Europe's 'Stagflation' Could Jeopardise More Integration

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HEN an economy slows down, things start to unravel, as Europe is now finding. Six months ago, the air was thick with assurances that the continent would not be much affected by the economic downturn in the United States. Au contraire: the impact has been marked, business confidence in Europe continues to deteriorate and even Otmar Issing, chief economist of the European Central Bank, now warns of stagflation.

There is a growing credibility gap over future statements by EU finance ministers that this week's "shock" 3% plus inflation number will do nothing to alleviate. This all makes markets and commentators wary of any talk of early improvement. Indeed, independent forecasts suggest worse is in store.

This weekend ABN Amro, in an analysis starkly headed Stagflation, has revised its euro zone economic forecasts for this year and next. Growth is lower and inflation is higher for both years, so that for this year, the growth forecast comes down from 2.6% to 2.1% (with Germany slowing to 1.4%). The forecast for inflation increases from 2.1% to 2.8%, with a prediction that the headline number due this week for May will show inflation up at 3.5%.

ABN economist Robert Lind says: "Despite policymakers' assertions to the contrary, the slowdown in the euro zone in 2001 will be sharper than we, or they, previously thought. At the same time, inflation will be higher than expected. Consistently, economic forecasters have underestimated the scale of the inflation pick-up over the past year."

As the growth story unravels, it is not just the credibility of EU finance ministers and officials that suffers. A Europe that does not have a compelling economic story is one that lacks a compelling integration story, too.

The idea of Europe is never more potent and persuasive when economic performance looks like a cure that everyone wants. Without the allure of growth, dynamism, higher investment and net capital inflow, then the "cure" soon becomes the disease nobody wants to catch.

How much more easy Tony Blair's task would be of persuading a sceptical British electorate of the merits of membership of the single currency were the euro zone enjoying surging capital inflow, resilient growth and an employment and productivity performance to die for. But why, if there is no evident growth benefit, should the UK back more integration?

Put another way, Ireland's 'No' vote in the referendum on the Nice Treaty may be indicative of a new attitude gaining ground across greater Europe. This viewpoint does not much differentiate between the Jospin and Schroder approaches of a more integrated Europe. However, it is not scepticism of the British type, more a signal from normally pro-EU voters to the European Commission and the Council of Ministers: don't assume we'll just go along.

Ireland's 'No' to Nice has brought forth a variety of explanations, ranging from insufficient understanding by voters of the purposes and importance of the treaty, to sheer bloody-mindedness by an electorate that has enjoyed large dollops of EU subsidy and does not want enlargement to spoil it. There is probably some element of truth in both of these. But what rankled with the Irish, and figured in the referendum campaign, was the official reprimand issued by the commission in February for Ireland's low tax policy, in spite of their low debt and budget surpluses.

For many, this offended ,not only because it was poor economics - a stricture against growth - but also because it infringed Ireland's right to set its own levels of tax. All official assurances throughout Europe insist there is no agenda of tax harmonisation. But if that is really the case, why was Ireland admonished for its fiscal policy? …