BlogSpot - September 29th, 2014
Weakness at the core
The euro zone’s economic recovery continued to falter, as reported by EuroIntelligence. Growth in the third quarter is expected to remain weak according to the flash PMI—at a nine-month low of 52.3 in September. For EuroIntelligence, this is due to lack of structural reforms and public sector investment programs. Weakness is appearing in the core, with business confidence in Germany fell to its lowest level in nearly 18 months. Among others, Roubini, in its quarterly outlook, revised downward its growth forecast for the eurozone, despite the periphery relatively good performance and because of the core’s extremely poor performance. German GDP was the main downward surprise in Q2, along with Italy’s technical recession (see EuroIntelligence). The French economy continues to disappoint (see for example Annalisa Piazza’s review at Roubini) with domestic demand suffering from the still restrictive fiscal policy stance and the pressure on corporate profitability, but also from the delay to structural reforms and the still high unit labor costs. For Simon Tilford, this is largely the fault of failed austerity policies imposed from the outside.
Weaknesses in Germany—Philippe Legrain (Project Syndicate) suggests that, behind Germany’s success, some weaknesses are apparent—stagnant wages, busted banks, inadequate investment, weak productivity gains, dismal demographics, and anemic output growth. And its growth strategy seems to reach its limits. Written off as the “sick man of Europe” when the euro was launched, Germany cut costs, and investment fell from 22.3 percent in 2000 to 17 percent of GDP in 2013. Now hobbled by underinvestment, Germany’s economy struggles to adapt. Wage compression saps domestic demand, while subsidizing exports, on which Germany’s growth relies. The euro has helped by reducing the prices of German goods and preventing France and Italy from pursuing currency depreciation. But, with southern Europe now depressed, and China’s economy decelerating and shifting away from investment spending, the German export machine has slowed. Legrain concludes that policymakers should focus on boosting productivity rather than “competitiveness” through internal devaluation and wage compression. Germany’s government should take advantage of near-zero interest rates to invest, and encourage businesses. FreeExchange is supporting this analysis by looking at the growing eurozone external surplus, reaching almost $400bn—as the adjustment in the periphery was not matched by a symmetric reduction in the German surplus.
Supply and demand-side policies? Joseph Stiglitz disagrees with the focus on supply side reforms in both France and Italy—with demand-related problems, many structural reforms would be untimely as they would depress demand further. He advocates for a three-pronged approach: a more fiscally expansionary Germany, a “real” banking union, and Eurobonds. He criticizes Germany’s current approach for weakening economies in the periphery. Simon Wren-Lewis, in Mainly Macro, goes further and argues that the downturn could have been largely avoided if the fiscal consolidation had been delayed until monetary policy was able to offset its impact. EuroIntelligence adds that the Eurozone is underperforming on average even though many countries implemented reforms—characteristic of a demand-side, rather than supply-side, downturn. This calls for appropriate countercyclical policies. Francesco Giavazzi and Guido Tabellini (VoxEU) join them in defending coordinated monetary and fiscal expansions in the Eurozone through a money-financed temporary tax cut, associated with credible medium-term plans to avoid moral hazard. Wolfgang Munchau, in Spiegel, suggests injecting liquidity directly with a “helicopter drop” by exploiting a legal vacuum: lending by the ECB to the EU, technical not a State and therefore not subject to monetary financing…
The economic consequences of the Russia-Ukraine conflict
Sanctions on Russia are being review this week, increasing attention on their economic impact. The conflict between Russia and Ukraine touches many economic dimensions, from Ukraine-EU integration (e.g., the trade agreement issue) to energy provision (see Les Echos). Given the close economic ties between the two countries, sanctions and disruption would have a strong direct cost to their economies, as suggested by Reuters and by the downward revisions to the Russian growth outlook (FT). With sanctions, some European countries as Netherlands or Italy could be pay a heavy toll.
With too many losers from sanctions, a diplomatic solution is urgent. Dan Steinbock (EconoMonitor) writes that without a diplomatic solution, the sanctions against Russia will have an adverse impact on its economy, but could also push Europe to a triple-dip recession. Steinbock traces the conflict back to misguided EU policies under the “Eastern Partnership” and American foreign policy mistakes—reinforcing Putin’s domestic popularity. Spillovers are significant for Russia: growth downgrades, currency fall, and economic uncertainties.
David Saha (Bruegel) provides an interesting review of blogs on the economics of sanctions against Russia—restrictions of access for Russian banks to EU and US financial markets, bans on military and “dual use” goods as well as travel restrictions for individuals close to the Russian government. Russia has retaliated by imposing bans on the import of food from Western countries. This has a disproportionate impact on the Russian stock market according to Francesco Pappadia.
For Matthew Yglesias, sanctions will have mixed results, with the most effective impact on banking (forcing Russia to devote increasing resource to its domestic banking sector, as described by Peter Spiegel) and on stopping imports of Russian-made equipment to the EU. Robert Kahn also finds that the most powerful effect on Russia comes from financial sanctions. According to The Economist, the sanctions have had no impact on Putin’s military strategy. Further measures could include blocking the property and accounts of entire sectors of the Russian economy, stretching asset freezes and financing restrictions across the entire banking industry or blocking Russia access to the SWIFT network.
Retaliatory sanctions by Russia would focus on agricultural trade. Open Europe finds that the Baltic countries are most exposed, with Poland, the Netherlands, Germany and Denmark also facing losses. But this could also translate into food price inflation in Russia, according to Sarah Boumphrey, while lower food prices could affect European countries (Gabi Thesing and Whitney McFerron).
Silvia Merler, in a Bruegel Publication, finds data that supports a geographical reshuffling of capital flows to Russia, with China possibly starting to substitute outgoing European countries— raising important questions about the effectiveness of measures supposed to restrict Moscow’s room of maneuver in seeking access to capital.
By Paula Garzon and Victor van den Bulke
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