Eurozone: Optimism Is Warranted

In this edition of The Interview, Fair Observer talks to the senior fellow at the Peterson Institute for International Economics, Jacob Funk Kirkegaard. 

Is 2018 going to be the year the eurozone finally leaves behind nearly a decade of financial and political instability? Projections in answer to this question are contradictory. Over the last eight years, the Europeans tended to adopt an optimistic outlook, while the International Monetary Fund chose to keep a more pragmatic approach to Europe’s economic prospects, albeit without being overly pessimistic. This trend seems to be on course for 2018. The IMF avoids being triumphant about the end of the eurozone crisis, warning about political and exterior risks as well as reform challenges that may arise. European leaders maintain a bright outlook about what’s next for the currency union after years of economic turbulence.

However, there seems to be a consensus that the short and long-term future of the eurozone is dependant on the ability within the European Union to eliminate potential risks at the political level by the end of the year. Germany’s political uncertainty persists, with a stable coalition still to be voted in; Italy’s upcoming elections raise questions about the direction the country will take; and, with its momentous debt nowhere near being resolved, the situation in Greece continues to be of concern.

Europe also has to deal with an unpredictable US president in the face of Donald Trump, whose comments on NATO, Europe’s unity and his intentions on trade policy restrictions inflamed tensions between the European Union and the US.

In this edition of The Interview, Fair Observer talks to Jacob Funk Kirkegaard, senior fellow at the Peterson Institute for International Economics, about Washington’s perspectives on eurozone recovery, Greece, Brexit and the Trump’s administration relationship with America’s European allies.

Athanasios Dimadis: Over the last few months, there’s been an impression of calm across the eurozone, after several years of a financial and political turmoil. Is this an illusion, or are the economic and political prospects for the currency union becoming more optimistic?

Jacob Funk Kirkegaard: The euro area is currently at around 2.5%, growing at its fastest pace in a decade and well above its potential growth rate. As a result, unemployment is falling — and overall employment is rising — which, together with the decline in immigrant numbers, helps insulate incumbent governments from populist challenges. The upswing is widespread and hence likely to be quite sustainable in the medium term. Hence current optimism is warranted.

Dimadis: Do you agree with the view that the EU’s political recovery came much faster than expected after the initial Brexit shock?

Kirkegaard: Early 2017 was the turning point for populism in the West. The Dutch rejected [Geert] Wilders and his Party for Freedom, and the French rejected [Marine] Le Pen. This was not unexpected by some of us, but evidently a surprise in the English-speaking press and large parts of the financial markets, in which the domino theory prevailed until May-June 2017. Merkel’s re-election was expected and did not add much to a changing political tide in Europe.

Dimadis: What are the greatest political risks you foresee for the eurozone in 2018? Is the Greek case one of them?

Kirkegaard: The main risk for the EU and the euro area in 2018 is a failure to form a German government. This would not lead to populism in Germany, but would cause paralysis in the EU and the eurozone right at the time when the political window of opportunity for reform was open after the election of [Emmanuel] Macron and ahead of the 2019 EU elections. This would be a wasted opportunity, which could set back reform of the euro area by a decade. Greece, in my opinion, does not amount to a major risk to the euro area, as there will be next to no contagion from Greece, no matter what happens in Athens. Greek politics (and economics) is again only a risk to itself!

Dimadis: Seeing a leftist Syriza government in Greece implement austerity measures and painful social reforms requested by the country’s creditors, does it signify an end of political ideology, as a result of the financial crisis?

Kirkegaard: In a way, Syriza had had to travel the road of all centre-left parties since 1989 and adopt a much more market-friendly and fiscally sustainable economic policy. As such, what happened with Syriza in Greece merely confirms prior similar developments in other EU countries. Political ideology, though, is not dead, but has merely shifted from a predominantly economic axis of disagreement over the size of the state etc. to conflicts over how open to immigration and foreign economic influence countries should be.

Dimadis: The Greek government’s view is that 2018 will bring an end to the memorandums and austerity measures. Is this a narrative based in reality?

Kirkegaard: I think 2018 could well see the end of “new austerity” and the memorandums, but it will certainly not herald a return to the past for Greece. Some rollback of crisis reforms is to be expected, but the phased debt relief that the euro area will agree to will prevent material backsliding of reforms in Greece. As such, the Syriza government will predictably declare victory and liberation for Greece, but conveniently forget that it (Syriza) of course lost the political and economic reform war and was forced to implement the victors’ plans. Hence, this to me is real progress for Greece, but does not help Syriza as a political party much. They will try to put lipstick on the pig, but few of their core supporters are likely to be convinced.

Dimadis: What is the IMF’s stance on the Greek crisis to date?

Kirkegaard: I think the IMF is quite sanguine about the need for some further reform of pensions etc. in Greece, and that the country — even with politically realistic debt relief from the euro area — will continue to face a challenge in avoiding backsliding on crisis reforms. Hence, they are probably more generally skeptical about Greece’s prospects than the euro area or many market participants. This is quite normal though, as it is the IMF’s job to be skeptical. To me it remains a mystery why the Greek government hates the IMF so much. The reality is that without the IMF, they would never have gotten any debt relief.

Dimadis: In Washington, is there speculation about what might the next exit from the EU or the eurozone be, after Brexit?

Kirkegaard: Among the realistic Washington-based analysts (i.e. not necessarily including the Trump administration), it is generally acknowledged that there is unlikely to be any additional exits from the euro area or indeed the EU. The travails of Greece highlights how it is essentially impossible to leave the euro, while of course the UK is also making a huge mess of Brexit, proving much of the same point about exit from the EU. There are no countries lining up to leave anymore.

Dimadis: Does the current US administration share the understanding of the Obama White House that a stable Europe means better prospects for the American economy?

Kirkegaard: In general, yes. You will not find many even in the Trump administration who support more exits or the manner in which the British government is embracing and implementing Brexit… Even Trump himself said that he would do it differently (though his tactics would have been worse of course).

Dimadis: The tensions between the US and Europe persist and seem to affect a broad spectrum of bilateral relations between the two allies. How do you see this EU-US relationship evolving over the next few years?

Kirkegaard: I think EU leaders essentially have chosen to wait Trump out, to engage with him when they have to, but not antagonize him unnecessarily (even if it would generally play well politically for them at home). This makes the transatlantic relationship, which for 70 years has been characterized by close political collaboration, a lot less special these days than before. The West is no longer united and its ability to act together in a crisis cannot be taken for granted. This will not cause the transatlantic relationship to collapse, just degrade it to just another relationship with a large economic power. Whether this will change in the long run depends on the reaction of the UK political system and public to Trump. If he is rejected in 2018/2020, a quick reset/return to normal is certainly possible, but if he is not, the strategic alliance we have known since the Second World War will be a hollow shell.

The views expressed in this article are the author’s own and do not necessarily reflect Fair Observer’s editorial policy.

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