Europe works!

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In a previous article we promised you we would provide some justification for this optimistic headline about Europe. The time to do so has arrived.

Our first piece of evidence is probably not very charitable, but we still think it is meaningful. Not until the 10th page out of 11 of Jean-Claude Juncker’s 2017 state-of-the-union speech to the European Parliament on 13 September did he mention the word Brexit. And, even then, only in very few words: “On 29 March 2019, the United Kingdom will leave the European Union. This will be a very sad and tragic moment in our history, and we will always regret it. But we have to respect the will of the British people. And we are going to make progress, we will keep moving forward because Brexit isn’t everything and Brexit isn’t the future of Europe.”

Of course, one could argue that, as president of the European Union, it would have been hard for Juncker to say anything other than that Brexit negotiations between the UK and its partners are still just getting started. This is a quite valid objection, but Juncker’s pithy closing words, ‘on 30 March 2019, we will be a union of 27’, reflect a clear shift. For several months now, the conversations of economists, financiers and bankers on the eurozone’s future have focused invariably on Brexit.

Exhibit 1: Barometer of Brexit news items

EuropeSource: Bloomberg, BNP Paribas Asset Management, as of 18/10/2017

What are Europeans talking about among themselves?

  1. First of all, they are glad that Europe is stronger institutionally than it was before the crisis. The 2012 creation of the European Stability Mechanism (ESM) was crucial, even though it at first seemed like the mere extension of the European Financial Stability Facility and the European Financial Stability Mechanism. By providing financial assistance to five distressed countries, four of which have since emerged from emergency packages (Ireland, Spain, Portugal and Cyprus), the ESM has facilitated progress on reforms. Its managing director, Klaus Regling, often says, based on research by the OECD and the World Bank, that these four economies are ‘champions’ in this area. Greece is still in the programme, but its troubles, as we all know, were of a different order altogether. Last July, for the first time since 2014, the Greek state issued EUR 3 billion in five-year paper (syndicated, not auctioned) at an interest rate lower than its previous issues, thus passing an important test prior to a true return to the market. On 9 October, the Eurogroup discussed the roles and missions that the ESM could undertake as part of the deepening of the European Monetary Union (EMU). The German stance has long been to strengthen the ESM and turn it into a ‘European monetary fund’. According to media reports, German finance minister Wolfgang Schäuble, who will be the next Bundestag president, reiterated this stance at his last Eurogroup meeting. Beyond the political aspects of this stance, the more consensual idea within the Union is to give the ESM a role in preventing crises and not just in managing them. The implications for national sovereignty are great, but the ESM story has hardly begun.
  2. Economically as well, Europe looks more solid than before the crisis. It is now widely acknowledged that the eurozone’s cyclical economy has been very strong in recent quarters and that there are many signs that it will remain so, driven by stronger domestic demand. The IMF has raised its forecast of eurozone growth by 0.3 percentage points to 2.1% for this year and by 0.1 points to 1.9% for next year.

Exhibit 2: Eurozone: GDP growth in % (actual and IMF forecasts for 2017 and 2018)

EuropeSource: Datastream, BNP Paribas Asset Management, as of 10/10/2017

While ‘instantaneous’ economic growth is important, other indicators may be worth looking at today with regard to the issue at hand.

First of all, while the eurozone’s debt-to-GDP ratio is still far higher than it was before the crisis, it is below the levels of Japan and the US and is on a better trajectory.

A country’s economic ‘good health’ indicator that is often used (even though intrinsic factors in the structure of individual economies should also be considered) is the state of the current account. This now looks well ensconced at a surplus of about 3% of GDP in the eurozone as a whole, even though domestic demand is strong and is boosting imports. The private sector savings rate is another important indicator of both imbalances vis-à-vis the rest of the world and the financing of investment.

Exhibit 3: Consolidated gross public debt as a percentage of GDP: eurozone (E-19), US and Japan

EuropeSource: European Commission, Spring 2017 Economic Forecast, BNP Paribas Asset Management, as of 25/04/2017

Exhibit 4: Gross private sector savings rate as a percentage of GDP: eurozone (E-19), US and Japan

EuropeSource: European Commission, Spring 2017 Economic Forecast, BNP Paribas Asset Management, as of 25/04/2017

If we turn now to the indicators measuring the distribution of inequalities, Europe is outperforming the US too. The Gini coefficient of equivalent disposable income, which measures the distribution of income within a population (with “0” being perfect equality and “100” being absolute inequality) is 31 in the EU and 41 in the US (World Bank estimate). Within the EU, the coefficient has fallen in those countries that took part in the ESM programme (and that undertook reforms), but it has been rather flat (and lower than in the first group) in signatory countries to the 1957 Treaty of Rome, with the Benelux being represented by Belgium in exhibit 6 below.

Exhibit 5: Gini coefficient: Ireland, Greece, Spain, Cyprus and Portugal

EuropeSource: Eurostat, BNP Paribas Asset Management, as of 15/10/2017

Exhibit 6: Gini coefficient: Belgium, Germany, France and Italy

EuropeSource: Eurostat, BNP Paribas Asset Management, as of 15/10/2017

What should the next step for Europe be?

First of all, there is general agreement that banking union must be completed as this is a key component of stronger economic and monetary union. The Single Supervisory Mechanism (SSM), which placed the eurozone’s top 120 banks under the direct oversight of the ECB in November 2014, is the first pillar of this union. A European deposit insurance system will be a big step forward in this area.

A capital market union will also have to be built. These two items involve both reducing and sharing risks. Pending our next article on this issue, we refer you to “Completing the Banking Union by 2018” published on 11 October by the European Commission.

Written on 18/10/2017

Nathalie Benatia


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