Risks to Europe that economists fail to see

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Politicians like to behave as if the laws of economics do not exist. We learnt that lesson the hard way in the eurozone crisis, dealing with the consequences of a single currency created without key economic safeguards.

On the other hand, economists and investors have a habit of ignoring the laws of politics. That is equally wrong and could turn out to be particularly risky in Europe over the next couple of years.

There is no pressing economic crisis confronting the continent in 2016, thank goodness.

There will be continued worries about Greece, and maybe Spain given the uncertain result in its recent election. At first glance, however, it is difficult to see anything that will cause the kind of jitters and contagion that we have seen in financial markets in each of the past five years.

There are also few events in the political calendar that could disturb markets or the economy, with a key exception being the possible UK referendum on membership of the EU. Mostly, we have to wait until 2017 for the big set-piece events, including general and presidential elections in Germany and France.

This outlook has many people in the markets feeling calm about Europe, for once. Some would even say that the “doom-loop”, between Europe’s politics and its economy that so often infected markets during the financial crisis, has finally been broken. We can but hope.

Growth is not nearly strong enough in the eurozone at the moment and it is unlikely to be a lot faster in the coming year. With consumption and consumer confidence picking up and unemployment continuing to fall, however, the recovery does now have its own momentum.

November’s terrorist attacks in Paris will have delivered a short-term hit to the economy in France and Belgium but I do not know many economists cutting their forecasts for growth in 2016 because of fears of a new terrorist attack — or the migrant crisis.

In fact, many economists have argued that the net effect of the influx of migrants will be positive, both in the short term and further off. The additional spending associated with the crisis, especially in Germany, will mean a net stimulus at a time when the overall fiscal stance in Europe is looser than it has been.

Looking through an economic lens, the massive influx of people from Syria and elsewhere, many of them highly skilled, also appears to offer a long-term boost to economic potential for a country such as Germany, whose working-age population would otherwise be set to shrink.

This narrow economic take on the migrant crisis is probably right as far as it goes. The political storms buffeting Europe are unlikely to derail the recovery soon but experience suggests some longer-term reasons to worry.

One lesson is that something that looks like an overwhelming economic positive can rapidly turn into a negative if the politics go in the other direction.

That sounds blindingly plain but it was not that obvious in the UK in the 1990s and early 2000s, when net immigration from inside and outside the EU picked up sharply.

For economists and businesses the benefits of this influx of labour were clear, yet its political and social consequences have helped put the UK on a path to potentially leaving the EU. For most in the markets and a big chunk of the business community, that would be a seriously negative outcome.

A similar dynamic has played out much more quickly in Germany where, since summer, Chancellor Angela Merkel’s popularity has been hit by her brave welcome to hundreds of thousands of migrants.

So along with the positive fiscal and supply-side consequences of migration, investors may now have to add a rather large negative: that the most effective politician in Europe could be unable to stand for re-election.

We learnt in the eurozone crisis that a single currency area is only as strong as its weakest link. Now we are learning a similar lesson when it comes to Europe’s single border.

If people feel that their security, economic or personal, is being put at risk by integration, it will become that much harder to achieve the deeper co-operation that security and faster growth will probably require.

Ask David Cameron, UK prime minister, whose team is terrified that the migrant issue will end up dominating the referendum campaign.

How much should we worry about Europe? At the height of the eurozone crisis the answer to that question was clear: the risks of broader contagion were such that policymakers, investors and ordinary humans all had to worry about Europe a lot.

Now that the trouble has shifted from economics to geopolitics and migrants, it is not so obvious why investors should fret.

The short-term economic outlook looks calm but no one should be in any doubt that if these crises are handled badly, they hold long-term risks for Europe’s economy.

The writer is chief market strategist for Europe at JPMorgan Asset Management

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