Forget Trump’s trade war. The real economic threat is in Europe

9/4/2018

By Sebastian Mallaby

Almost anywhere you look these days, the economic news is heartening. The United States has rock-bottom unemployment and above-normal growth. China has tamed its crazy trade surplus and is starting to tackle its excessive debt. Europe and Japan are out of the doldrums. Across the world, 120 countries, accounting for three-quarters of global gross domestic product, saw growth accelerate in 2017. The IMF expects this year and next year to be even better.

The political picture could hardly be more different. The Trump administration has purged reasonable officials and elevated ideologues. China’s dictator seems intent on governing for life and enforcing creepy mind control via Internet surveillance. His Russian counterpart goes one better, exporting psychological manipulation. Meanwhile in the European Union, a Trumpian thug has just won reelection in Hungary. Britain is bent on a witless policy of de-globalization. Even in France, one of the world’s few political bright spots, a reformist president faces angry street protests and his poll numbers are slipping. Freedom House judges that in 2017 democracy faced its most serious crisis in decades.

This economic/political contrast begs a question. How might political dysfunction derail economic expansion? To many in the United States, the escalating trade fight with China looks like the obvious answer. But for now, that fight is mostly just rhetorical — nearly all the tariffs that both sides have laid out don’t take effect until some unspecified future. With luck, the panicky selling on Wall Street will persuade President Trump that a deal is better than a market collapse ahead of the midterm elections. On Sunday, the president reaffirmed that “President Xi and I will always be friends” and that “a deal will be made.”

In Europe, on the other hand, the obvious danger lies elsewhere. The spring of 2018 was meant to be the time when the continent fixed its rickety monetary union. Major national elections — in France, Germany and Italy — are now done, supposedly opening a window for reform before next year’s European elections. But because of that toxic tide in politics, economic reform appears unlikely to happen. Barring a major political surprise, an eventual repeat of the euro zone crisis is beginning to seem inevitable.

Europe’s predicament reflects an earlier time in which politics and economics became unhinged from one another. In the euphoria following the Cold War, pro-globalization, anti-nationalist, utopian statesmen cooked up the idea of a single currency for Europe. They ignored the economic obstacles, including the reality that a single currency and a single interest rate are unlikely to serve a territory as large and varied as Europe. The monetary policy that suits Germany at any given time probably won’t be the one that happens also to suit Italy or Ireland. To manage this problem, you need large budgetary transfers from booming areas to depressed ones. You also need central insurance against banking crises in weak countries.

The United States has both these stabilizers. It also has higher labor mobility: If one state experiences a downturn, its workers can go to another state without facing linguistic barriers. But Europe is stuck in the middle of the road. The countries of the euro zone have a single central bank but multiple budgets and deposit-insurance schemes. As the old Texas saying goes, the only thing you’ll find in the middle of the road is a dead armadillo.

European economists have proposed multiple ways to fix the monetary union. But they can’t get past a political fact: Rich countries of the north don’t want to underwrite the precarious ones on the periphery, which they regard as irresponsible. The rising tide of populist nationalism has deepened the northerners’ tight-fistedness. Recently, a bloc of eight hawkish northern states made clear its opposition to a “transfer union.” In Germany, the surge of the xenophobic Alternative for Germany party has narrowed the government’s scope for solidarity with the periphery.

But the worst news comes from Italy. Last month’s election yielded a parliament dominated by two populist parties that reject economic responsibility. Even though Italy’s government debt is already off the charts, the populists support a ruinously expensive universal basic income and a rolling back of pension reform. Indeed, their irresponsibility extends further: More than a month after the vote, they continue to bicker about the shape of the next government.

Europe’s monetary fragility, too obvious to deny, means the region will at least pretend to do something. France’s president is keen to see progress, and some German leaders support him. But Italy looks less deserving of trust and assistance than it has in a long time. Odds are that the French will extract minimal concessions from the northerners.

Maybe Trump is reckless enough to tank the world economy with a trade war. But the political risk looks higher in Europe. Remember the armadillos.

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