2016 Outlook Euro Crisis To Rumble On

The euro zone won't overcome its chronic structural problems in 2016, predicts Dirk Heilmann, chief economist of the Handelsblatt Research Institute. The European Union will be preoccupied with refugees and the prospect of Britain's exit -- but the debt crisis will rumble on.
The European Union faces another difficult year in 2016.

2015 was a rollercoaster of emotions for Europeans. The Syriza Party's victory in the Greek election in late January marked the beginning of an unnerving showdown over whether Greece would remain in the euro zone. The winner of the election, Alexis Tsipras, portrayed himself as Berlin's adversary in a crucial battle over the future of Europe. But now, at the start of 2016, little remains of this revolutionary momentum. Mr. Tsipras is grudgingly implementing tough reforms, against both his declared will and that of a majority of Greeks, and in doing so he is saving his country from bankruptcy. He no longer qualifies as a leader of the anti-austerity movement.

On the other hand, the left-wing populist Podemos Party achieved a respectable result in Spain's elections last month, although it was not nearly enough to put it in charge of the government. Still, Podemos is likely to bring about the tentative end of growth-promoting structural reforms in Spain. This would be unfortunate, because the country, with GDP growth of more than 3 percent this year, serves as a positive example of a successful reform policy. Spain has an export surplus, the budget deficit is shrinking and the situation in the labor market is beginning to improve. These successes will be jeopardized if a prolonged period of political instability begins now.

Italian Prime Minister Matteo Renzi is already interpreting the Spanish election result as a signal against an austerity policy that, as he says, primarily serves German interests.

Structural reform and fiscal consolidation, as backed by Germany, has been losing support across Europe for some time now. The message sent out by the decisions of 2015 isn’t one of continued austerity. Instead, the message is that no country will leave the euro. Lip service to the Stability and Growth Pact and a show of effort to comply with reform requirements are sufficient as quid pro quo for financial support. The most important thing is that appearances are preserved. The European Central Bank supports the protraction of the crisis with its zero interest-rate policy and its massive government bond-buying program.

The European project could be on the verge of a struggle for survival.

The strategy has not been unsuccessful. The twin deficits of government budgets and current accounts, which highlighted the unsustainable economic policy of many euro countries at the beginning of the crisis, were reduced. The total budget deficit of all euro zone countries shrank from 6.3 percent of GDP in 2009 to only 2.6 percent in 2014. In other words, we are heading in the right direction, and zero interest rates, as long as they continue, are making it easier for governments to continue cleaning up their finances. A current account deficit of €152 billion ($166 billion) in 2008, the year before the crisis, was turned into a surplus of €213 billion by 2014.

The worst also seems to be over in the labor market. The unemployment rate in the euro zone peaked in 2013 and is currently at 10.7 percent. The ratio of the working population to those of working age is increasing again and is now at 68 percent. This is only three percentage points less than in the United States. Net incomes have also been on the rise again for the last three years.

What remains high is the debt burden. After reaching a high in 2010, private household and corporate debt has declined by only about 3 percentage points to roughly 165 percent of GDP. By contrast, government debt has increased from 68.5 percent of GDP in pre-crisis year 2008 to an estimated 94 percent in 2015, and it is only expected to decline slowly, starting in 2016.

The euro zone is on the road to improvement. Still, it will be a long time before economic momentum creates enough new jobs and government finances are healthy again. The question is whether the euro zone will manage to regain leeway on fiscal and monetary policy before the next economic downturn. Unfortunately, the pace of reform is expected to slow down in 2016.

The euro crisis probably will not play as prominent a role in 2016 in Europe's political debate as it did in 2015. Other issues have come to the fore: the refugee crisis, the rise of populist, anti-Europe parties in large E.U. countries and the referendum over whether the United Kingdom will remain in the bloc. The European project could be on the verge of a struggle for survival. The fight will not become easier if Europe resigns itself to gradual economic decline instead of tackling decisive reforms.


The author is Managing Partner of the Handelsblatt Research Institute. You can reach him at: [email protected]