AP_F_EuroEconomics_1

This article was first published in the September 2016 China edition of Accounting and Business magazine.

The European Union and the euro are relative newcomers to the global stage. But both had quickly come to be seen as permanent fixtures – much like the US and the dollar. Now the project of European political and economic integration faces the most serious challenge. 

For the first time in the history of the EU, citizens of a large member state – the UK – have voted to leave. Pressure is mounting for similar referendums in France and Italy, and the approval ratings of the EU have been sinking. Tensions are high between debtor nations – such as Greece – and creditor states, including Germany. The economic record of the continent has been disappointing. (While the UK and US economies are 7% and 10% bigger respectively than in 2008, the eurozone has only just regained its former size after years of contraction and sub-par growth.) Even once-enthusiastic recruits in Eastern Europe have been souring on the project. 

So what has gone wrong and can Europe recover its mojo, and public trust? ‘The European project has achieved a great deal, promoting peace, prosperity and trade,’ says Gary Hufbauer, a fellow at the Peterson Institute in New York. ‘And there is much more it can do for its members and the world. But it needs to carry the citizens of Europe along or it will never fulfil its great potential.’ 

The public standing of European integration has suffered three major hits over recent years, according to Anthony Walters, ACCA’s policy manager for Western Europe. ‘The first is that GDP growth has been sluggish, undermining confidence that the project is delivering benefits to ordinary people,’ he says. ‘The migrant crisis has been adding to tensions and the rumbling debt crisis in Greece has also raised concerns. Add these together and you’ve had a pretty toxic cocktail.’ 

All appear to have played into the decision of the British voters to leave the EU, a decision that some fear will open a Pandora’s box in Europe. ‘Brexit could have two contrasting effects,’ argues Walters. ‘It has the potential to strengthen unity among those that remain, since the UK was seen by some as a brake on integration. Alternatively, it could embolden separatist movements across Europe and make it harder to resist votes on EU membership elsewhere.’ 

Emmanuel Kapizionis FCCA, a senior financial accountant at Nereus Shipping in Greece and a member of ACCA’s International Assembly, fears that the uncertainty itself will harm business investment and financial markets, since it will take years for the full implications of the UK vote to play out.

‘We are in uncharted territory,’ he says. ‘The fear is that without the EU, the UK will be less powerful; and without the UK, the EU will be less powerful.’ The UK was a powerful voice for economic liberalisation and reform. Without the UK, many economists believe that the EU will become even less willing to embrace bold measures that will boost longer term economic growth. 

‘On the flip side,’ Kapizionis says, ‘it is possible that the UK will be able to establish a close relationship with the EU and that the rebuff from UK voters will provide a spur for the EU to resolve some of its problems.’ 

Too many policy flaws

At the heart of many of the problems for the EU has been the failure of a large proportion of its members to generate sufficient economic growth. Jonathan Loynes, chief European analyst at Capital Economics, believes too main policy flaws have contributed to economic sluggishness in much of the eurozone. The first has been the lack of sufficient structural reforms to improve productivity among the peripheral nations – notably Italy, Portugal and Greece. 

Between 1999 and 2016, unit labour costs rose by about 20% in Germany. By contrast, they rose by around 50% in Greece, and between 30%-45% in Italy, Spain, and Portugal. ‘These countries have long had inferior productivity growth to Germany, leading to periodic currency devaluations to restore balance,’ says Loynes. ‘But within the eurozone they no longer have the option of restoring competitiveness through depreciation. Nor have they been willing to engage in the difficult reforms needed to improve economic efficiency.’ The result has been slower growth and increasing imbalances within the zone. 

The shock from Brexit may actually make reform less likely. ‘Part of the reason reforms have been so hard to implement is that they challenge vested interests,’ Loynes says. ‘Now governments are likely to be even more fearful of stoking populism – even if reforms would be beneficial in the long run.’ The recent momentum in Europe backs up this worry. The French government has recently watered down labour market reforms that had the potential to significantly reduce labour costs for smaller companies in particular; and Portugal’s government has reversed previous public sector wage cuts. 

The second major policy defect, according to many economists, has been the reluctance of less indebted countries, such as Germany, to deploy fiscal stimulus. ‘The nation has defied pressure not just from other nations but also from the European Central Bank [ECB] to boost growth,’ says Loynes. ‘Instead, the focus has been on setting an example of fiscal probity for the rest of Europe.’ 

Public debt to GDP in the eurozone is down from a peak of 80% to around 70% and is on track to fall below 60% by 2020, according to Capital Economics. Partly as a result, the overall fiscal stance has been restrictive, constituting a net drag on economic growth between 2011 and 2014. In 2016 and 2017 the stance is expected to be only marginally expansionary. 

‘The ECB has attempted to offset this through easier monetary policy,’ he says. Even the ECB’s unconventional easing, however, started later and has been less aggressive than similar measures adopted by the Bank of England and the US Federal Reserve. In the UK and the US the central banks purchased assets equivalent to nearly 25% of GDP. The ECB’s bond buying has, as of May 2016, amounted to roughly 17% of GDP. 

Slow economic growth has in turn increased social tensions over immigration, argues Simon Evenett, professor of international trade and economic development at the University of St Gallen in Switzerland. 

‘There is plenty of evidence that immigration and free movement of labour boosts growth overall and lifts government revenues,’ he says. ‘Still, it can be difficult to convince lower income families that this is the case. Especially in periods of economic stagnation, many can feel that they are having to compete for jobs and state benefits with immigrants.’ Such worries were accentuated by the refugee crisis as Syrian refugees fled the nation’s civil war. 

Central European concern

There has even been pushback on integration from central European nations, who have been among the largest beneficiaries of funds from the EU since they joined the club in 2004. Just days after the outcome of the UK vote was known, the Visegrad countries of Poland, Hungary, Slovakia and the Czech Republic, blamed the European Commission for Brexit. 

‘The genuine concerns of our citizens need to be better reflected,’ the prime ministers of these four countries said in a joint statement. ‘National parliaments have to be heard. The institutions of the EU need to stick to their missions and mandates.’ 

Eastern European leaders are resisting deeper integration, despite billions of dollars of fiscal transfers from the EU and a surge in remittances as many of their citizens have well-paid jobs in richer nations such as Germany and the UK. A more nationalist spirit has been reflected in the election of more EU-sceptic parties, such as Poland’s Law and Justice government and Hungary’s Fidesz party. There has also been growing opposition to the fiscal austerity preferred by the core-EU nations, led by Germany. 

In Hungary, prime minister Viktor Orbán has implemented tax cuts and raised the salaries of healthcare workers. The government in Poland is planning to boost benefits, a move that the International Monetary Fund has warned could cause the budget deficit to widen ‘significantly’. 

Meanwhile Marcel Coppini FCCA, a corporate governance, ethics and audit quality consultant in Malta and a member of ACCA’s International Assembly, believes the European Commission needs to respond. ‘They must convey that they are receptive and willing to adjust, as well as conveying their mission in terms that resonate more clearly to citizens,’ he argues. ‘It is clear that the EU suffers from a reputational problem, often being perceived as bureaucratic, top heavy and spewing out “one-size-fits-all” regulation. Many contend that Brexit is a wake-up call to the EU. The truth is that the EU has been faced with a number of decisions it had to take, not only to maintain financial stability during the European debt crisis in late 2009, but also had to address other important socioeconomic problems facing Europe – for example, immigration and the environment. 

‘Clearly, some of the decisions then taken by the commission, although in the best interest of a unified Europe, did not go down well with a number of European citizens, including politicians of a number of member states. This has caused division, not only within the Establishment itself but, even more so, at individual member-state level.’ The EU should, he says, focus on ‘educating the citizen on what the commission is seeking to achieve’.

Still, most economists and trade experts believe that the EU and the world would be worse off if the European project rolls into reverse. ‘If the EU were to fall apart, it would be a huge loss,’ says Hufbauer. ‘It is not that we would see obvious trade barriers or tariffs being erected again. Instead, you would see a lot of backsliding on issues such as subsidies and government procurement that are more covert and harder to combat.’ 

In addition, the EU has been working on a number of projects that have the potential to enhance the economic benefits of the union. For a start, the single market has still yet to reach full fruition, experts argue. ‘There is still a lot more to be achieved,’ says Hufbauer. ‘If you compare the level of trade to the commerce between US states, admittedly a high bar, this ‘trade density’ is about twice as great in the US versus Europe. Not all behind-the-border barriers have been removed. In local markets there are still some cartels and progress still needs to be made making government procurement more equitable.’ 

The next obvious frontier for the EU has been to create a single market for services. ‘Services sector jobs in areas such as healthcare, retail, universities and public administration, along with some parts of law, have been relatively immune to globalisation,’ says Evenett. ‘The economic benefits from opening up some of these sectors within the EU would be considerable.’ 

Under current political conditions, he says, the chances for significant progress look slim. Still, over the long run, the potential gains could be considerable, he argues. The UK, as a leader in services, would have been especially well placed to benefit from advances in services trade. 

Digital drive

One of the most promising initiatives, according to Walters, is the Digital Single Market, which would make it easier for EU citizens to buy, sell or watch things online. The commission – the EU executive – has predicted that this could add €415bn to the bloc’s economy every year and create hundreds of thousands of jobs. 

The digital initiatives promise to eliminate ‘unjustified geo-blocking’, which prevents people from viewing content from foreign nations; harmonise tax rules; and even introduce more transparency on parcel delivery. ‘This kind of initiative has the potential for huge benefits,’ says Walters. ‘It would give greater uniformity and certainty to businesses operating in this fast-growing part of the economy, which would ultimately drive growth,’ adding that ‘We face a conundrum in the UK where we top the global leader-board for e-commerce yet rank just 14th for company-level adoption of digital technology, so the Digital Single Market was hoped to go some way in bridging this gap by boosting digital uptake across the EU.’ 

It is not clear, however, how this initiative will now fare, given that the UK, along with the Nordic and Benelux countries, were among the major proponents of the Digital Single Market, while France and Germany have been wary of further liberalisation. 

The EU has also been working on a capital markets union, designed to allow investment funds and traders to operate freely across Europe – a plan intended to increase access to funding for businesses, among other things. (While the EU economy is roughly the same size as the US, its equity markets are less than half the size – and the EU debt markets are less than one-third as large.) 

How this initiative develops has also been thrown into doubt by the UK exit, since British negotiators favoured a lighter approach to regulation surrounding the capital markets union. 

The upshot is that the entire European project is now in flux. The EU and euro were already struggling with slow growth, fading public approval and slow progress on further liberalisation. ‘It is unclear how the situation will now develop,’ says Walters. ‘But the UK decision to exit the club could make it even harder for the EU to make positive changes that will stimulate sustained economic growth.’

Christopher Fitzgerald and Fernando Florez, journalists