Sniff the air, did you smell it? There is a whiff of panic in the media again today, it seems we are all doomed. This time the big fear relates to Eastern Europe and the countries that once formed the Soviet Union. If the fears are right, we are set to see another banking crisis, one which could bring the economies of Austria, Greece, Sweden and Italy to their knees. This will have a knock on effect on Germany, and the crisis we have seen so far will feel like a walk in the park by contrast.
And yet, before you conclude there is just no hope, take comfort from this, there is another point of view.
But first, let’s take a gander at the latest figures from Eurostat on how the EU’s individual economies are performing.
Figures out last Friday finally confirmed the Eurozone is suffering from a shocker. Q1 growth data is still not available for around a third of all EU countries (Bulgaria, Denmark, Ireland, Greece, Luxembourg, Malta, Poland, Slovenia, Finland and Sweden), but for the rest it really is bad, with one exception, little Cyprus.
Eurostat, which compiles this data, has two versions. First off it shows growth in GDP between Q1 this year and Q4 last.
Listing the countries in order by best performers down to worst, we see that Cyprus is in the top slot, with zero growth. The second best performer was France which contracted by 1.2 per cent. The list continues: Portugal (-1.5 per cent), Belgium (-1.6 per cent), Spain (-1.8 per cent), UK (-1.9 per cent), Hungary (-2.3 per cent), Italy (-2.4 per cent), Romania (-2.6 per cent), Austria and the Netherlands (both -2.8 per cent), Germany (-3.8 per cent), Estonia, (-6.5 per cent), Lithuania (-9.5 per cent), and finally, bringing up the rear we have Slovakia and Latvia which both contracted by 11.2 per cent.
What is quite interesting about that list is that it shows the UK in sixth place, with 10 countries seeing a worse performance.
Secondly, Eurostat also shows annual growth over the 12 months to Q1 this year. On this list, Cyprus is once again the star, and was the only EU economy listed to actually expand during the period, growing by a respectable 1.6 per cent.
Tying for second place we have Austria and Spain, which both contracted by 2.9 per cent. Then there’s Belgium (-3 per cent), France (-3.2 per cent), Czech Republic (-3.4 per cent), Bulgaria (-3.5 per cent), Portugal (-3.7 per cent), UK (-4.1 per cent), the Netherlands (-4.5 per cent), Hungary (-4.7 per cent), Slovakia (-5.4 per cent), Italy (-5.9 per cent), Romania (-6.4 per cent), Germany (-6.9 per cent), Lithuania (-10.9 per cent), Estonia (-15.6 per cent) and Latvia (-18.6 per cent).
This time the UK is about halfway down the list. So the data suggests the UK saw a mild improvement relative to the rest of the EU in the most recent quarter.
The big fear, however, is that some of the smaller emerging economies could default. Writing in The Times, Anatole Kaletsky fretted about certain Eurozone economies, namely Spain, Greece, Portugal, Ireland and Denmark. During the good old days when the world was booming, these economies all saw massive balance of payments deficits, while they each saw their own housing bubbles. But, because they are members of the euro, they do not have the luxury, available to the Bank of England, of printing money. Therefore, there is a theoretical possibility they could go bust, just as certain states in the US have suffered that fate.
It was said here a week or so ago that while the European Central Bank has at last gone down the quantitative easing route and is printing money, it is reluctant to buy government debt because it does not want to be seen to be bailing out the region’s debtor countries.
But for some of Europe’s emerging countries, the problem is even more serious. This is what Mr Kaletsky had to say on the subject. “Countries such as Latvia, Estonia, Hungary and Romania…will suffer a tsunami of bankruptcies if their currencies ever fall. Eastern European governments are, therefore, desperate to avoid devaluations. But the actions they take to ‘protect’ their currencies — for example, cutting public sector wages — only deepen their recessions and magnify the mortgage defaults.”
But there is another way of looking at this. Sure, some of these countries, especially the Baltic economies, enjoyed a ridiculous boom which was simply unsustainable. But the fact remains, emerging Europe has massive potential for growth by virtue of the fact that these economies operate with capital infrastructure which is way below optimum levels.
The former winner of the Nobel Prize for Economics, Robert Solow showed that economies can maintain growth until they reach a point when there is no benefit from additional capital. At that point, investment in capital is only useful inasmuch as it replaces old capital as and when necessary.
Think of it this way. A farmer may find he can benefit from buying a couple of tractors. Say he drives one, and his most experienced labourer Joe Grundy drives the other. But, if he then buys a third, there may not be another driver available, and even if there was, he just may not have enough land to justify this extra piece of machinery.
It is just like that with economies. When countries that lack capital (that’s by the economic definition of capital: machinery and the like), there is greater potential for growth, unlike mature economies that have already reached their level of optimal capital infrastructure. Such mature economies, by contrast, are reliant on innovation for growth.
So, Europe immediately after the Second World War had massive potential for growth, as do the likes of China and India today.
It makes sense for economies with this potential, to borrow. This is why the huge borrowing in Europe seen after the last world war ultimately proved to be fundable.
So, while it is true that emerging Europe might be over reliant on Western banks, and that if the credit crunch migrates to apply to national debt they may default, in the longer term there is no solid economic reason why we should be so worried. In fact, the opposite is true. We should lend to these economies, thereby funding their growth, and ultimately creating new customers to buy our own goods and services.
As was pointed out by RGE Monitor this morning, many developed economies within Europe have borrowed far more from abroad than the entire emerging Europe block put together. In any case, a high proportion of debt in the region relates to debt within international banks. So, say a subsidiary bank in Hungary may owe money to its parent bank based in Austria or Frankfurt, it seems unlikely that parent banks are going to foreclose on their own subsidiaries.
It is essential that the developed world continues to provide the money required by the region. Not only will this mean another crisis can be avoided, in the longer term there is no reason to believe the debt is any less safe than loans to developed economies, such as the UK, which are reliant on innovation as the engine of growth.
© Investment & Business News 2013