The eurozone’s economy appears to have stalled. It was widely expected that growth would pick up to 1 per cent this year, but these estimates are now being toned down as the first two quarters of 2014 have been below expectations. The pattern shown in chart one (below) is, at best, one of stagnation. It is therefore agreed with near unanimity that the eurozone’s economy needs a boost.
It is a common error to assume that economies are so alike that one medicine is always the answer for all those suffering from weakness or excessive strength. The difference between economists often consists of which nostrum they favour for all occasions, and they therefore give insufficient consideration to the particular and relevant circumstances of the individual economy being studied. Those who favour more fiscal stimulus have therefore been pushing this, not only for the eurozone, but for the UK and the US as well. Those who see money as the route of all growth want more quantitative easing everywhere and there are those for whom deflation or deleveraging is the bugbear.
I hold that economics is much more complicated. Countries differ from one another and from their former selves as times change. I see the eurozone as being very different from Japan, where tax reform is the key and deflation presents no problem. It is different again from the UK, where a lower exchange rate is vital, and different again from the US, where the key lies in the reform of management incentives.
Unlike Japan, the UK or the US, the eurozone is the economy where those who favour fiscal stimulus are correct. I am sorry that the message that they rightly preach for the eurozone should be weakened by their tendency to call for similar policies in Japan, the UK and the US, where they would be damaging rather than helpful.
Two questions follow. The first is whether the eurozone can return to sustained growth without a fiscal stimulus, and the second is whether it will in time receive one.
My objections to QE vary from country to country. My main concern is that in the US it has little impact on demand, but increases the risk of another financial crisis by driving up asset prices. I think it unlikely that QE by the European Central Bank will add much to the financial risks of excessive asset prices, but equally I doubt if it will do much for demand. It may serve to lower the euro, but this is a negative sum game in world terms and does nothing for demand worldwide.
The main reason for the ECB to resort to QE, and for the support that this receives, is the feeling that something must be done to stop the rot. It is, however, unhelpful to do something silly because there seems to be nothing sensible that can be done.
The view that the eurozone needs a fiscal stimulus seems to have near universal agreement outside Germany. Change will therefore require either a revision of German policy or a decision to take no notice of the fiscal rules that call for further cuts in government budget deficits. The latter seems to be happening slowly. Both France and Italy seem to be disinclined to cut their deficits. But the problem is that the one country with real scope for increasing its deficit is Germany. Mr Draghi has called for more fiscal stimulus but not for any weakening of the fiscal rules. This means that Berlin must act as it is only in Germany where such a combination is feasible.
There are three possible ways forward. The first is that my prognosis is too pessimistic and domestic demand in the eurozone economy will pick up, either of its own accord or because QE is effective. The second is that Germany’s view changes under the pressure of reasoned argument and that its government introduces a sharp rise in its fiscal deficit. The third is that events, rather than reason, cause a policy change. This last is the usual pattern and therefore seems the most likely.
The events that would precipitate the change are unlikely to be ones we welcome. I can readily envisage two. One is a deterioration in Ukraine to the point where Nato and the EU decide on massive financial aid to shore up a tottering government and economy. The other is a continued rise in voter support throughout the EU for populist and nasty political parties. It is hard to see the steady growth in their popularity that we have seen for them in recent years halting without an economic recovery. At some point, I hope, self-preservation will start to become the watchword of the established parties and be seen as more important than the preservation of the eurozone, at least under the current fiscal constraints.
Ukraine’s economy is already in dire straits. It would be a statesmanlike move by David Cameron, or any other EU leader, to propose a new “Marshall Plan” funded by loans raised by the EU, jointly and severally guaranteed by its members, which would be lent to the Ukrainian government to support and develop its desperate economy. President Harry Truman is said to have persuaded the US Congress to approve his aid programme for Europe by the expedient of having it named after General Marshall, who was popular, rather than himself, who by then was not. Prime Minister Cameron should propose that the programme is called “The Merkel Plan”. Almost anything can be achieved by people, provided they do not want the credit for it.