual growth in 2015 was more sluggish: just 1.6 percent in the euro area and 1.9 percent in the EU, mainly due to a stronger performance by the United Kingdom and Poland. The eurozone’s three biggest economies – Germany, France and Italy – grew by about 1.7 percent, 1.1 percent and 0.9 percent, respectively. To make matters worse, repeated efforts to boost output and confidence through an extremely generous monetary policy have produced poor results. Much of the liquidity has ended up in financial markets, as investors have used cash to buy stocks and high-yield bonds. Rather than stimulating production, the new euros created bubbles that will be hard to deflate. It is unlikely that the EU will achieve high growth rates in 2016 or in the following years. Significant increases in productivity would need to occur, spurred on by technological progress. Excessive regulation, weak protection of property rights, heavy taxation, overly generous welfare systems and inefficient bureaucracies at the national and supranational levels continue to stifle entrepreneurship and long-term investment. These were the core problems that many European countries inherited from the previous decade, and none of them have been seriously addressed. No fundamental economic change is in sight. Predictions vary, but this much is clear: growth this year will be modest and vulnerable to many risks, and quantitative easing will not help. The two main weak spots of the EU economy – public finances and an undercapitalized banking system saddled with large quantities of bad loans – will not disappear. The European Central Bank is likely to continue pumping money into the economy, hoping to defuse tensions and give financial institutions the liquidity they need to absorb new public debt and shore up their balance sheets. This will lead to very low interest rates remaining in place as long as two requirements are met: consumer-price inflation remains modest, and no major crisis batters the European banking system. All in all, it seems that the strategy currently pursued by European policymakers consists of keeping their fingers crossed. If nothing happens, quantitative easing will act as a placebo, providing the liquidity banks need in order to avoid a run. Yet none of the maladies afflicting the EU economies will be remedied. At best, it will act as a painkiller, although most economies have already developed a dangerous addiction to the drug. For a more in-depth look at this subject with scenarios looking to future outcomes, go to our sister site: Geopolitical Information Service. Sign in for 3 Free Reports or Subscribe.

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