Our commercial interests in Europe are huge. In 1991, U.S. exports to Western Europe (an estimated $118 billion) exceeded our combined exports to Japan, South Korea, Taiwan, Hong Kong and Singapore (estimated at $94 billion). A slowdown won’t help our recovery. But the ultimate stakes in Europe’s shrinking growth transcend the immediate impact on us. What’s really at issue is the nature of the post-cold-war international order.
It is Europe-much more than Japan-that will be decisive in shaping this new order. The great danger is that a flagging economy will deepen Europe’s preoccupation with its own problems and weaken its willingness to deal with global problems. Europe sits at the fulcrum of change. Slower growth would make it harder for the European Community to aid Eastern Europe and the former Soviet Union, either by providing direct assistance or (more importantly) by buying their exports. And slower growth would worsen Europe’s protectionist tendencies. Already, the EC’s unwillingness to make sharp cuts in its massive farm subsidies is obstructing a new world-trade agreement.
The cold war inspired a certain populist internationalism. People in the United States, Europe and Japan knew they faced a common global threat. The end of the cold war has shaken that sense of shared destiny. There’s a looking inward-not just in Europe, but also here and in Japan-that ignores the many common problems that remain: from trade to the environment to nuclear proliferation. The political basis for international cooperation is slowly eroding, as countries focus more on their own troubles.
It is in this sense that Europe’s economic slowdown, unless reversed, could have profound political consequences. The slowdown is pronounced. Between 1988 and 1991, the EC’s annual growth dropped from 4 percent to 1.3 percent. In France, the jobless rate is expected to top 10 percent in 1992, up from 8.9 percent in 1990, according to the Organization for Economic Cooperation and Development in Paris.
In effect, Europe is suffering a delayed reaction to German reunification. Initially, this stimulated a huge spending boom in Germany. The 17 million East Germans got instant purchasing power when their East marks were converted into West German Deutsche marks. And Germany borrowed huge amounts to pay for welfare benefits (unemployment insurance, old-age assistance) and reconstruction. Now, the aftershock of all this spending has suppressed growth. The Bundesbank-Germany’s Federal Reserveraised interest rates to quell the inflation (now 4.2 percent) caused by the spending boom. And then Germany increased its gasoline tax by about a third and imposed a 7.5 percent income-tax surcharge to help finance unification. “The net effect has been to induce a slowing of the European economy for the last 18 months,” says economist Alan Davies of Barclays Bank in London.
To see why, you have to understand the European Monetary System (EMS). It commits 10 of the EC’s 12 members (the exceptions are Greece and Portugal) to keep their exchange rates closely aligned with each other. This means that high interest rates in Germany forced other countries to maintain high interest rates. If they hadn’t, money would have shifted out of currencies like the French franc to take advantage of higher rates on Deutsche-mark deposits. That would have undermined the EMS’s exchange rates.
There was an alternative: the EMS could have changed its exchange rates. A higher Deutsche mark would have dampened inflation by making German imports cheaper and German exports more expensive. But the Europeans regard the EMS’s exchange rates as sacrosanct. The result is tight money that suits Germany and hurts the rest of Europe.
When will the Bundesbank cut rates? Last week German steelworkers accepted a 6.35 percent wage increase-higher than the Bundesbank wanted. Wage talks now loom for 2.5 million civil servants and 4.1 million workers in machinery industries. Economist Rainer Schroeder of the Dresdner Bank doubts the Bundesbank would lower rates until these talks conclude in late spring. “If the settlements are good-6 percent or less-there might be some chance to lower rates in the second half of 1992,” he says.
Once that happens, Europe’s economy may recapture its previous buoyancy. And perhaps it won’t. The present slowdown could be a harbinger. In late 1991, the EC agreed to establish a single European currency by no later than 1999. European leaders celebrated this as a huge step toward greater unity. The trouble is that creating a European money requires individual countries to meet stringent conditions-lowering budget deficits and achieving similar inflation and interest rates-that could temporarily hobble economic growth.
This would aggravate Europe’s political tensions and increase its self-absorption. There’s already a resurgence of ultranationalist feeling aimed at immigrants and European bureaucrats in Brussels. Strains are growing between France and Germany. Their reconciliation has been the pillar of European unity. It no longer seems so sturdy. France is experiencing a crisis of confidence. It worries about Germany’s enlarged economic power (as a result of reunification) and newfound assertiveness. “There is suddenly more Germany and less France,” says Dominique Moisi of the French Institute of International Relations in Paris. Some Germans, too, have new doubts. “Germans are saying, ‘My God, my pension isn’t going to be paid in Deutsche marks but in European funny money’,” reports John Yochelson of the Center for Strategic and International Studies.
As yet, these fears are only vague forebodings. But prolonged economic sluggishness would surely intensify them. Europe would become a much more fractious and unhappy place. It would be so obsessed with its own problems that it could hardly help with anyone else’s.
