Europe’s economy on the edge

The European economy oscillates between recession and growth. The cutting edge is sharp because European decision makers have exactly no control over the outcome.

Before Russian President Vladimir Putin’s attack on Ukraine, Europe’s recovery from the damage caused by the COVID-19 pandemic was consolidating. Industrial production increased in January and retail trade rebounded. Economic sentiment improved in the first half of February, surpassing pre-pandemic levels. But then the war shook consumer confidence by increasing uncertainty and driving up energy and commodity prices. In mid-March, the European Commission’s consumer confidence indicator fell to its lowest level since the start of the pandemic.

So far, however, the data shows only a slight slowdown in demand and limited supply disruptions. They report nothing remotely resembling the collapse in activity that accompanied the pandemic lockdowns of 2020-21. The OECD’s weekly economic activity monitor, which uses machine learning and Google Trends data to infer real-time changes, also signals only a slight slowdown. Box office receipts are stable. Restaurant receipts are stable. Data from the TomTom navigation service does not suggest much of a decline in mobility-related activity.

In response to the war and the energy shock, the European Central Bank rightly lowered its forecast for Eurozone growth in 2022 from 4.3% to somewhere between 2.3% and 3.7%, depending on what happens to oil and gas prices. Nonetheless, even his “harsh scenario” of sustained high energy prices still predicts above-trend growth in 2022.

More expensive energy will undoubtedly dampen growth. But if Russian gas keeps flowing, higher prices won’t cook through a recession. Inevitably, profits will be squeezed by more expensive inputs. Even so, European producers can take steps to save energy and keep the wheels turning.

But using less gas is one thing; not using any is another. In this last scenario, the gasworks will not make any savings; they will close. Over time, US natural gas can be replaced. But Germany has no liquefied natural gas terminals and will need the rest of 2022 to install its first floating LNG terminal – a converted supertanker – even if all goes according to plan. In the meantime, German gas consumption will fall by 30 to 40%. Even assuming that monetary and fiscal authorities react forcefully to prevent second-round business cycle effects, this could lift German growth in 2022 to 1.8%, the latest forecast from the German government’s Council of Economic Advisers, to negative and recessive territory.

And here Europe’s lack of control comes into play. Whether gas supplies are suspended further, as they have been with Poland and Bulgaria, is entirely up to Putin, who may decide to end further no more retaliatory shipments to Western sanctions. He may need the income, but it wouldn’t be the first time that anger and pride have trumped economic logic. If the West makes payments not to Gazprombank but to escrow accounts, Putin will lose his last incentive to keep the gas flowing. He knows that these accounts will ultimately be used to finance Ukrainian reconstruction rather than to bail out the coffers of the Russian government.

Above all, if Putin allows his military to continue committing atrocities against Ukrainian civilians, Western European publics and policymakers will unite against him. Given the history of their country, the Germans will not be able to settle comfortably, in houses heated with Russian gas, in the face of this monstrous behavior. If Chancellor Olaf Scholz does not lead, then other members of his coalition, such as Defense Minister Christine Lambrecht, will almost certainly step in. And at some point, the German people will take Scholz with them. Whether that is depends on Putin’s next steps.

It’s easy for an American, hot on natural gas from Texas and the Dakotas, to say that Europe should suffer a recession to turn up the heat on Putin. But if President Joe Biden’s administration and the US Congress think it’s crucial to step up the pressure on Russia, then they can make it worthwhile for Europe.

Europe will take the lead in Ukraine’s post-war reconstruction. The logistics are simpler. Ukraine is in the neighborhood of Europe, as Ukrainian President Volodymyr Zelenskyy reminds us. The European Union can deploy its cohesion funds, its trans-European transport and other infrastructure projects and its common energy policy even without – or preferably before – admitting Ukraine.

But if Europe is the logical party to do the legwork and administer the aid, then the United States can provide the bulk of the financing, beyond the part financed by the escrow accounts and other external assets of the Russia. It will be an appropriate humanitarian gesture once the war is over. But a US pledge now to compensate Europe for the steps it must take, starting with a ban on Russian oil and gas imports, is also a way to incentivize it to help end the war quickly. .

Barry Eichengreen, professor of economics at the University of California at Berkeley, is the author, most recently, of In Defense of Public Debt (Oxford University Press, 2021). Syndicate Project, 2022

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