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Christina

FINANCIAL TIMES            3.7.09 

EU faces permanent loss of output

By Tony Barber in Stockholm

Europe is likely to suffer a permanent loss in potential economic output as a result of the global crisis, and government finances will be under pressure for years to come, according to a new European Commission study.

“The crisis is the equivalent of capital destruction, reducing – at least for a time – the productive potential of the economy,”the report says.

“Current market disruption in financial markets and the more heavily regulated environment that is likely to follow can also be expected to have a permanent negative effect on potential growth, e.g. through reduced availability of capital for R&D and innovation activities.”

The Commission’s report on the 16-nation eurozone’s economy represents the European Union’s first in-depth attempt to assess the long-term consequences of the crisis for economic growth and Europe’s public finances.

Its warnings are likely to reinforce the view of policymakers in countries such as Germany, Europe’s largest economy, and Sweden, which assumed the EU’s rotating presidency on Wednesday, that Europe has absolutely no more room for fiscal expansion to combat the crisis.

The report notes that, even before the crisis, the eurozone’s potential economic growth rate was projected to fall from 2.2 per cent in 2007-2020 to 1.5 per cent in 2021-2030 and a meagre 1.3 per cent in 2041-2060.

The report says potential economic growth will slump to 0.7 per cent this year and in 2010, but predicts that it should make a gradual recovery over the medium term.

However, it cautions: “Empirical evidence of the effect of past crises shows… that the economy will not return to its pre-crisis expansion path but will shift to a lower one. In other words, the crisis will entail a permanent loss in the level of potential output.”

According to the Commission’s forecasters, the eurozone’s public debt will soar to 83.8 per cent of gross domestic product in 2010 from 66 per cent in 2007. Belgium, Greece and Italy [and probably Britain too -cs]  will have debts above 100 per cent of GDP in 2010, France’s debt will be 86 per cent and Germany’s debt will be 78.7 per cent.

In all, 11 of the 16 eurozone nations will have debts higher than the 60 per cent level that, according to EU treaty law, countries hoping to join the eurozone must meet.

The Commission’s report suggests that matters may get even worse, saying: “Further rising debt ratios in the years beyond 2010 can be expected. The current high deficit levels can indeed be partly seen as structural in the sense that the economy is likely to face a deceleration in its medium- to long-term growth prospects.”

Long-term pressures on Europe’s welfare state will increase as the continent grapples with rising life expectancy, low fertility rates and a shrinking working-age population, the report says.

Almost half of the EU’s population today is aged 50 or older, but by 2060 half will be aged 55 or older and there will be nearly twice as many elderly people as children, it predicts.

The Commission says it will be vital for EU governments to resist protectionist temptations and reject measures that promote national interests at the expense of the single European market.

Measures that reduce labour market participation, such as early retirement schemes, must also be avoided, it says.

Summing up the state of Europe’s banking sector, the report says: “The most acute phase of the crisis… has now receded, but the situation remains fragile. Euro area banks are still highly leveraged, and persistent concerns about the quality of their assets have fuelled fears about the overall health of their balance sheets.