Bill Jamieson Crisis point

COMMENT

BILLJAMIESON | Executive Editor of The Scotsman

Crisis point

A manufacturing miracle – but how long can it last?

For 30 years the prescription for European economic success has been an exportled manufacturing revival. But now that one has started to unfold, it only seems to have added to the greater problem of European financial stability: growing divergence between the northern European states and the others, pressure for higher interest rates and a deepening realisation that inequalities across the single currency zone are rising, not declining as European leaders had hoped.

A manufacturing recovery hand in hand with a debt and deficit crisis as great as Europe has experienced since the 1930s: the growth figures for manufacturing coming out of Germany and France – and the UK, too, for most of the past year – has surprised everyone. It has been helped in large part by continuing strong economic growth in developing country markets – Latin America and Asia-Pacific in particular. It has been supported (in Britain) by currency devaluation making exports more competitively priced, and (in Germany) by hard-fought labour market reforms reaching back over a decade.

But it is testimony, too, to the resilience and determination of thousands of private companies to respond and adapt to an economic world still traumatised by the financial crisis of 2007–08 and subsequent recession. As economic history has repeatedly shown us, it is precisely in periods of maximum adversity that companies can surprise even themselves, driven by the compulsion of survival to become more adaptive and innovative. Government finances may be in disarray and an escape route out of debt default impossible to find but companies in sectors ranging from electronics to car assembly, process engineering to infrastructure have found ways to improve productivity and achieve efficiency gains to win more business.

Manufacturing companies have achieved innovative solutions against seemingly colossal odds – little short of a miracle given this context. The business environment in Europe has threatened a truly existential storm: growing strains on the single currency, fears of higher taxation and rising resistance across many part of Europe to any further austerity measures with unemployment already so high. Indeed, such is the rising tide of street protest across several countries we may now have reached the limit of the public’s austerity tolerance.

Little wonder in these circumstances and with the European Central Bank embarking on a series of interest rate rises, that Euro area manufacturing orders declined 1.8 per cent in March – the first decline since last September, and that growth momentum is slackening after the growth spurt recorded at the start of the year.

The consensus view is that this is a slackening of the recovery pace rather than anything more serious. But it would be brave to predict that business confidence, so vital to continuing innovation and expansion, will not be affected by the eurozone’s deepening sovereign debt crisis.

Banks at risk

Some have argued that the stricken economies of Greece, Portugal, Spain and Ireland should simply bite the bullet and announce a sovereign debt re-structuring under which debt holders have to accept a write-down in the value of their investments – after all, Argentina underwent this and survived.

But that is to turn a blind eye to the dire repercussions this could potentially have on international banks, many of which are still in a fragile state after the 2007–08 crisis. International bank loans – mostly from European banks – to European governments total almost US$12 trillion. The claims of foreign banks on Portugal, Italy, Ireland and Greece, which would be at risk in event of debt re-structuring, stand at US$2.4 trillion. Put bluntly, Europe’s credit bubble may be even bigger than America’s mortgage bubble. Hence the recent warning from an ECB executive director that debt default could unleash a crisis in Europe greater than that unleashed by the collapse of Lehman Brothers in September 2008.

A clear symptom of the depth of this crisis is the open split between the stance of the ECB (resolutely opposed to debt ‘re-profiling’) and political leaders in the eurozone. Far from the institutions of Europe speaking with one voice, there is a cacophony of opinions and positions as a profound moment of decision approaches. Either the eurozone moves towards a future as a full fiscal transfer union (Germany and the more prosperous states agreeing to subsidise Portugal, Ireland, Spain and Greece) or the euro area splits into two zones: a strong northern area with Germany at its centre, and countries in the southern periphery still sharing a single currency, but one de-coupled from the D-Mark and able to devalue and to set interest rates at a level more appropriate to their domestic conditions.

A transfer union would be deeply unpopular with northern country members and may be politically unacceptable, while a euro split would be a humiliating defeat for those who have championed economic and fiscal integration for more than 30 years in the belief that greater economic stability, investment and growth would result.

With such a deeply unpalatable stand-off, this leaves the third way: continuing eurozone dissemblage, muddle and fudge – amid growing intrusion into the affairs of debtladen members (forcing Greek asset sales and a supervisory regime for the quick enactment of these sales being just one example).

So far, the manufacturing recovery has been the one positive storyline in Europe over the past year. But to expect it to continue as this crisis deepens would be a brave bet indeed. n