Thursday, November 27, 2014

Cementing Europe’s Recovery

BRUSSELS – During my current trip to Europe, I have been encouraged by the hope and deeper sense of economic and financial calm that has arrived this spring. With risk spreads compressing markedly, the region’s financial crisis has been relegated to the history books, and the region is again attracting the interest of foreign investors. Consumer confidence is recovering as well, and businesses are again looking to expand, albeit cautiously. Economic growth has picked up and unemployment, while still alarmingly high, has stopped increasing in most countries.

Remarkably, all of this is occurring in the context of a major geopolitical crisis to the east, following what the Financial Times rightly pointed out constitutes “the first annexation of another European country’s territory since the Second World War.” Equally disturbing, Russia’s annexation of Crimea has occurred with stunning ease – indeed, simply “with the stroke of a pen,” as the FT put it. And neither Western Europe nor the United States can even pretend to provide a military counterweight to Russian actions in Ukraine.

Yet, rather than disrupt its growing confidence and composure, the Ukrainian crisis has been a catalyst for renewed political cooperation and solidarity within Western Europe. It has also fostered closer relations with the US at a time when political leaders face inevitable headwinds in completing historic negotiations on the proposed Transatlantic Trade and Investment Partnership (TTIP), aimed at boosting economic ties in a manner consistent with a strengthened multilateral system.

Europe badly needs all of this good economic and financial news. The region has only just exited a recession that has devastated many livelihoods. Far too many citizens are still trapped in long-term unemployment, while a distressing number of young people struggle to secure a job – any job.

The region’s ongoing recovery is also good news for a global economy that has yet to rebalance properly and fire on all available growth cylinders. US growth, while edging up, is still below its potential, let alone high enough to offset prior shortfalls. After a short burst, Japanese growth has begun to sputter. And several systemically important emerging economies (including Brazil, China, and Turkey) have slowed, while their transitions to new growth models remain incomplete.

But Europe’s renewed sense of hope and confidence, however encouraging, is not sufficient – at least not yet – to produce appreciable welfare gains for current and future generations. A few things need to happen rather quickly – specifically, over the next several weeks and months – if the continent is to minimize the risk of slipping into another prolonged period of under-performance and additional asymmetrical downside financial risk.

Let us start with the immediate geopolitical threat. To put it bluntly, Europe’s economy, and even more so the economies of Russia and Ukraine, is not particularly well positioned to weather a further disorderly escalation of tensions. Enlightened diplomacy needs to replace the Cold War-style posturing and rhetoric that have re-emerged. Further escalation would mostly likely cause the West to impose deeper economic and (critically) financial sanctions on Russia, followed by Russian counter-sanctions that would disrupt the energy flow to Europe. All of this would tip Europe as a whole into recession and renewed financial turmoil.

Second, the European Central Bank needs to pivot from financial-crisis prevention – an area where it has performed impressively – to striking the delicate balance of supporting growth (and countering currency over-appreciation) without fueling excessive risk taking. This may well involve renewed experimentation, which would again take many policymakers outside their comfort zone.

Third, with European institutions acting as catalysts, political leaders will need to reinforce efforts to place the eurozone as a whole on a firm footing. This requires complimenting monetary union with deeper political integration, better fiscal coordination (where progress has been painfully slow), and a proper banking union (last month’s agreement should be treated as a stepping stone, not the ultimate destination).

Fourth, at the national level, individual countries need to continue to rebalance their policies with a view to achieving the trifecta of structural reforms, solid aggregate demand, and fewer debt overhangs.

Finally, anti-establishment parties must not dominate the European Parliament election in May. Most of these parties are committed to greater national isolation and, at least initially, would work hard to halt and reverse recent gains made on regional economic and financial integration.

That is quite a to-do list, to be sure, especially given that it only covers the next few weeks and months. Yet every item on it is achievable, and progress on each would help to ensure that Europe’s encouraging spring leads to a bountiful harvest of economic opportunity, growth, and jobs, while reducing the risk of a hot political summer and a more frigid economic winter.

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    1. CommentedStephen Pain

      I find myself increasingly cynical about the macroeconomic systems, as they are often too complex and too vulnerable at the same time, predicated not on production or people, not on sovereign economic interests, but on the interest of interest ifself. We see in the world economy a vast glut of wealth in the hands of few, and arbiters of economic strategy are a minority too. Trillions of dollars are wasted. The sovereign debt of the US and Europe is mindblowing, China has overstretched its economy, spirited away the subprime dividend on construction that has not earned anything, it has manufactured at speed quantiy rather than quality, India has burnt out, Africa and South America have become havens of inequality and exploitation. When we see the paltry offers of a billion to the Ukraine - after the ex-President stole 60 billion or so, what nonsense economics. I see no redeeming quality at all in the market - the mentality of the Wolf of Wall Street pervades - and questions of the real economic processes at the level of daily enterprise and work are never accounted, nor rewarded as they should be.

    2. CommentedMargaret Bowker

      Hopefully, in his stimulating post, Mohamed El-Erian is correct in saying that TTIP's negotiation process is accelerating. This is such an important issue. US growth is encouraging, but as he says, still below potential; and it seems reasonable to be more confident than he is about Japan. Of the points on Europe, the first on diplomacy is very important; the second on the ECB brings to mind the report that the two central Banks, ECB and BOE, are working on alternative forms of QE, perhaps presenting them at the IMF Spring meeting. Not happy with the third point, political integration within the Eurozone as well as monetary union. Like the fourth point. Don't like the fifth point because I don't quite see what it was trying to achieve - 'must not dominate' how does that work with democracy?