Friday, May 25, 2012

The European Problem

Most North Americans misunderstand the crisis in Europe. They think it is about profligate governments being forced to cut spending so as to deal with the challenges of debt. It is not. It is much more complex.

The first challenge is indeed economic. It is about the lack of economic growth in European countries other than Germany. This includes countries within and beyond the Eurozone – the countries using the euro as their currency. Britain lacks growth and it is economically challenged.

Growth was the “bet” governments made when making decisions about social policy, energy and their public spending. They now find themselves growing not only less than anticipated but less than they have been used to. Revenues to government are therefore falling while their costs are growing. This is one source of public debt.

A second source of public debt is generous social service provision. With very high rates of unemployment and an ageing population, European social provisions are now becoming very expensive. France, with the least number of working hours and working life of any country, has a growing unemployment problem. Spain has 27% unemployment, with the 16-24 year olds looking like a “lost generation” with unemployment for this group at 50%. Each retired and unemployed person is a significant cost to benevolent states – costs they can no longer afford.

A third source of public debt is the systematic transfer of private debt to the public purse. Here the financial sector, which is largely responsible for a great deal of the economic mess the world now finds itself facing. Banks in many European countries are poorly regulated and over extended with risk debts, which now look unlikely to mature. Spanish banks have been downgraded by bond rating agencies due to their exposure to risk debt and many French financial institutions are equally vulnerable. So as to stop a bank depositor exit, Governments are acting to assume responsibility for bank debt, thereby transferring private risk to the public purse. No one wants to see any major national bank collapse.

The final source of public debt is public policy. The policy of austerity, forced on the Eurozone and accepted by almost all of Europe (Britain and Czech republic saw sense and said no) is itself a source of public debt. By reducing the scale of government, cutting public spending and forcing austerity through taxation, government revenues fall and spending power within national markets is reduced. In the case of Greece, austerity will kill the State before it will lead provide the basis for the State to respond. As Joseph Stiglitz, the Nobel prize winning economist noted, the adoption of the “fiskalunion” by the majority of the members of the EU is equivalent to a suicide pact – a view supported by Paul Krugman of the New York Times, another Nobel laureate.

This is the economic context. It is in itself challenging, but the challenge for Europe is more complex.

A second factor at the heart of the European challenge is the demography of Europe. With the exception of Britain, Europe is experiencing a demographic deficit. Most countries – especially Germany and Italy – are experiencing low birth rates and the longevity of its older population. Italy and several regions of Germany are not replacing themselves and are now experiencing more deaths than live births. Many married couples are not having children and the economic conditions do not encourage them to do so. Regions of Europe are now finding that the elderly, unemployed and people not in work outnumber those in work, especially in Spain. The implications are economic – fewer people in work to pay taxes to support those not in work as well as a burgeoning underground economy – and social volatility. Many parts of Europe are political firecrackers ready to be lit and explode at a moments notice.

The third problem is energy. Energy costs are rising in Europe. This is almost entirely due to the adoption and pursuit of “green” policies. Germany is a classic case. Following the Japanese tsunami, the German government decided to decommission its nuclear energy provision and to adopt renewable energy as the replacement. This is likely to produce annual increases in base energy costs of 30% or more while at the same time giving rise to massive volatility in the energy system, producing unreliability. This is forcing several German companies to leave Germany and move production to lower costs energy providers in Asia. Britain and other EU countries are on a similar track. This “saving the planet” policy is killing the economies of Europe.

These three pressures – demography, economics and energy – are at the heart of the “mess” we call the European project. These are not easily fixable, which leads to the fourth problem. The complete lack of visionary leadership in Europe.

The putative leader of Europe is German Chancellor Angela Merkel. Her understanding is that all of Europe needs to pursue austerity in order to return public finances, especially in the Mediterranean EU States, to some sense of “normalcy” from which economic recovery can begin. She also assumes that the failed experiment of fiscal union in the Eurozone without concomitant political union must succeed. She is wrong on both counts.

A decade or more of mass unemployment and growing inequality and poverty will not provide the basis for economic growth, especially with high energy costs and a declining working population. But this is the vision implicit in Merkel’s position. While she is now giving lip-service to some stimulus for growth, she is refusing to support some of the key instruments which would enable growth – Eurobonds, support for inflation, infrastructure spending by Government and encouragement for employment. She is a one trick pony.

Hope is now pinned on the new President of France, Francoise Hollande – a politician who has never held political office. He is a pragmatist and not a visionary and is likely to find a course through the crisis which will secure him a second term, but is unlikely to hold a vision for the future of Europe.

One of two things will happen. Either Europe will seek closer political integration – a necessary condition for making the Euro work – or it will seek to loosen the political noose and focus more on trade and markets so as to stimulate growth. In either case, Europe will change faster than politicians can imagine. The market and global forces will see to it.

As all of this is happening, much to the surprise of many in the world, one country should surprise us all. Croatia voted recently to join the Eurozone and Europe. What are they thinking?

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