Eurozone looks beyond the Brexit vote

23/8/2016

Growth is solid but longer-term performance needs improvement

Three leaders meet on an aircraft carrier to declaim that Europe will stay strong. It sounds dramatic but the gathering of Angela Merkel, François Hollande and Matteo Renzi on Monday mainly saw them relieved that short-term risks to the eurozone economy had not materialised.

The gathering of leaders from the eurozone’s three largest economies came ahead of an EU summit in Slovakia in September that will probably be dominated by the relationship with the UK in the aftermath of the Brexit vote.

As far as the economies of most EU countries are concerned, the Brexit poll has had far less impact than many feared. But while the three leaders talk about the need for more European policy co-ordination, their economic problems remain the same as before the UK referendum. In large part these problems do not require “more Europe”.

The latest data suggesting the eurozone had shrugged off the Brexit vote came on Tuesday. Purchasing managers’ indices for the single currency area, a reasonably reliable indicator of future growth, showed a composite measure of confidence holding up well in August, consistent with the economy turning in another solid performance in the third quarter with growth around 0.3 or 0.4 per cent.

The reading for France, whose economy stalled in the second quarter, was particularly encouraging, suggesting it will bounce back in the third.

Still, while growth seems solid — no doubt helped by the European Central Bank’s policies of unconventional easing — it is far from spectacular. It is certainly not running at rates likely to make a serious dent in unemployment levels.

European leaders would do best to embrace less Europe rather than more — or rather apply European rules with a lighter touch and address the many problems with their own economies that do not need international co-ordination.

Mr Hollande and Mr Renzi are right to argue for more fiscal stimulus. The eurozone’s fiscal pact is already on the way to being as much of a laughing stock as its predecessors, as evidenced by the European Commission’s decision not to levy fines from Spain and Portugal for missing their deficit targets by handsome margins.

Germany has quietly been letting its own fiscal position slip, partly because of spending related to the migrant crisis. But it is still a long way from accepting that taxing and spending should be considered at least equal with monetary policy in guiding the economy for the medium term.

All three European leaders also need to address longer-term problems and recognise that a cyclical rebound does not imply healthy trend growth. Although liberalising reforms do not have a good record of generating expansion in the short-to-medium term, Mr Hollande should strive to resurrect the deregulatory drive from which he was forced to retreat.

As for Mr Renzi, he has staked his government’s credibility on winning an October referendum on constitutional reform aimed at loosening up Italy’s sclerotic state. And while Germany’s economy has been performing well in recent years, it too has turned in a feeble productivity performance over the past two decades.

On Monday the three leaders struck a tone of defiance. Privately, the prevailing emotion was probably one of relief that the eurozone economy had ridden out the immediate impact of the Brexit vote. Yet to raise their sights from avoiding disaster to celebrating a marked improvement, keeping things as they are will not be sufficient.

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