Europe: The Biggest Loser?

The IMF just released a revised survey of its global economic outlook, which is generally less pessimistic than the one it originally released in April, particularly for GDP growth in 2010. There is one obvious exception amidst this "optimism": Europe.

Of all advanced economies, only Japan is expected to perform worse in 2009 (though the German economy, Europe's largest, should contract more). The Eurozone is the only entity forecasted to experience negative growth in 2010. The recovery in Central and Eastern Europe, when it arrives in 2010, is forecasted to be slower than in any other emerging market.

The difficulties on the continent are widespread. A drop in global manufacturing has pummeled Germany's export-led growth model; collapsing housing markets in Spain and Ireland have led to skyrocketing unemployment; capital outflows have devastated the Baltic countries and sparked fears of a currency collapse.

How did Europe end up in this position? 

The IMF recently released a series of papers that analyzes the effects of the crisis throughout Europe. The leading paper, Europe Under Stress, charts how Europe's diverse economies all fell into deep recession.

The paper includes several suggestions of how Europe can recover from its current economic malaise and prepare for the next crisis. It argues for deeper Europe-wide macroprudential oversight to avoid future boom and bust cycles that can spread throughout the Eurozone. Europe's economies are far more interdependent than disparate, and its economic governing needs to reflect this. 

The paper recommends an overhaul of the EU's financial stability framework in order to streamline the crisis responses within the EU when the next economic shock hits: 

Europe's regulatory and supervisory frameworks have lagged financial market integration.  The current framework, while slowly evolving toward a more European solution, is ill equipped to adequately anticipate systemic risks. Preventing Europe's financial markets from splitting up along national boundaries requires "more Europe," especially in terms of regulating, supervising, and agreements on sharing the costs of supporting cross-border institutions.

There is a silver lining to all of this, which is the unambiguous success of the euro in protecting the Eurozone's more vulnerable economies from a currency crisis and higher borrowing costs. According to two other IMF European policy papers, the crisis has been an important test for Europe's single currency. 

The first paper, The Euro's Finest Hour, comes to a blunt conclusion:

The euro works and that is no mean feat.

Yet, in spite of the euro's successes, there are some politicians in Europe who occasionally ponder leaving the Eurozone. In the second paper, Stress Test for the Euro, the IMF considers the consequences of leaving the euro area. Such an exit, and subsequent currency devaluation, would lead to an unpleasant beggar-thy-neighbor climate within the EU that Brussels would strongly discourage. The piece concludes:

 If not inconceivable, we can safely say that exit from the euro area is exceedingly unlikely.

If Europe is to rebound from this crisis, it must deepen it's intra-European roots.