Sunday, March 10, 2013
The eurozone crisis could still blow Britain away
Posted by David Smith at 09:00 AM
Category: David Smith's other articles


My regular column is available to subscribers on This is an excerpt.

What happens in Europe doesn’t stay in Europe, and right now the picture there is downbeat.

The dampening effect of the eurozone crisis will be one of the factors George Osborne cites in his March 20 budget (of which more next week), and was highlighted by David Cameron in his infamous economic speech a few days ago.

He meant to say that the eurozone, high oil prices and the prolonged banking crisis explained why growth has undershot the Office for Budget Responsibility’s forecasts of three years ago, not the tax increases and spending cuts it had alreday incorporated into its forecasts. But it came out differently, hence the rebuke from the OBR.

But the eurozone is the biggest risk to Britain’s recovery hopes this year, and it remains the central threat to the world economy, in spite of the calming effect of the European Central Bank’s pledge to buy the government bonds of troubled eurozone economies.

Figures last week confirmed that eurozone gross domestic product fell by 0.6% in the final quarter of last year, which included falls of 0.8% in Spain, 0.9% in Italy and 1.8% in Portugal. Even Germany succumbed, down 0.6%. A quarterly figure for Greece was not available, but its GDP was 6% down year-on-year; grim for a recession that began in 2008.

Eurozone unemployment, 19m, or 11.9% of the workforce, has risen by 1.9m in the past year. The European Central Bank, like the Bank of England, sat on its hands on Thrusday but confirmed a 2013 recession for the eurozone, predicting a drop of between 0.1% and 0.9% in GDP this year.

Some say Britain’s problems are unrelated to the eurozone’s woes but that is plainly not the case. Apart from the crisis’s effects on confidence and bank funding, it has impacted heavily on Britain’s hoped-for export-led recovery.

Between 2009 and 2012 exports did recover, by 11% in volume terms, though imports rose at a similar rate. Exports to non-EU countries have risen strongly, by 31% in volume terms, while EU exports have been much weaker.

Since 2009, Britain’s GDP has risen by 2.9%. Had exports to the EU risen as strongly as non-EU exports, GDP would have increased by 8.7%, close to 3% a year, and nobody would be talking about the economy’s failure to recover.

Even if a stronger eurozone economy had simply resulted in 21% rather than 11% overall export growth. the recovery would have averaged a respectable 2% a year.

But the eurozone crisis is the cross Britain’s exporters have to bear. When will it end or is Europe doomed, like Sisyphus, to keep trying to push the boulder up the hill, only to have it roll down again?

We are used to visions of eurozone disaster as set out by British economists. Roger Bootle of Capital Economics did it well recently at the Institute of Economic Affairs, arguing convincingly that the eurozone is not sustainable in its present form, that it will condemn Europe to prolonged economic misery and that partial break-up will be part of the solution, not the problem, for Europe.

What you do not expect is to get equally doom-laden assessments of the eurozone’s prospects from the heart of Europe. The Munich-based CESifo is one of Germany’s “five wise men” institutes, and is headed by Professor Hans-Werner Sinn, one of the country’s leading economists. It has just published its 2013 European economic advisory group (EEAG) report on Europe.

The report highlights, as I have taken to doing, the fact that there is not a single eurozone crisis but three inter-linked ones: the sovereign debt crisis, the banking crisis and what it describes as a balance of payments crisis.

As it puts it: “Large imbalances have emerged in the euro area since 2000 in the form of current account deficits and surpluses. The euro area periphery countries of Greece, Portugal, Spain and Ireland in particular experienced credit bubbles that led to current account deficits and corresponding capital imports.”

Credit bubbles were accompanied by a loss of competitiveness, with the troubled eurozone economies gradually moving further and further away from Germany, Europe’s benchmark economy, losing between 20% and 30% competitiveness since the euro came into being.

What that means, as well as sorting out banking problems and putting sovereign debt on a secure footing (which for countries like Greece will mean further write-offs), the problem economies have to claw back that lost competitiveness.

There are two ways of doing that. One is so-called internal devaluation; cutting their costs, in particular their wage costs. It is, as the EEAG report notes, likely to be painful, involving “prolonged recession and high unemployment”.

The other route, external devaluation - leaving the euro- is no easier, it says, boosting public sector debt, driving companies into mass bankruptcy, with even anticipation of a euro exit causing “destabilising capital flight and contagion effects”.

It is not all bad news. Ireland is held up as an example of a country that is meeting the challenge of clawing back competitiveness, not least because its crisis erupted about two years before the others.

For most of the others, however, progress is painfully slow or non-existent. Italy, having had chronically weak growth for years, is in a political crisis and was downgraded to BBB-plus by Fitch on Friday. France, which is having a torrid 2013 judging by the surveys, is not immune.

Does not the euro hold together as long as Germany will finance it? As Sinn put it wryly: “We love the French, they lover our money.” But German pockets are not bottomless. Germans are suffering a wage squeeze and face the challenge of an ageing and declining population.

Not everybody is so gloomy. Berenberg, a German bank, in a new report, says: “If the eurozone and its member countries stay the course, the euro crisis could be largely over by the end of the year.”

It thinks the weaker countries are making better progress in restructuring their economies than CESifo believes. Even here, however, there is a sting in the tail. France, it says, is not making progress and urgently needs economic reform. My take would be harsher; that France is goijng backwards under Francois Hollande.

We need to hope that the optimists are right and that the eurozone is closer to resolving its crises than appears. Britain needs growth, not fog, across the Channel. But Europe has disappointed before. The fear is that it will do so again.