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EU Economy: Not Out of the Woods Yet?

9 September 2010

On 6 and 7 September, EU finance ministers met for the first time after the ‘silent’ month of August – a traditional vacation season in the EU institutions. While the latest news about the economic recovery in the eurozone, in particular Germany, has been encouraging, ministers still had a handful of difficult questions to address.

The euro crisis has been a good lesson for the EU finance ministers, which seem to be ready to take firm measures in order to achieve better fiscal harmonisation. These include a special six-month cycle of budgetary coordination – the so-called “European semester” – in which the EU Member States will have to submit their budgetary strategies for review in Brussels. This would allow the EU to see the inconsistencies and imbalances in advance and to act preventatively. The question of sanctions, however, is still open (history shows that good will is not enough to ensure budgetary discipline), and the Commission will come out with the proposals on this by the end of September.

Ministers also gave the green light for the establishment of the European Systemic Risk Board that will oversee the health of the financial system, as well as a set of other supervisory bodies: the European Banking Authority, the European Insurance and Occupational Pensions Authority, and the European Securities and Markets Authority. It is expected that European Parliament will ratify these bodies later this month and they will become operational from 1 January 2011. This new framework for financial supervision will hopefully help to reduce the economic uncertainty still prevailing in much of the EU.

All this indicates that there is much to be done to solidify the economic recovery of the EU. Of course, the latest economic indicators have given ground for cautious optimism. While delivering the first State of the Union address on 7 September, the President of the European Commission, José Manuel Barroso, praised the EU for emerging from the economic crisis: “Those who predicted the demise of the European Union were proved wrong.” Indeed, the eurozone is showing some better-than-expected results in the second quarter (GDP increased by 1.0% in both the eurozone and the EU as a whole during the second quarter of 2010), largely thanks to Germany’s rapid recovery. Boosted by exports, German economy seems to be going full steam ahead and growing faster than ever before in the last two decades (by 2.2% in the second quarter of 2010), with unemployment rate also going down (6.9%). The figures from France, the second biggest eurozone economy, are also solid (0.6% in the second quarter, instead of 0.4% as previously expected).

However, many analysts fear that strong German growth will only increase the divergence between the core and peripheral eurozone countries, like Spain and Portugal, whose GDP rose by a meagre 0.2% in the second quarter. The most worrisome case is Greece, whose economy contracted by 1.5%. The problem is that this gap may be persistent and continue to widen, as the countries are pursuing the path of austerity (with no certainty that ‘tightening the belt’ even more will help to rein in deficits). Jean-Claude Trichet, the President of European Central Bank, argues that such divergence, although an important issue, is normal between states in a currency zone. Nevertheless, the financial markets are worried, as attested by the widening bond yield spreads between Germany and other eurozone countries. José Manuel Barroso in his speech also emphasized that “there is no room for complacency”, and Olli Rehn, EU Commissioner for Economic and Monetary Affairs, also cautioned that the EU is “not out of the woods yet”.

Ministers will also have to return to the highly contentious question of a Europe-wide bank levy or a tax on individual financial transactions that would cover the costs of future financial crises. French President Nicolas Sarkozy has already announced that he intends to advance the idea of taxing financial transactions at the G20 meeting this November, when France is taking up the G20 presidency. Other controversial proposals include reforming the exchange rate system. As there is currently no consensus on these issues within the EU, one can ask how the rest of the world will look at these proposals, if European countries were to appear disunited on the international stage.

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