The silent revolution of Europe – hope for the future
By Freddy Van den Spiegel, Adjunct Professor, Vlerick Business School
It is remarkable how silent markets are these days about the future of Europe and the Euro. But as the saying goes: “no news is good news”. And indeed, the transformation of Europe seems to be going on without major problems of discussions. Quite surprising for the eternal Euro-sceptics.
Weak member state expected to grow in 2014
First of all, the economic mess is more or less under control. All weak member states show significant improvements. Ireland, for example, is almost ready to confront the markets without official support from the union. The country has restored its competitiveness and has a solid current account surplus, the economy is growing again and the government deficit is definitely under control. All the other weak member states, like Greece, Spain, Portugal and Italy, show encouraging signs of bottoming out and restoring competitiveness. Current account deficits shrink steadily thanks to significantly lower unit labor costs, and their government deficits come down. Many economic textbooks, in which “nominal reduction of salary costs” is considered to be impossible in practice, have to be rewritten, as most weak member states have just proved that it is indeed a possible way to regain competitiveness. Cyprus, the most recent problematic case is still in the doldrums but does not have the potential to create Europe wide chaos. And even if Greece needs another rescue package before the end of the year, the situation remains stable and the political discussions make progress in a serene atmosphere. All these countries are expected again to return to economic growth in 2014, and growth is an important signal that further improvement is within reach because it facilitates the digestion of the legacy of the crisis. If this process continues, it could as well reduce the democratic pressures of the populations against the severe austerity measures of the past few years.
Banks are becoming more stable again
Second, the banking industry is still suffering from bad assets, excessively large balance sheets, under capitalization and dependence on international flows of “hot” money. Furthermore it merely survives thanks to the artificial oxygen provided by the ECB under the form of low interest rates and almost unlimited funding. Their profitability at about 4% on average and their price/book value of about 0,5 on average tell the whole story .And the process to comply with the new capital and liquidity rules remains a challenge for most banks. But the fatal connection between the financial situation of banks and the situation of their home country seems to be under control. Some banks are already showing their confidence in the future, developing new business models and making selective acquisitions to strengthen their future market position. Without any doubt, further fundamental changes in the banking landscape will occur and further shocks are not excluded, but as all operators recognize the risk, an accident will not be a complete surprise, and markets will probably not get into panic as they did in 2008.
In the meantime, cleaning up the political mess has also made huge progress.
The banking union is almost a fact. And while there are still many aspects of its functioning unclear, the fundamental design is clear and approved: the ECB will be the supervisor, a kind of EU wide resolution mechanism with EU fiscal backstop will exist, and an EU wide deposit guarantee fund will come later on, but is not indispensable in the short run. An important step towards the implementation of the union will be the “asset quality test” of the ECB early next year. There are still doubts about the strength of such a test and about “what if a big bank is declared unsustainable”, but it is remarkable that nobody at Member state level opposes such an “independent” test. What a difference with the discussion about stress tests in 2008, which became a complete mess and totally incredible because of the “national” interference.
Some kind of limited fiscal union is already a fact. What else is the ESM (European stability mechanism) which is a kind of a EU banks guaranteed by all Euro Member states, and available to rescue failing member states.
Also in its capacity to manage crisis, the EU seems to have made huge progress. The Cyprus crisis was handled in such a way that spill over or contagion effects remained largely under control. Again a huge contrast with the confusing way the Greek crisis was handled when it first appeared in 2010, and threatened to undermine the whole concept of a monetary union.
This being said, the need to reform Europe is certainly not finished. Important challenges remain.
European challenges for the future
How will Europe get back to a sustainable growth path is probably the biggest challenge. While the consolidated Eurozone is still competitive, it struggles with internal imbalances and a complete lack of confidence. Some are already pointing to the fact that Europe could well be on the path which Japan follows since 20 years, characterized by low growth and deflation, certainly not an interesting perspective. Indeed, the ongoing aging of the European population will put a damper on sustainable growth, but the actual situation is exaggerated.
Second challenge is the fundamental reduction of the excessive debt position of many European member states, be it through public finances, the banking system, private households or the corporate sector. The open question is if a gradual reduction is feasible, or if a more determined action is unavoidable. In a recent paper, the IMF seems to support a flat tax of 10% on all savings in the whole Eurozone area. Such ideas could well be a nuclear weapon for any confidence.
Third challenge is to define which banking system Europe wants. Until now, the new regulations essentially point to what banks should not be, but such an approach reaches now its limits, as a more positive plan is the only way to bring the banking industry back to a sustainable development.
Europe is like a semi-finished building. Two options remain open: or to finish it or to demolish it. As it stands, finishing it is clearly less costly than demolishing it. There is rational hope for Europe if emotions and nationalism remain contained.