Chinks of light emerging from amid euro gloom – UK economist

Headline news from the euro area has been downbeat, but amid the gloom there are signs of progress, according to Ian Stewart, Deloitte’s chief economist in the UK.

Recent positive developments include the deal reached last week by the ‘troika’ of the IMF, the EU and the European Central Bank on a new funding agreement which will cut Greece’s long term debt burden, and Portugal passing another hurdle by agreeing an austerity budget for 2013.

Confidence about prospects for the euro area has been on the rise since early September when the ECB announced a new, radical programme to buy the government bonds of at-risk countries without limit, Stewart said. Last week’s news boosted confidence further, helping take Italy’s cost of borrowing to the lowest level in two years.

Two studies released last week suggest the painful process of adjustment in the peripheral euro area economies is starting to deliver results, he added.

A joint study conducted by Berenberg Bank and The Lisbon Council found that “the euro area has advanced significantly further [in 2012] on the rocky road to balanced growth in the future”. Another study by insurer Allianz concluded that “behind the less pretty headlines, genuine progress is being made towards restoring the health of the euro area economy.”

Both reports argue that the peripheral euro area countries have made significant progress in restoring competitiveness. Labour costs are heading down, fiscal deficits have fallen sharply and exports are growing.

Stewart said he recently met the author of the Berenberg paper, Holger Schmieding. “He believes that if Europe sticks to the path of reform it could become one of the fastest growing parts of the industrialised world in a couple of years’ time,” said Stewart in his weekly briefing report. “He also believes there is a tendency to overstate the weakness of the euro area, and points out that the euro area fiscal deficit is smaller than those of the US, Japan and the UK.”

The hard data show that change is happening, he pointed out. Greece reduced its fiscal deficit before interest payments by 13.4% of GDP between 2009 and 2012. Spanish and Portuguese exports have risen by 22% in the last 3 years. Labour costs have been falling in Greece, Portugal, Spain and Ireland (although not Italy). With German and French labour costs on the rise this means that the competitiveness of much of the euro area periphery is starting to improve.

“Indeed, some are now starting to worry that the real threat to European competitiveness lies, not at the periphery, but at the core of the currency zone. Last month the Economist declared France the ‘time bomb at the heart of Europe’, citing a rising budget deficit, large trade deficit and the fact that its government accounts for a larger share of the economy than in any other euro area country.”

“The recent decision by the car-maker Renault’s decision to build two new vehicle platforms in Valladolid, Spain, citing the ‘competitive performance’ of the workforce there, plays to such fears.”

The debate about competitiveness arouses strong passions, he notes. Different economic indicators give different messages and much is subjective, but two things are clear. “First, the pace of reform and the time it takes to raise growth rates varies across countries. Ireland seems to be ahead of the rest of the euro area periphery. On average economists see the Irish growing by 1% in 2013 driven by strong exports.”

By contrast Italy, Spain, Greece and Portugal are all expected to contract further next year, albeit at a slower pace. The IMF does not see Greece returning to growth until 2015 by which time its economy is forecast to be 25% smaller than at the start of the crisis.

“Second, reforming economies takes time. A recent paper from the Organisation for Economic Co-operation and Development (OECD) found that the full benefits from structural reforms usually take about five years to materialise.

“The hope among European policymakers is that the euro area will emerge from the current crisis stronger and more competitive. Economies can certainly achieve remarkable change. The real question is whether countries can sustain the political will and public consent needed to make it happen.”


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