We can dodge Europe's gloom

23:49, May 08 2012

I've just come back from a couple of weeks in London, Madrid and Paris, speaking with various groups about the state of and prospects for the New Zealand economy and getting from them some insight into what is happening in Europe.

As I noted in this column last week, the situation in Europe is not good. There is growing societal discord with the high and rising unemployment rates in most countries except Germany, cutbacks in state support mechanisms, and deregulation of long-protected labour markets.

The discord has reached such a level that, in the past year, eight European Union governments have been turfed out. The latest is in France, where voters have elected a former leader of the Socialist Party who has no ministerial experience and is preaching a Left-wing agenda. Francois Hollande's policies include a 75 per cent top personal income tax rate, lowering the retirement age to 60 from 62 for some, boosting teacher numbers by 60,000, raising business taxes, increasing subsidies to employ the young and old, and renegotiating the Fiscal Pact to include a focus on growth.

In other countries, calls for a pause in the speed of fiscal policy tightening are growing and the chances are high that some allowances will be made for the deep extent of pain in the short term.

The trouble is that, while the likes of the United States and maybe even Britain could get away with a fiscal "cup of tea", Europe may not when it comes to the view of the markets.

That is, Europe is a mishmash of competing interests and 27 governments forming the EU, so getting agreement is a difficult and very lengthy process.


This means that investors who will be called on to buy the extra bonds governments will look to issue as they slow the extent of deficit reductions may not be all that willing.

In contrast, in Britain and the US, single governments prevail and there is general faith that, although the path will be rocky, plans will probably be stuck to and positive results achieved. Britain proved it could do it under Margaret Thatcher while the US has the benefit of being the world's biggest economy with some deep automatic deficit-reducing measures to start from next year.

The risk is that, as interest rates go up in Europe, the European Central Bank will be prevailed upon to print even more money, and debt levels will simply get transferred from one group to another and the problem kicked further down the track. The risk is a lengthening of the period of poor competitiveness for many European economies.

For us, the relevance is that, whether or not an easing in fiscal austerity occurs, growth in Europe one way or the other will be weak in the next few years. The euro is likely to weaken anew further down the track, and the New Zealand dollar's recent fall against even the British pound is likely to prove temporary.

For exporters, the European market will remain tight. But all we can ever hope to be as New Zealand exporters is niche operators, and niches exist whether economies are rising, falling or simply rising slowly. So the poor macroeconomic outlook for Europe is not a good reason for diverting all resources toward the Asian market, even though over time more and more of our aggregate export receipts will come from near than far.

zTony Alexander is chief economist for the Bank of New Zealand.

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