By
Scott B. MacDonald
There is a whiff of tear gas in the air in Europe this summer.
Vocal and sometimes violent opposition against economic reform
is giving Europe a troubled image. Indeed, the Eurozone economy
is struggling to stay on the positive side of the growth picture,
especially as Germany, the major locomotive, is expected to
slip back into recession this year. Most recent economic forecasts
for the German economy call for a decline of 0.1%, which would
be the first annual contraction since 1993.
The outlook for economic growth in the Euro area is expected
to be an anemic 1%. At the same time, unemployment is rising.
In Germany it is shooting toward 11%, while Belgium has the
distinction of having the highest unemployment rate among
Eurozone countries at 11.6%. The average across the Eurozone
is close to 9%. At the same time, much of the Eurozone’s
labor unions are in a militant mood about their rights, with
demands ranging from shorter workweeks to pension benefits.
What is the problem with Europe? The Eurozone economy (excluding
the UK and Ireland) is in the process of some very painful
changes. The old system of state-dominated economies, protected
labor markets, and generous and extensive social nets paid
by high taxes is clearly in trouble. In a sense, many of the
European economies, like France and Germany, wanted to enjoy
the benefits of market forces such as stronger economic growth,
while managing the risk through less social upheaval and lower
unemployment. The recent roots of this system of managed risk
economics came at the end of World War II and were implemented
to help stop any drift toward Communism as well as to pull
badly damaged economies out of dire straits. Consequently,
inflexible laws concerning the firing of workers, unemployment
compensation and retirement benefits, became engrained in
the system. Over time they have become entitlements –
something that many Europeans have come to expect.
That was then. This is now. Globalization and technology have
put the old system under acute pressure. Economies that are
more open to risk taking, such as the UK, Ireland and Netherlands,
were rewarded by the new world that opened up in the 1990s.
They have proven more flexible in adapting to change and the
more managed risk-adverse economies have had to move at a
slower pace. At the same time, demographics indicate an aging
European population. This raises the delicate question of
how to pay for generous benefits and early retirement, let
alone the question of how to sustain businesses by working
fewer hours. Add to this mix, a lack of domestic demand throughout
much of the Eurozone and a weakening in export performance
due to the rise in the value of the Euro.
Another factor facing the Euzozone economies is that the corporate
sector is in the process of deleveraging and restructuring.
This means short-term pain, but probably long-term gains.
Generally speaking, most companies are cutting capital spending
and payroll and pricing power is declining. Consequently,
2003 is not going to be a year of economic recovery for many
corporations in terms of profitability. It is also indicates
that Corporate Europe is responding more aggressively to the
globalization of world markets.
Although we have our concerns about the Eurozone economy and
there are clearly deflationary pressures at work, we think
the slump will bottom out during the second half of 2003 and
as the U.S. economy regains momentum, the seeds for a moderately
stronger 2004 will be sown. Despite labor unrest in France,
Germany and other countries, economic reforms are gradually
making headway. Tax cuts should pass in Germany and some form
of compromise will be negotiated over pension plans in France
-- though not enough to make the problem go away. Moreover,
the European Central Bank has finally indicated that inflation
is no longer the main concern, but deflation and therefore
they are in an interest rate cutting mode. All the same, angst
is in the air in Europe over the state of the economy and
there will be ongoing worries that European governments have
opted for reform too late to deal with deflation. Europe is
in for a long hot summer.
