Will sick men of Europe be able to weather economic storm?

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Will sick men of Europe be able to weather economic storm?

A hard Brexit is looking increasingly likely since Theresa May will probably not get the majority needed for a deal. (Reuters)

A whirlwind of events has engulfed Europe over the past six months. While the effects have most been felt on its economies, these ripples were inspired by politics. In fact, if the events of 2018 show one thing, it is to what extent politics can undermine economic prosperity.

First there is Brexit, a self-inflicted saga. Prime Minister Theresa May has “pushed” the vote on the Brexit deal to January 21, hardly enough time for the European Union (EU) to get ready for it.

A hard Brexit is looking increasingly likely since May will probably not get the majority needed for a deal.

The International Monetary Fund estimates a six-percent decline in GDP if a hard Brexit prevails, a stark comparison with projections of a 1.4-percent increase were the United Kingdom to stay in the EU.

The finance, automotive and chemicals industries would likely be the hardest hit. Brexit will be a hard blow to small and medium-sized enterprises (SMEs) because they lack the financial wherewithal to hire the accountants and lawyers necessary to brace themselves for a no deal scenario. And yet, SMEs currently hire 60 percent of the national workforce, making them the most important segment of the labor market by far.

In the shorter term, exporters fared well because they were aided by the falling pound, which was thanks, of course, to Brexit.

Brexit will be a hard blow to small and medium-sized enterprises (SMEs) because they lack the financial wherewithal to hire the accountants and lawyers necessary to brace themselves for a no deal scenario.

Cornelia Meyer

This will come to an abrupt end if Britain comes crashing out of the EU under a no deal scenario. Both the exports and supply chain fronts will be severely affected. The FTSE 250, which is composed of more traditional British companies, is a good litmus test of what the Brexit wobbles have done to the economy. It is down roughly 13 percent on the year.

But it is not just the UK economy that is going to be hit by a hard Brexit. Supply chains are inherently integrated within the automotive and other manufacturing sectors, meaning importers will feel the pinch once the free trade agreements come grinding to a halt, especially if there is no transition period. The extent to which these chains are affected is contingent on an orderly Brexit.

As if Brexit was not enough, there is Italy. The stand-off between the European Commission and the Italian government over the budget deficit may have been somewhat quelled with Italy’s latest proposal, which brings down next year’s GDP deficit from 2.4 percent to 2.04. Yet it is still too high to enable Italy to draw down on its overall debt, which stands at 131 percent relative to GDP, well above the Eurozone’s 60 percent limit.

Only Greece beats Italy in this category. However, Italy matters much more than Greece because it is the Eurozone’s third largest economy.

The Italian debacle is yet another man-made kerfuffle. Italy’s government is composed of two populist parties, the left wing M5S and the right-wing Lega. The budget is a compromise of sorts between their two ideologies. While the former wants to guarantee minimum income and a raft of other forms of social spending, the latter wants to reduce the tax burden on the wealthy. While one side spends, the other limits the fiscal income stream.

Meanwhile, in the Eurozone’s second largest economy, France, French President Emmanuel Macron had to abandon the direly needed economic reforms he initiated after violent protests paralyzed Paris and many cities over several consecutive weekends.

While the riots were sparked by fuel tax, the issues run deeper. In fact, far too many French feel economically disenfranchised and politically powerless. 

Those people cannot make ends meet. They also feel that they do not have a seat at the table. This sense of disenfranchisement is by no means limited to France. It permeates throughout Europe. The unrest led Macron to abolish fuel tax, increase minimum wages and cut taxes in some sectors, resulting in a projected budget deficit of 3.4 percent for next year. Once again, this exceeds the three-percent limit allowed under under Eurozone rules. The debt-to-GDP ratio stands at a whopping 97 percent and is set to grow further if things continue the way they are.

As though it is not enough that Europe’s second, third and fourth largest economies are basking in such struggles, the EU’s largest economy, Germany, has thrown a curve ball at the zone as well.

The German economy contracted in the third quarter of this year for the first time since 2015, bringing the overall Eurozone growth rate down from a projected 0.6 percent to 0.2 percent. Germany’s woes had a lot to do with a fear of trade wars ensuing both between the US and China and the US and Europe. Germany is the economic locomotive of the Eurozone. 

Its automotive sector is the driver behind the manufacturing juggernaut. US tariffs on imported cars would hit the economy badly, as will trade wars with China.

Germany exports a lot of machinery to China and its Volkswagen and BMW brands export a lot of their cars from their plants in the US to China. Once again, the culprit is political forces in the US.

In short, economic storm clouds are fast gathering in Europe. That is why the decision of the European Central Bank (ECB) to halt the $2.85 trillion stimulus program in December was a courageous move.

True, Mario Draghi, ECB president, left himself some wiggle room by reserving the right to reinvest the proceeds of previous bond purchases and leaving the interest rate unchanged. Only time will tell us whether this can provide sufficient liquidity to help the economy weather these largely self-inflicted storms.

  • Cornelia Meyer is a business consultant, macro-economist and energy expert. Twitter: @MeyerResources
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