The spectre of default stalks the eurozone by Simon Tilford
A popular narrative has taken hold across much of the eurozone. The economic situation, so the story goes, is improving, or at least bottoming out, and the necessary institutional reforms are being put in place. True, progress is messy and imperfect given the politics, but the currency union is on the right track. This narrative, however, is complacent. The economic situation remains grim, not least because of a failure to strengthen the region’s banks. And there is a disconnect between the scope of the reforms under discussion and the scale and immediacy of the crisis. This bodes ill for the solvency of Italy and Spain. Europe, it seems, has become anaesthetised to bad news. Six consecutive quarters of economic contraction, record unemployment and rapidly rising debt burdens trigger little reaction from policy-makers. By contrast, an easing of the pace at which unemployment is rising, or tentative signs that there could be respite from outright recession, are cited as evidence of economic recovery. The reality, however, is that the Spanish and Italian economies will shrink by a further 2 per cent in 2013. Greece’s is on course to contract by an additional 5-7 per cent and Portugal’s by 3-4 per cent. Even Ireland will struggle to grow. The core’s prospects are not much better. Germany is growing but the country’s exports are faltering in the face of slump across the eurozone and a rapid slowdown in China, and it is far from clear that domestic demand will take up the slack.
The European Commission points to declining trade deficits across the eurozone periphery as evidence of improved competitiveness and hence of growth prospects. It is true that exports are growing (quite rapidly in Spain’s case), but not by enough to offset the decline in domestic demand. Far from being on the mend, the economic crisis across the south is deepening. Real interest rates are increasing from already high levels, as inflation falls. Mounting bad debt is forcing banks to rein in lending, resulting in a wave of corporate insolvencies and more bad debt. Eurozone policy-makers should be concentrating on bringing down borrowing costs. If ‘competitiveness’ is to mean anything other than a zero-sum game (in which countries compete to beggar their neighbours by cutting wages), it has to mean improved productivity. But Spain and