Europe in 2013: A Year of Decision

January 3, 2013 | 1000 GMT

By George Friedman
Founder and Chief Executive Officer

 

The end of the year always prompts questions about what the most important issue of the next year may be. It's a simplistic question, since every year sees many things happen and for each of us a different one might be important. But it is still worth considering what single issue could cause the world to change course. In my view, the most important place to watch in 2013 is Europe.


Taken as a single geographic entity, Europe has the largest economy in the world. Should it choose to do so, it could become a military rival to the United States. Europe is one of the pillars of the global system, and what happens to Europe is going to define how the world works. I would argue that in 2013 we will begin to get clarity on the future of Europe.


The question is whether the European Union will stabilize itself, stop its fragmentation and begin preparing for more integration and expansion. Alternatively, the tensions could intensify within the European Union, the institutions could further lose legitimacy and its component states could increase the pace with which they pursue their own policies, both domestic and foreign.
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The Embattled European Project

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It has been more than four years since the crisis of 2008 and about two years since the problems spawned by 2008 generated a sovereign debt crisis and a banking crisis in Europe. Since that time, the crisis has turned from a financial to an economic crisis, with Europe moving into recession and unemployment across the Continent rising above 10 percent. More important, it has been a period in which the decision-making apparatus created at the founding of the European Union has been unable to create policy solutions that were both widely acceptable and able to be implemented. EU countries have faced each other less as members of a single political entity than as individual nation-states pursuing their own national interests in what has become something of a zero-sum game, where the success of one has to come at the expense of another.


This can be seen in two ways. The first dimension has centered on which countries should bear the financial burden of stabilizing the eurozone. The financially healthier countries wanted the weaker countries to bear the burden through austerity. The weaker countries wanted the stronger countries to bear the burden through continued lending despite the rising risk that the loans will not be fully repaid.



The result has been constant attempts to compromise that have never quite worked out. The second dimension has been class. Should the burden be borne by the middle and lower classes by reducing government expenditures that benefit them? Or by the elites through increased taxation and regulation?


When you speak with Europeans who support the idea that Europe is in the process of solving its problems, the question becomes: What problem are they solving? Is it the problem of the banks? The problem of unemployment? Or the problem of countries' inability to find common solutions? More to the point, European officials have been working on this problem for years now, and they are among the best and brightest in the world.



Their inability to craft a solution is not rooted in a lack of good ideas or the need to think about the problem more. It is rooted in the fact that there is no political agreement on who will pay the price geographically and socially. The national tensions and the class tensions have prevented the crafting of a solution that can be both agreed upon and honored.


If the Europeans do not generate that sort of solution in 2013, it is time to seriously doubt whether a solution is possible and therefore to think about the future of Europe without the European Union or with a very weakened one. If, however, Europe does emerge with a plan that has general support and momentum behind it, then we might say that Europe is beginning to emerge from its crisis, and that, in turn, would be the single most important thing that happens in 2013.


At this point, a reasonable person will argue that I am ignoring the United States, which has different but equally significant economic problems and is also unable to generate consensus on how to solve them, as we have seen during the recent "fiscal cliff" affair, which will have many more iterations.


But as valid as the comparison is on the financial level, it is not valid on the political level. The United States does not face the dissolution of the republic if it follows contradictory policies.



The United States is more than two centuries old and has weathered far worse problems, including the Civil War and the Great Depression. The European Union is only about 20 years old in its current form, and this is its first significant crisis. The consequences of mismanaging the U.S. financial system are significant to say the least. But unlike Europe, the consequences are not an immediate existential threat.
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The Other Costs of the Crisis



It is the political dimension that has become the most important, not the financial. It may well be that the European Union is in the process of dealing with its banking problems and might avoid other sovereign debt issues, but the price it has paid is both a recession and, much more serious, unemployment at a higher rate than in the United States overall, and enormously higher in some countries.


We can divide the European Union into three categories by measuring it against the U.S. unemployment rate, which stands at about 7.7 percent. There are five EU countries significantly below that rate (Austria, Luxembourg, Germany, Netherlands and Malta).



There are seven countries with unemployment around the U.S. rate (Romania, Czech Republic, Belgium, Denmark, Finland, the United Kingdom and Sweden). The remaining 15 countries are above U.S. unemployment levels; 11 have unemployment rates between 10 and 17 percent, including France at 10.7 percent, Italy at 11.1 percent, Ireland at 14.7 percent and Portugal at 16.3 percent. Two others are staggeringly higher -- Greece at 25.4 percent and Spain at 26.2 percent. These levels are close to the unemployment rate in the United States at the height of the Great Depression.


For advanced industrialized countries -- some of the most powerful in Europe, for that matter -- these are stunning numbers. It is important to consider what these numbers mean socially. Bear in mind that the unemployment rate goes up for younger workers. In Italy, Portugal, Spain and Greece, more than a third of the workforce under 25 is reportedly unemployed.



It will take a generation to bring the rate down to an acceptable level in Spain and Greece. Even for countries that remain at about 10 percent for an extended period of time, the length of time will be substantial, and Europe is still in a recession.


Consider someone unemployed in his 20s, perhaps with a university degree. The numbers mean that there is an excellent chance that he will never have the opportunity to pursue his chosen career and quite possibly will never get a job at the social level he anticipated. In Spain and Greece, the young -- and the old as well -- are facing personal catastrophe.



In the others, the percentage facing personal catastrophe is lower, but still very real. Also remember that unemployment does not affect just one person. It affects the immediate family, parents and possibly other relatives. The effect is not only financial but also psychological. It creates a pall, a sense of failure and dread.


It also creates unrooted young people full of energy and anger. Unemployment is a root of anti-state movements on the left and the right. The extended and hopelessly unemployed have little to lose and think they have something to gain by destabilizing the state. It is hard to quantify what level of unemployment breeds that sort of unrest, but there is no doubt that Spain and Greece are in that zone and that others might be.


It is interesting that while Greece has already developed a radical right movement of some size, Spain's political system, while experiencing stress between the center and its autonomous regions, remains relatively stable. I would argue that that stability is based on a belief that there will be some solution to the unemployment situation. Its full enormity has not yet sunk in, nor the fact that this kind of unemployment problem is not fixed quickly. It is deeply structural. The U.S. unemployment rate during the Great Depression was mitigated to a limited degree by the New Deal but required the restructuring of World War II to really address.


This is why 2013 is a critical year for Europe. It has gone far to solve the banking crisis and put off a sovereign debt crisis.



In order to do so, it has caused a serious weakening of the economy and created massive unemployment in some countries. The unequal distribution of the cost, both nationally and socially, is the threat facing the European Union.



It isn't merely a question of nations pulling in different directions, but of political movements emerging, particularly from the most economically affected sectors of society, that will be both nationalist and distrustful of its own elites. What else can happen in those countries that are undergoing social catastrophes? Even if the disaster is mitigated to some degree by the shadow economy and emigration reducing unemployment, the numbers range from the painful to the miserable in 14 of Europe's economies.
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Europe's Crossroads

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The European Union has been so focused on the financial crisis that it is not clear to me that the unemployment reality has reached Europe's officials and bureaucrats, partly because of a growing split in the worldview of the European elites and those whose experience of Europe has turned bitter. Partly, it has been caused by the fact of geography. The countries with low unemployment tend to be in Northern Europe, which is the heart of the European Union, while those with catastrophically high unemployment are on the periphery. It is easy to ignore things far away.


But 2013 is the year in which the definition of the European problem must move beyond the financial crisis to the social consequences of that crisis. Progress, if not a solution, must become visible. It is difficult to see how continued stagnation and unemployment at these levels can last another year without starting to generate significant political opposition that will create governments, or force existing governments, to tear at the fabric of Europe.


That fabric is not old enough, worn enough or tough enough to face the challenges. People are not being asked to die on a battlefield for the European Union but to live lives of misery and disappointment. In many ways that is harder than being brave. And since the core promise of the European Union was prosperity, the failure to deliver that prosperity -- and the delivery of poverty instead, unevenly distributed -- is not sustainable. If Europe is in crisis, the world's largest economy is in crisis, political as well as financial. And that matters to the world perhaps more than anything else.




January 2, 2013 6:44 pm
 
Europe: Burnt and abandoned
 
Fears of a fresh chapter in the continent’s crisis heighten
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A car burns as workers block the main gate of the Ford plant in Genk, Belgium©AP
Ford workers set fire to a Mondeo during a protest against the US carmaker's decison to shuit its factory in the Belgian city of Genk




Peter Hulsmans had worked for Ford in the industrial Belgian town of Genk for 26 years. So when company executives summoned him and his 4,300 colleagues to a meeting on a rare blue-skied October day in eastern Flanders, he knew it would not be good news.


He expected a minor tremor, maybe a few job cuts. What he got was an earthquake: the US car maker, which laid its first brick at the facility in 1962, was shutting the plant down.
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“We always thought that there was more security working for a multinational than a small company but we were wrong,” says Mr Hulsmans, standing next to the charred wreckage of a Ford Mondeo set alight by protesting workers outside the plant’s gate. Ford is going and nobody will replace them ... nobody wants to invest here any more.”


In the three years since the eurozone crisis began roiling the continent, tales such as Mr Hulsmans’ have grown increasingly common. Foreign companies that once considered Europe a haven for slow but sure growth are now rapidly closing plants or cutting investment.


Between 2007 and 2011, annual investment in the 27 countries of the EU dropped by more than €350bn, vastly outpacing falls in other economic indicators, according to a study published last month by McKinsey, the US consultancy. The decline was 20 times the fall in private consumption, for example, and four times the decline in the overall economy.


That lost investment means companies in Europe will not generate €543bn in revenues they would otherwise have churned out between 2009 and 2020, the study estimated.


Businesses are cutting costs by shifting operations to emerging markets to take advantage of cheaper production; and shedding thousands of jobs, contributing to record levels of unemployment in the euro area.


Executives from global companies doing business in Europe say they largely shelved contingency plans for a break-up of the euro after Mario Draghi, European Central Bank president, announced in August he would use the bank’s printing press to prevent the currency’s collapse. But they have yet to return with their dollars, yen and renminbi. Their biggest fear, as they anticipate decades of stagnation across the bloc, is that the continent is turning into the new Japan.

 

Europe is going to be slow-growth for a long time. If they allow a bank to bust like what happened here in September 2008, it could be worse. So count on Europe being slow,” Jeff Immelt, chief executive of General Electric, said last year at a conference in New York.


Corporate executives say it has not helped that the easing of the crisis has been followed by the rise of anti-reform politicians in eurozone countries such as France, Greece and Italy.


“We are seeing some worrying signs of anti-business rhetoric among some of Europe’s leaders and believe that this is not a productive and collaborative approach to take,” says Ian Hudson, president of Europe, Middle East and Africa operations for DuPont, the US chemicals group. Business and government need to collaborate to face the challenges of the future.”


The list of high-profile closures and divestments in manufacturing is growing. Just five months before Ford closed its Genk plant, General Motors shut its 50-year-old Opel plant at Bochum in Germany’s Ruhr rust belt region, shedding more than 3,000 jobs. GE, once one of the most prominent US manufacturers in Europe, is focusing most of its $2bn in company-wide cuts announced in May on its EU operations, where executives say they fear the crisis is far from over.


Dow Chemical, the US conglomerate, announced in October the closure of operations in Belgium, the Netherlands, Spain and the UK to shore up the bottom line.


Hewlett-Packard, the US technology conglomerate, has axed 8,000 positions in Europe as part of a restructuring effort. Meanwhile Kimberly-Clark, the maker of Kleenex tissues, has closed most of its European factories in its efforts to boost profitability.


Overall, global companies have lost close to $2tn as a result of the sovereign debt crisis that has engulfed Europe since 2009, according to data compiled by Grant Thornton, a US consultancy that interviewed more than 12,000 executives in 41 countries.


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The shift is taking place not only in manufacturing, where the tilt to emerging markets is long established. It has also begun to manifest itself in services, including financial services, the sector in which Europe was thought to boast a competitive advantage.


Having cut costs in Europe by about $1bn, Nomura, Japan’s leading investment bank, decided in September to further reduce its presence and focus more on fast-growing Asian markets. Citigroup, the US bank, has recently announced a wave of job cuts across the globe, including 350 in Spain and Greece.


“The cash balance of US companies is very high, particularly in the high-tech industry. But overall, they are not investing that cash [in Europe],” says Walt Shill, a senior director at Accenture. The US consultancy interviewed more than 450 executives from large business for a survey of global investment to be published in the coming weeks. “What we do hear is that folks are continuing to invest in fast-growing emerging markets.”


The data show that only 3 per cent of US executives have increased investment in the eurozone since the crisis began, while 25 per cent have boosted spending in emerging markets. Just over half say they have either already started to, or are about to begin, cutting costs by shifting business to emerging markets.


Shrinking investment in Europe raises the question of whether the continent, which some leaders claim is finally emerging from its financial and sovereign debt crisis, is entering an equally risky economic crisis. So far the bulk of economic suffering has been focused on “peripheralcountries such as Greece and Spain, which have been forced into severe austerity programmes.


But a broader scaling back in foreign investment in Europe could deepen the double-dip recession that appears under way. Foreign direct investment has shrunk at a rate of 10 per cent a year since 2008, according to European Central Bank data. Merger and acquisition activity in Europe last year was down 34 per cent on 2011, and down 70 per cent from a 2007 peak, according to the OECD, a club of mostly rich nations.


“In 2010 and 2011, several non-Europeans looking at the continent were saying: ‘Well, companies are getting hammered over there; let’s go buy stuff,” says Michael Gestrin, senior economist at the OECD. “But this sentiment has changed in the last year as scepticism returned.”


The eurozone crisis has also exacerbated concerns that foreign companies have had in Europe since before the crisis about regulation and a failure to come up with a coherent restructuring plan.
Sergio Marchionne, head of Fiat in Europe and Chrysler in the US, last March urged the EU to follow Barack Obama’s approach to US car makers. In 2009, the US president took a hands-on approach to the overhaul of the industry.


“There needs to be a structural fix which is local, and which needs to be managed and addressed by the EU as the holder and repository of the notion of the single market,” Mr Marchionne said. But executives say little has been done to this day.


A common criticism is that the EU has paid a lot of attention to austerity – which most agree was needed – but made little effort to open markets to stimulate investment and growth.


“The underlying problem ultimately lies in the competitiveness of Europe, and there are many regulatory burdens that must be addressed,” says Mr Hudson at DuPont. “If it takes longer to create a business, to build a plant ... in Europe versus elsewhere around the world, then Europe is, of course, at a disadvantage.”


Hendrik Bourgeois, a vice-president at GE Europe, says the crisis has played an important role in forcing countries to tackle significant structural problems such as closed labour markets in southern Europe. But the pace of reform has been slow.



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There have been exceptions. Liberty Global, the US cable operator, has been selling non-EU assets and expanding its presence in northern Europe. With demand unexpectedly holding up, it has invested more than €7bn in the past two years through three acquisitions. “Our sector has been crisis- resistant,” says Manuel Kohnstamm, the company’s senior vice-president. “We plan to invest more in the future.”



In addition, is a growing trend among emerging market companiesparticularly Chinese groups – of using today’s volatility as a strategic opportunity to build their presence in Europe. Huawei, the Chinese telecommunications group that has run into national security barriers in the US, has been aggressively expanding in Europe. Since the end of 2010 it has invested more than €6bn and hired more than 2,000 people.


“For a Chinese company like us, Europe is still a very attractive place to do business, partly because there is still a lot of demand in our [technologies] and because the macroeconomic and political environment is fairly stable for us,” says Leo Sun, president at Huawei in Europe.


But Adrian van den Hoven, director of international relations at Business­europe, the EU’s main employers’ lobby, says that in the short term, emerging market investors cannot make up for the loss caused by the retrenchment of US companies. “There is a growing amount of investment from emerging markets but a lot of it is not so relevant because it’s so small,” he says.


Chief executives and analysts for foreign companies are adamant that Europe remains an important part of their business, even if it becomes a smaller portion of their global footprint.


But multinationals in developed economies appear simply too scared the quagmire in which Europe now finds itself is going to be the new normal. For Mr Hulsmans and his 4,300 colleagues, who will soon be out of work, the prospect of finding a secure job with a big company is not promising.



“The future is dark for Europe,” he adds.


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Copyright The Financial Times Limited 2013.