Eurozone Economies – Storm clouds ahead

I have always maintained that Euro zone is condemned to the Hindu rate of growth unless some fundamental reform happens both at societal and governmental level.A lot of relieved sighs could be heard when it looked as if EU will be growing faster than any other economy in the world. Especially from US. After being the engine of global economy for the past 6-8 years, it does get a bit tiresome to be called up for duty time and again; even more so when the country is not appreciated abroad. However, I would not break open the champagne bottles if I were US.

All the promising signs that EU economy shows are just fluff with very little stuff inside. The fundamental problems which are the root cause for EU’s decline, while the rest of the world (excepting that perennial underachiever Africa) seem to be speeding ahead, remain unsolved. Worse, there is no light visible at the end of this tunnel. Of course with ECB bent upon raising rates, it is almost a shoo in that the growth rate will slow down.

The recent article in Economist (sub required), raises this cautionary flag.

There are three short-term reasons to expect slightly choppier waters in the euro zone. The easiest one to exaggerate is the slowdown in America, where growth tumbled to (an annualized) 2.5% in the second quarter and where consumers will surely be less willing to snap up German plastics and French perfumes. In fact, the euro area’s growth increasingly seems to be being pushed along by its own consumers’ spending rather than exports. The zone as a whole depends on exports much less than its individual countries do: the 43% of Germany’s exports going to other members of the club count as domestic demand at the level of the euro area. And America is less important as an export market for the zone than you might expect. Britain counts for more; so, combined, do other European Union countries. And when it comes to recent additions to exports—which is what really matters for growth—China is buying an ever bigger share. On the other hand, a slowing America is plainly no help to Europe’s exporters.

The second reason to expect a slowdown is that some euro-area countries, notably Germany and Italy, are due to tighten their budgets. That their public finances need repairing is not disputable; the timing and style of the repairs is, especially in Germany. Just when German consumers seem to have recovered their confidence, after years of low wage-growth and worries about jobs and pensions, the government wants to raise value-added tax by three percentage points next January. Paradoxically, this may boost growth in the second half of this year, as spending is brought forward to beat the tax increase. But it will surely hold the economy down at the start of 2007.

Third, the European Central Bank (ECB) is providing less of a following wind than it did. It started raising interest rates last December and is expected to keep doing so at least until the end of this year. So far, there is little sign that these rate increases are holding the euro zone back, but eventually they will have an effect. And the second-quarter spurt makes further rises in interest rates more likely.

The key structural issues of unemployment, labor laws, healthcare remain unsolved. The key social problems of low enterprise formation, stigma of failure, stigma of success remain unresolved. Unless some deep and committed reform happens in these areas, I fear EU will continue to become marginal.

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