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A few things need to happen soon if Europe is to minimize the risk of slipping into another prolonged period of under-performance and additional asymmetrical downside financial risk. A column by Mohamed A. El-Erian.
Mohamed A. El-Erian
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 Partership (TTIP), aimed at boosting economic ties in a manner consistent with a strengthened multilateral system.
Unemployment remains a curse
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.
Escalation in Ukraine would pose a grave threat
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).
Crucial European elections coming up
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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