In the wake of Europe’s latest debt crisis, the eurozone could be diverging into two or even three different economic parts, a move that threatens to compound the problems even further.
Significant economic differences have always existed between the eurozone’s northern and southern countries. But some economists now believe that, intensified by the shocks of the financial crisis, multiple differences threaten the future of the euro itself.
“I don’t think it’s sustainable in the absence of a much greater degree of political and economic integration,” said Simon Tilford, chief economist at the Centre for European Reform, a research institute based in London.
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After publication of new figures on Monday, a senior EU official acknowledged for the first time that a two-speed eurozone might be developing, with Germany racing ahead while debt-laden countries on the continent’s periphery battle stagnation.
“It has to be admitted, there is a certain dualism in Europe,” European Commissioner for Economic and Monetary Affairs Olli Rehn said on Monday while announcing the commission’s autumn economic forecasts.
Germany has “rebounded very forcefully from the financial crisis and economic recession with a strong growth of exports — increasingly spilling over to the domestic demand,” Rehn said.
Ireland and some countries in the south of Europe, in contrast, “have faced significant difficulties,” he said.
Adding to the complexity, other European officials say, is a third group of economies that includes France and Italy, which did not suffer as much during the recession because they were less reliant on global trade yet have not recovered as well even as trade has rebounded.
Financial markets gave a largely negative reaction Monday to the 85 billion euro (US$111.2 billion) bailout package for Ireland announced on Sunday night and to the announcement of new rules for dealing with debt crises in the eurozone after 2013. EU officials had hoped the Irish rescue, and greater clarity on future rescues, would quell market fears of crisis spreading to other heavily indebted euro countries, like Spain and Portugal.
After initial gains, European stocks retreated and investors continued to sell the bonds of Spain, Italy, Belgium and Portugal. The spread, or interest-rate differential, between Spanish and German 10-year bonds rose to the highest level since the creation of the euro in 1999. Wider spreads indicate that investors are seeking a higher yield to compensate for greater perceived risk.
Ben May, an economist in London with Capital Economics, said investors had been troubled by a sense that some policymakers were trying to discourage other governments from applying for bailouts. For example, he said, Ireland will be charged a rate of around 5.8 percent on its loans, compared with the 5 percent that Greece has to pay, and there were reports suggesting that Germany wanted the rate even higher.
“The further details of the Irish bailout package and the euro zone’s permanent crisis resolution mechanism confirm that Germany and other European hard-liners are in no mood to make major concessions to the periphery,” May wrote. “Accordingly, market stresses are unlikely to ease any time soon.”
Unlike Iceland, which pulled out of its debt crisis in part by devaluing its currency to increase exports, euro countries like Greece, Portugal and Ireland cannot use devaluation to stimulate growth. That makes their prospects for escaping a debt crisis look bleak because the cuts needed to control budget deficits also depress growth.
“It’s very hard for any economy to flourish in the teeth of fiscal austerity of this magnitude — let alone those that can’t devalue,” Tilford said.
EU officials do not entirely accept that analysis, though neither do they hide the challenge posed by the economic performances of different euro zone nations.
The economic forecasts announced on Monday show that Germany and “some smaller export-oriented economies have registered a solid rebound in activity, while others, notably some peripheral countries, are lagging,” the report said.
“Looking forward, the expectation remains for a differentiated pace of recovery within the EU, reflecting the challenges individual economies face and the policies they pursue,” the report said.
Overall economic growth in the euro zone is expected to be 1.5 percent next year, slightly lower than the projection for this year, and 1.8 percent in 2012.
But the divergence in performance is striking on a range of measures.
In 2012, general government debt as a proportion of GDP is projected to hit 156 percent in Greece, twice the level of Germany and more than seven times that of Luxembourg.
Next year, GDP is expected to shrink 3 percent in Greece and 1 percent in Portugal. In Ireland it is projected to grow, but by under 1 percent — less than half the rate of Germany.
According to one European official not authorized to speak publicly, the picture is more like a three-speed currency area.
“The eurozone was hit by a crisis and a number of countries have been through an adjustment,” the official said. “In this crisis, different countries were affected in different ways.”
Because Germany is an open trading economy, it was hard hit by the collapse of global trade during the recession. However, its competitiveness has helped a rapid, export-led recovery. Some smaller North European nations like the Netherlands, Finland and Austria have had similar rebounds.
The French and Italian economies, however, were never as open and therefore were not as hard hit by the slump in trade. But, having made only limited structural changes, they have not gained the competitiveness to take advantage of recovering conditions the way the Germans have. Worst affected have been the countries that suffered overheating and asset bubbles and that are still struggling with a painful adjustment.
European officials concede that, because troubled eurozone nations are unable to devalue, the process of adjustment may be long and painful. Their strategy is to push structural changes and new rules based on the lessons of the crisis, in hopes of preventing such divergences in the future.
In his remarks on Monday, Rehn stayed upbeat about Ireland’s prospects of achieving projected growth of 1.9 percent in 2012.
“The Irish are smart, stubborn and resilient people, and they will overcome this,” he said.
The EU also hopes that Germany’s recovery will prove the motor for the rest of the eurozone, particularly if domestic demand starts to pick up. That could help resolve the issue of trade imbalances within the eurozone by reducing Germany’s trade surplus.
Tilford said Germany would experience “reasonable export-led growth,” but it would not be as strong as assumed by the European Commission. It is too early to assume that domestic demand is taking off in Germany, he said.
The result, he said, really could mean two speeds of growth — and rather low ones at that.
“It could mean weak economic growth across the euro zone as a whole and economic stagnation and debt deflation in the periphery,” he said.
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