Sunday, 1 February 2009

Icarus Visits Europe

We wrote in a previous post about the ‘Icarus Effect’ – those economies that have risen the highest and the fastest in recent years that have the potential to fall the furthest and hardest in the downturn (see post). This week, it has been the fate of Europe to experience some of the more disruptive consequences of the downturn. In France, a general strike gave way to rioting against the prospect of falling living standards (see report), in Spain there were protests against unemployment (see report), in Latvia there was rioting against the terms of the IMF bailout (see story), in the UK refinery workers are striking against the use of foreign labour (see report), and Iceland may be fast tracked into the EU – and the Euro – as the country starts to cease operating as a sovereign entity (see story). In order to make sense of this, we need a framework through which we can interpret events as they unfold.

We are quite convinced by the categorisation of the European economies by the Bruegel Institute in Brussels (see web site). Their research indicates that Europe can usefully be categorised as having four styles of economy:
1. The Mediterraneans (Greece, Spain, Italy).
2. The Continentals (France, Belgium, Germany).
3. The Anglo-Saxons (UK, Ireland).
4. The Nordics (Denmark, Sweden, Finland, Netherlands).
These classifications are based upon how the economies behave rather than their geographical location. As a reference point, the US would be classified as an Anglo-Saxon economy. The Mediterraneans are sometimes referred to, unkindly, as the PIGS Economies (Portugal, Italy, Greece, and Spain).

It is an interesting exercise to cast the A8 (the eight EU accession states from 2004 – Estonia, Latvia, Lithuania, Poland, Slovakia, Slovenia, Cyprus, and Malta) in terms of the more established Bruegel categories. The Eastern European members of the A8 have tended to be more influenced by the Anglo-Saxon agenda of privatisation and flat taxes than any of the other European models. In the current downturn, this leaves these economies rather vulnerable. They will suffer the loss of living standards without a fully developed social welfare system to mitigate it.

Iceland is, perhaps, the most interesting case. Traditionally, Iceland would be cast as a Nordic economy – very unimaginative and very solid. In recent years, Iceland has moved from being a Nordic Economy to being more of an Anglo-Saxon economy by liberalising its banking system and accumulating large leveraged positions. In doing so, it has become a microcosm of how the recession might play out. Financial collapse in Iceland has been rapidly followed by the collapse of the Icelandic real economy. This has led to political instability, with the fall of the Icelandic government this week. The escape route for the nation is now to accept the pooled sovereignty of the EU, which has all sorts of geo-political implications.

An alternative would be for the Icelandic people to revert to an inward focus. To retain as much independence as they have today, which is highly prized in Icelandic society, the nation would have to become far more self-sufficient than it is today. The Icelandic currency has depreciated to a point where it is effectively valueless, Icelandic trade has dropped away significantly; tax revenues are set to fall, and just at the point where pressure on government spending is rising. If foreigners are reluctant to fund the Icelandic PSBR because of the devalued currency, then the only thing that the Icelandic government can do is to tighten its belt until it really hurts.

This highlights the danger of being where we find ourselves. The popular reaction during a downturn is to rail against foreign companies, foreign staff, foreign finance, and so on. A good number of protests in Europe at the moment are specifically directed against the involvement of ‘foreigners’ in the domestic economy. To their credit, European politicians have resisted calls for protectionist measures. We can only hope that they stay on course. Already the US has shown an alarming sign of protectionism through the ‘Buy American’ clause in the financial stimulus package. This assertion of nationalist sentiment is dangerous because it is confrontational and invites retaliation, which is in nobody’s interest. In a trade war, we are all the losers.

Although Icarus has visited Europe this week, let us hope that we can avoid his fate by overcoming the dangers that we face.

© The European Futures Observatory 2009

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