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The Resilience of the European Economy

Unlike all the doomsayers, the EU economies (UK is another story) are doing much better than expected. According to European Commission estimates, growth in 2022 is already over 3% (more than half a percentage point higher than the summer forecast), unemployment is at a record low of 6.5%, and industrial production has fallen much less than expected. The European economy is showing great resilience.

That doesn’t mean the EU won’t face a tough winter. With Russian energy supplies effectively cut off, some European countries could slip into recession in 2023 and inflation may struggle to come down. But unlike previous crises (the economic disaster caused by COVID-19 in 2020 and the euro and global financial crisis in 2008-2012), this economic contraction, if it occurs, is likely to be mild and short-lived. Spain will certainly try to get around it.

Economic collapse is not

European economies will take longer to recover from the impact of the pandemic in 2021 than the US. But Russia’s invasion of Ukraine in late February cast a gloomy picture on the macroeconomic outlook as growth began to pick up. The prosperity of Germany and its neighbors rests on cheap Russian gas and exports to China. Russian ties were abruptly severed, and relations with China, while still tense, had to be reconsidered in the context of great power geopolitical competition. Furthermore, with inflation already at high levels due to years of expansionary monetary and fiscal policy, the outlook for the economy last summer was very bleak. Some even talk of a return to the stagflation of the 1970s.

However, the economy performed better than expected. There is no doubt that the war in Ukraine – triggering sharp increases in energy, food and commodity prices while increasing uncertainty – combined with China’s zero-COVID policy – slowing growth across Asia – has taken a heavy toll on the country as a whole Hit the world, especially Europe. But EU countries have made good (and fast) economic and energy policy decisions. Plus, they had some luck.

One is to implement a good expansionary fiscal policy to ease the impact of rising energy prices.In addition to substantial investment in projects Next Generation EU, is moving at a good pace, with all governments taking steps to protect the most vulnerable citizens and companies. This makes it possible that investment and consumption will not be significantly reduced, but it must be emphasized that such aid cannot be sustained indefinitely.

Second, monetary policy, while tighter than in the past, continues to maintain an expansionary stance (real interest rates remain negative). As the Fed tightens liquidity more aggressively, the euro has weakened against the dollar, favoring eurozone exports (the euro has gained recently, but remains “cheap”). Furthermore, the «limited» rate increases did not lead to a significant reduction in credit, problems with bank balance sheets or a collapse in the housing market. The downside is persistent inflation, which has peaked in the US but certainly not in the Eurozone, which may require more aggressive and prolonged monetary tightening in 2023.

Third, energy and commodity prices have returned to more reasonable levels, partly because China’s abandoned zero-COVID policy has reduced demand in Asia. Natural gas, while still very expensive in most countries (not so much in Spain and Portugal, with the exception of Iberia), has fallen from 340 euros per megawatt-hour in November to less than 100 euros today. Oil is already at the level it was when Russia invaded Ukraine. This all eases the pressure on European economies. In addition, measures to replace Gazprom with liquefied natural gas, alternative suppliers and, most importantly, energy-saving measures have achieved remarkable results. European economies could thus face ample reserves to avoid blackouts in the winter of 2023, especially if temperatures are mild and French nuclear plants continue to ramp up production (problems could arise in the winter of 2024, but that’s still far away).

But Europe’s response on energy and climate issues has gone much further, entering the realm of geopolitics entirely. In addition to the RePowerEU package, the EU agreed to an embargo on Russian coal and oil, set a price cap on Russian oil exports and reached a historic decision after intensive negotiations to jointly buy 15% of its natural gas by 2023. price ceiling. The EU has also overhauled its Emissions Trading Scheme (ETS) to further reduce greenhouse gas emissions. At the same time, it launched the controversial Carbon Border Adjustment Mechanism (CBAM), which aims to ensure a level playing field between European companies with high production environmental standards and less stringent foreign companies through «green tariffs». While the CBAM is slow to come into force and could spark a new trade war, it could also be another example of the «Brussels effect», where the EU’s regulatory leadership is eventually adopted by other countries. This will be key to effectively addressing climate change.

Finally, despite slowing growth, rising interest rates and criticism of Europe from Italy’s far-right government, there is no sign of financial fragmentation in the euro zone or tensions in the financial sector that could lead to sovereign debt problems. Indeed, the mechanisms put in place over the past decade to prevent financial crises in the euro zone, and the ECB’s new role as lender of last resort in recent years, appear to have convinced investors that the single currency is here to stay.

In short, 2023 will bring important economic and geopolitical challenges for Europe. The war in Ukraine is far from over; inflation—especially core inflation—refuses to fall, massive US subsidies to speed up the energy transition threaten to deindustrialize parts of Europe, and, gradually, higher interest rates bring more High financing costs will weaken public budgets and deter investment. But for now, the European economy is holding up.

What to do now?

The European economy performed better than expected, but faced severe structural challenges. European leaders should use this situation to rethink their growth model and improve their economic governance.This will make it possible to strengthen the much-needed European Strategic Autonomy.

European countries emerged from the financial crisis 10 years ago and the euro’s austerity and export strategy is unlikely to be repeated. Protectionist and deglobalization trends, the fragility of the multilateral trading system, and internal opposition to austerity policies in most European countries make it politically unfeasible. Moreover, the EU can only thrive in a world of great power competition and geopolitical tensions if it deepens political integration, invests in industrial policies that accelerate digital and energy transitions, and develops stronger foreign and security policies.

An essential element of this transition includes having more flexible fiscal rules, joint borrowing at the European level and a permanent fiscal capacity to fund European public goods that strengthen the union. Such drastic changes were never explicitly on the table, both because they were rejected by opponents of the «ever closer union» and because they might call for treaty revisions, considered taboo in many capitals. But with war on European soil and the U.S. and China beefing up their industrial policies with heavy subsidies, the European economy has shown resilience and still has fiscal space (debt-to-GDP ratios in the Eurozone are over 20% lower than in the U.S.), and Europe There is a unique opportunity to take an ambitious leap. To do so, it must move from Germany’s small, open economy as a price taker to a more Anglo-Saxon approach of a globalized economy with strong domestic demand and the ability to shape the international economic order.

Elcano Stand

The Institute’s initiative aims to gather expert analysis on topics within the scope of our research agenda. Their publication is not bound by a fixed cycle, but emerges as current affairs or the importance of events, suggesting that we look for explanations that may be proposed by the broad academic community or members of the Elcano Royal Institute. Institute research team.

Image: The European Central Bank seen from the Osthafen Bridge in Frankfurt (Germany). Photo: (@cmophoto).

Author: Frederick Steinberg

The entry Resilience in the European economy was originally published on USA News Web.


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