Europe should not waste a good recovery

Europe could not have asked for a better end to 2017. Data from the Markit Purchasing Managers’ Index showed that economic activity was the strongest in nearly seven years. The unemployment claims rate in Germany is at its lowest level since the early 1990s. Even Greece’s factories are enjoying the best run in nearly a decade.
Indeed, the euro-zone economy must surely rank near to the top of any list of positive surprises of 2017. The European Commission believes the currency union expanded by 2.2 percent last year —compared with a 1.5 percent forecast from just 12 months before. All countries appear to have joined the party: Measures of growth disparity have fallen to the lowest level since the creation of the euro.
Doomsayers are likely to be proven wrong again this year, as the cyclical recovery from the sovereign debt crisis and the ensuing recession continue. However, betting on the euro zone’s long-term future is still risky. While the odds of a collapse of the euro zone have been significantly reduced, the steps required to make the area more resilient to economic shocks remain elusive.
Europe’s boom is expected to last into 2018. While unemployment is falling, it remains high, especially in countries such as Italy or Spain, allowing further growth without fueling significant price increases. At 1.4 percent, inflation remains below the European Central Bank’s target of just under 2 percent and is forecast to hover around that rate for most of the year.
There are, of course, risks on the horizon. Italy will hold a general election at the start of March and anti-euro forces are set for a strong showing: Political instability could spook markets and derail the recovery in the euro zone’s third largest economy. Spain is still grappling with a separatist threat in Catalonia. Across the euro zone, inflation could climb faster than expected, forcing the ECB to bring its bond-buying scheme to a halt.
These threats are small, however, compared to the real problem haunting the currency union: the difference between the wealthier core countries and poorer peripheral members, who have accumulated a large gap in competitiveness since the creation of the euro. Countries such as Spain, Portugal and Italy have embarked on a plan of ambitious labour market reforms since the start of the decade, which will help to make their economies more dynamic.
For all the good intentions of recent months, there is little reason to believe that politicians will address the institutional shortcomings that make the euro zone vulnerable to shocks. This means completing the banking union, to ensure that countries are not left alone in dealing with a banking crisis; And building elements of a fiscal union, to ensure that more common spending goes into a country that is facing an economic shock, whether to fund infrastructure or to help retraining the unemployed.
Unfortunately, none of these reforms appear close. The European Commission has set out an ambitious roadmap, but it is unclear this has support from governments. And while Angela Merkel, Germany’s chancellor, has pledged in her New Year’s speech to team up with France to make the EU more resilient, she has so far failed to form a government, three and a half months after a general election.
The euro zone is unlikely to experience a repeat of the existential crisis that nearly dismantled it at the start of the decade: Since then, it has established a sizeable rescue fund, the European Stability Mechanism. The ECB has proven it can intervene in the bond market in the event of recession and deflation. This will make investors think twice before betting that a country will leave the currency union. However, simply avoiding a new catastrophe is not sufficient for the euro zone to thrive; further reforms are needed. We can feel good about Europe in 2018. Beyond that, the case for optimism is less clear-cut.

—Bloomberg