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Crunch time for the eurozone?

William Keegan

A gloomy picture has emerged for the beleaguered European Central Bank.

IN COMMON with many British observers, this correspondent underestimated the degree of political commitment behind the setting up of the eurozone. On the other hand, those of us who questioned the economic structures and policies that have accompanied the early years of the single currency, appear to have been right to be pessimistic.

The growth of the eurozone economy since 1999 has been painfully slow, unemployment has been high, and the lack of buoyancy has made it inevitable that leading countries have been forced to break their own fiscal rules laid down by the Stability and Growth Pact. Never mind, say the European Commission and the European Central Bank (ECB), this year will be different: a strong recovery is now under way.

One would be more impressed by such reassurances if they were not an echo of the reassurances we have been given almost every year since 2000, accompanied by buoyant forecasts from the ECB which look a lot better at the beginning of the year than at the end.

This time, however, we are told it is different — so different that the ECB has already raised interest rates twice for fear that inflation will get out of hand. And what does "out of hand" mean? Well, inflation in the eurozone has been hovering around two per cent for several years, and this year, with the lagged impact of higher energy prices worrying the ECB, it is threatening to edge a little above two per cent. But "core inflation" a measure which is concerned with domestically generated inflation, is well below two per cent and there is precious little evidence that there will be any "second round effects" from energy prices — that is, that wage bargainers will up the ante. This is because in this modern economic world of "globalised" competition, the bargaining power of trade unions is pathetically weak. Indeed, in Germany, the engine-room of the eurozone, wages have been stagnant (and even falling for on some occasions) for years, a phenomenon that has helped the country's still powerful manufacturing industries to maintain competitiveness and enjoy quite an export boom.

With wages depressed, the consumer has not exactly been splashing out. The German corporate sector has been highly profitable, which explains why surveys of business confidence are so impressive, but the effect has not spread through to domestic demand.

Meanwhile, in contrast to Germany, the Italian economy has been losing its cohesion fast. Indeed, the new governor of the Bank of Italy, Mario Draghi, has called a spade a spade, by pronouncing: "Since the 1990s, it is as if the economy has run aground."

The Italian scene is so worrying economically that from time to time people raise the question: will Italy actually have to leave the eurozone? Under the single currency arrangements, Italy can no longer devalue against Germany and other European countries, as Mr. Draghi pointed out. True, he described "the remedy of competitive devaluations" as illusory, but merely by referring to what Italy could once do he was contradicting himself. Those devaluations were not illusory. They helped countries such as his regain competitiveness and boost output and employment.

If all this sounds pretty gloomy, it is. Taken with the sudden outbreak of protectionism with regard to cross-border mergers in Europe, the current macroeconomic prospect is disturbing.

Is it not time therefore for the leaders of Europe in general and the eurozone in particular to offer some hope? The vision of the Founding Fathers of what is now the European Union was that by economic means they would draw nation states closer together and avoid a repetition of the tragic errors of the 20th century, with nationalist rivalries and economic protectionism leading to two world wars. —

© Guardian Newspapers Limited 2004

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