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EU’s fragile recovery and the euro zone crisis

11 March 2010

On 25 February 2010, the European Commission published its Interim Forecast for 2010, giving an updated overview of the EU’s economic health. The previous fully-fledged forecast was published in November 2009 and the next one is scheduled for May 2010. The Commission estimates that the EU’s GDP will grow by 0.7% in 2010 (in 2009, GDP contracted by 4.1% in the EU and 4.0% in the 16-state eurozone). For most of the EU’s seven largest economies (which account to about 80% of the EU’s GDP) economic growth is expected to be positive: ​2.5% in Poland, 1.2% in Germany and France, 0.9% in the Netherlands, 0.7% in Italy and 0.6% in the United Kingdom. However, Spain will still be in recession (-0.2%).  The Commission estimates that the world GDP will grow by 4.5% in 2010. Especially, the recovery in Asia is much stronger than previously expected. EU Commissioner for Economic and Monetary Affairs Olli Rehn said the EU “should certainly be concerned” about lagging behind the rest of the world, stressing “the necessity of modernising our economies”.

The main problem is that, even though the recovery in other parts of the world might fuel EU exports, investment outlook is very weak and the labour market in many countries continues to deteriorate (in December 2009, the overall unemployment rate was 10.0% in the eurozone and 9.6% in the EU). This will, in turn, further dampen private consumption. It is clear that consumers are not going to “buy out” the EU from its economic troubles, as the consumer confidence level, according to the February Economic Sentiment Indicator, has been further deteriorating in both the eurozone and the EU. They remain cautious and worried about their employment prospects, probable tax increases, as well as the continuing “Greek drama”.

No doubt, Greece currently is the top priority for the EU, where both political and economic stakes are high. Moreover, the concerns about shaky government finances, rising debts and budget deficits have also spread to Spain, Portugal, Italy and other heavily indebted countries, whose leaders, on their part, try to show to the rest of the world that their situation is not in any way similar to Greece. However, even if other countries avoid the Greek scenario, it is clear that they will have to tighten their belts, because, as it was said Mr Rehn, “the state of public finances in clearly unsustainable”. Even Germany’s budget deficit is expected to rise to 5.6% of GDP, according to the Economist Intelligence Unit.

It is in this context that EU leaders are contemplating a new rescue fund (already dubbed European Monetary Fund, EMF) in order to help eurozone member countries better deal with a future economic crisis. The idea of an “EMF”, first officially expressed by German Finance Minister Wolfgang Schäuble on 6 March, has been supported by German Chancellor Angela Merkel, saying that the current instruments “are not sufficient”. So far, there are more questions than answers regarding this idea. It is not clear, for instance, whether the new fund would be just a financial instrument or a new institution, which would then, most probably, require renegotiation of the Lisbon Treaty, which already took so long to negotiate and ratify.

Also, not everyone is supporting this idea, even in Germany. Thus Axel A. Weber, the President of the Deutsche Bundesbank, the German central bank, has stressed that the focus now should be on the most urgent problems, saying that “it’s not helpful to talk about ways to institutionalize help when the question is how to implement the budget reforms”. It has also been criticized by Jürgen Stark, European Central Bank Executive Board member, who has said that such a mechanism would penalize countries with solid finances and encourage excessive spending. Some of the questions regarding the future “EMF” might be answered after the eurozone Finance ministers meeting on 15 March, and the Commission is already “working closely with Germany, France and other EU member states” on more concrete proposals that should be ready by June.

Whatever form or function an “EMF” takes, it has shown that eurozone member states are determined not to involve the International Monetary Fund (IMF) in solving their internal problems (apart from Greece itself, which has repeated many times that it does not exclude the possibility to approach the IMF – this could be, perhaps, a Greek ploy to put the pressure on other eurozone member states to come up with concrete help to ease the debt problems in Greece). If EU leaders opt for a veritable “EMF”, it might also have wider repercussions in the international financial system. This could revive discussions about other regional financial arrangements, particularly in Asia, where the idea of an Asian Monetary Fund (proposed by Japan in the wake of the 1997 financial crisis, but turned down at that time by the  IMF and the US worried about their influence) has never been forgotten. As it has been argued by Kishore Mahbubani and Simon Chesterman, “Asian countries must take more leadership in regulating financial markets (…)  the possibility of an Asian Monetary Fund remains on (or at least not far off) the table.” In this context, it will be important to observe developments regarding the Chiang Mai Initiative, a US$120bn worth fund between ASEAN, China, Japan, and South Korea, to be launched on 24 March 2010, which will provide financial support through currency swap transactions. Given the developments in the EU, Asian countries might also decide to pursue a path towards more elaborated regional financial architecture. All this would bring into question to the role of the IMF, an institution associated with American financial prowess, which is clearly in decline. The head of the IMF, Dominique Strauss-Kahn, has indicated that “regional institutions are welcome”, nevertheless stressing that they should work together with the IMF.

It remains to be seen how the EU will address the multiple problems of slow economic recovery, high unemployment, ballooning deficit and the euro under pressure. Perhaps the solution is to be found in “Europe 2020” – EU’s growth strategy for the next decade.  To be discussed by the EU’s heads of state and government at the EU summit on March 25-26, this strategy focuses on three main priorities: “developing an economy based on knowledge and innovation”; “promoting a more resource efficient, greener and more competitive economy”; and “fostering a high-employment economy delivering social and territorial cohesion”. This is not the first time that the EU has come forward with a grand strategy for growth: the previous Lisbon Strategy (adopted in 2000) contained many ambitious goals for the EU, and yet most of them were not achieved. It is now up to the EU’s leaders to review the Commission’s proposal and to say how they envisage the future economic development of the EU.

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