Europe may be through the worst of its recession, the latest data suggests. But the fallout from the credit crisis is likely to linger for years, poisoning politics and policymaking in the EU.
Mountains of debt incurred through government spending on economic recovery threaten to push up borrowing costs, while high unemployment may hinder the further opening of markets. The addition of new members to the 27-nation EU could be slowed.
“The next 10 years will be much more difficult for Europe than the last 10,” said Thomas Mayer, an economist at Deutsche Bank who has followed European affairs since the mid-1980s.
The EU can point to some major successes in the crisis. When the euro was launched 10 years ago, economists thought the single currency might not survive its first big recession, as weak countries found the pain of being locked into one exchange rate unbearable.
Those fears have not materialized, and without the euro, Europe might have sunk into a cycle of competitive currency devaluations that would have worsened the global crisis.
The crisis has probably enhanced the EU’s reputation as a safe port in a storm. Iceland, which traditionally spurned the idea of EU membership, is now moving toward joining.
The European Central Bank (ECB) is also proving a winner in the crisis. Although board members from individual countries have inevitably differed on policy, the bank seems to be steering a middle course on interest rates and money market liquidity that is broadly acceptable to the range of national interests.
FISCAL POLICY
But fiscal policy is more of a problem. ECB chief Jean-Claude Trichet noted this month that the collective public deficit of the euro zone was set to more than triple to 6.5 percent of GDP by the end of this year from 1.9 percent last year; the ratio of debt to GDP would hit 80 percent.
That prospect is putting tremendous pressure on the commitment of EU members to the deficit control rules of the bloc’s Stability and Growth Pact, which says budget deficits should not be higher than 3 percent.
Even in better times, EU members squabbled over the pact. It may now be very difficult for fiscally conservative members such as Germany to persuade other countries to restore fiscal discipline for years to come, even as economies recover.
“It could be a dirtier battle this time round,” said Jon Levy, a New York-based analyst for Eurasia, a consultancy.
The battle may already be starting. German Deputy Finance Minister Joerg Asmussen said this month that he opposed an idea raised by French Economy Minister Christine Lagarde, who hinted that deficits arising from economic stimulus packages might be excluded from the stability pact.
The crisis has also shattered the region’s belief in a major attraction of EU membership: the idea that debt default was inconceivable for most of the region, and that all nations could use their membership to borrow money at effectively the same price as the bloc’s strongest members.
Finland’s 10-year government bond yield, for example, was for years level with or even slightly below the yield on German Bunds. But it shot up to nearly 90 basis points over Bunds in January this year, and is still 42 basis points over.
Bond markets will never again believe membership of the euro zone is enough protection in itself to merit financing the likes of Ireland or Greece at similar rates to Germany, and the cost of funding could become prohibitive for some EU countries that remain outside the euro zone, Levy said.
Deutsche’s Mayer goes so far as to suggest the creation of a Europe-focused version of the IMF, with the financial firepower to fund rescues of indebted countries if markets demand too high a premium.
That, like the idea of a fiscal union across the euro zone, looks fanciful but it highlights the size of the problem, said Tito Boeri, economics professor at Bocconi University in Milan, Italy.
NATIONAL INTEREST
European governments have essentially gone their own way during the crisis, even if they sometimes presented their actions as part of coordinated initiatives, Boeri said.
French President Nicolas Sarkozy infuriated his Czech EU partners a few months ago when he said the government would like to see French carmakers relocate production to France from Eastern Europe in return for French government aid.
Ireland infuriated German investors in particular last September with its unilateral decision to guarantee bank deposits, which pressured EU neighbors into following suit.
Meanwhile, the European Commission, the closest thing that the EU has to an executive, is set to emerge weaker from the crisis after national governments pressured it into waiving restrictions on state aid for industries.
The commission could be further diminished as a force for integration and enforcer of free competition rules when its top officials are changed by national governments later this year.
That could take a toll on the push toward more open product and labor markets across the EU. Levy said merger and acquisition activity could suffer if the commission became a less vocal advocate of open markets.
INTEGRATION
Poorer EU member states have also been disappointed by the reluctance of rich ones to do more to help them in the crisis.
In April, Germany and Austria said they planned to keep labor market restrictions in place for the EU’s eight ex-communist newcomers for five years after they joined the bloc.
At a meeting of the European Bank for Reconstruction and Development last month, many officials from EU members and non-members in Central and Eastern Europe complained that the EU was not providing enough aid and was largely leaving rescue efforts to the IMF.
This reluctance to get involved suggested the EU might, for some years at least, drag its feet on further expansion of the bloc to include nations such as the Balkan states and Ukraine.
Jean Pisani-Ferry, head of Bruegel, a Brussels think tank, believes EU integration faces a serious setback, crowded out by narrow national interests as governments focus on saving jobs, factories and banks on their own patches.
“There’s a serious problem, because there’s an absence of enthusiasm for the project,” Pisani-Ferry said.
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