The European Central Bank in Frankfurt. The euro has neither made the single market work more efficiently, nor generated faster growth says Larry Elliott.
The next recession will expose the eurozone as a half-baked project in need of leadership.
As the clock has ticked down towards Brexit, the state of the UK has attracted even more attention than normal. Every scrap of official data and every survey of business opinion have been pored over by leavers and remainers alike.
Much less attention, understandably enough, has been paid to what is happening in the rest of the European Union, where the recent news has been poor. The frustration of the leaders of the other 27 EU countries towards Theresa May is that Europe has plenty of issues that need addressing, with Brexit not even the most serious of them.
The EU’s biggest problem is that its economic model has aged alongside its population. Europe has plenty of world-class companies but, unlike the United States, none of them were set up in the past 25 years. In Europe’s golden age, Volkswagen was a rival to Ford, and Siemens could go toe to toe with General Electric. But there is no European Google, Facebook or Amazon and in the emerging technologies of the fourth Industrial Revolution, such as artificial intelligence, Europe is nowhere.
China is making faster progress than Europe in the development of machine learning and has companies that pose a threat to the giants of Silicon Valley. That’s why China rather than Europe is the main target for Donald Trump’s tariff war.
When plans for the euro were being drawn up 30 years ago, the assumption was that the single currency would make the single market work more efficiently and so generate faster growth. It hasn’t happened. The performance of the eurozone countries has got worse not better, but so much political capital has been invested in the monetary union project that there is an unwillingness to accept as much.
Three separate events last week highlighted the extent of the economic challenges Europe faces. Firstly, the latest health check on the eurozone economy showed that growth remains chronically weak. Italy is suffering from its fifth recession in two decades, while Germany’s export-dominated economy is being hit hard by the slowdown in the global economy. Germany escaped recession only by the skin of its teeth in the second half of 2018 and early 2019 has seen little improvement. The eurozone as a whole appears to be on course to grow by 0.2% in the first three months of the year, unchanged on the last three months of 2018.
There was a brief period when heavy doses of stimulus from the European Central Bank (ECB) lifted the eurozone’s growth rate. But the impact of zero interest rates and the money-creation process known as quantitative easing (QE) has now worn off. A real solution to Europe’s growth problems means fixing the design flaws in monetary union, something that has been glaringly obvious since the financial crisis of a decade ago.
The lack of a political underpinning to the single currency proved costly back in 2008-09. While the US and the UK moved quickly to cut interest rates and embrace unconventional monetary policies such as QE, it took much longer for the eurozone to crank itself into gear. In part, that was due to the ultra-conservative nature of the ECB, which imported its culture from Germany’s Bundesbank, but it was also due to the fact that there was no real mechanism for taking the sort of speedy decisions made in Washington and London. Like any convoy, the eurozone moved at the speed of its slowest ship.
There were two important consequences of this: it took a lot longer for the eurozone to return to growth; and its banks were left saddled with large quantities of non-performing loans. The Americans socialised the bad debts of the big US banks, which enabled them to start lending again. Europe’s banks remain weak and highly vulnerable to another economic downturn, which is why the second significant event last week was the announcement by two of Germany’s biggest banks – Deutsche and Commerzbank – that they were in merger talks.
Europe’s diminished status
Italy has tired of waiting for monetary union to deliver. Its banks are in even worse shape than Germany’s, Rome has no control over monetary policy and its attempts to boost growth by running a bigger budget deficit have fallen foul of Europe’s hardline fiscal rules. Last week, Italy’s government announced that it would be the first EU country to take part in China’s Belt and Road initiative – an attempt to link Asia, the Middle East, Africa and Europe with a series of ports, railways, bridges and other infrastructure projects. Italy’s willingness to take part in the attempt to recreate the old silk road reflects its desperation to revive its economy by any means available. It also reflects Europe’s diminished status in the global pecking order.
Emmanuel Macron is convinced that the answer to Europe’s economic problems is closer integration. The French president wants the eurozone to have its own finance minister in charge of tax and spending policy for the single currency zone. But for the idea to catch on, Macron needs the support of Germany and Angela Merkel has not been wildly enthusiastic. It’s not hard to see why. German exporters have done well out of monetary union and Merkel knows that German taxpayers would be expected to bankroll spending in poorer eurozone countries.
Macron’s plan has a logic to it. The eurozone is a half completed project, lacking the political structure that would give it a chance of working. What’s more, if Europe continues to under-perform economically, the alternative to closer integration is disintegration. Not immediately, because returning to national currencies or moving to a hard and soft euro, would be fraught with difficulties. Crunch time will only come when the next recession blows in. It might not be all that far away.