Claude Smadja: A 2012 hostage to politics

The Berlin consensus will fail Europe hyper-polarisation will hurt the US. The global economy awaits good politics

Brace for impact. Next year, 2012, will be extremely difficult. Crucial decisions to get the global economy out of the recession looming ahead are in danger of remaining hostage to political considerations that may not be fully rational. The European summit of December 8-9 was supposed to be the “last-chance summit”, the one that would at long last deliver a convincing solution to the euro crisis. Instead, when all the rhetoric was peeled away, it appeared that – like the seven preceding summits this year– it had failed to provide the solutions that would help recreate a sense of confidence in the markets, and halt the inexorable drift towards a long and painful recession in Europe that would impact the global economy.

Angela Merkel, the German chancellor, got more or less what she wanted in the form of an agreement for an inter-governmental pact setting the basis for a fiscal union among the 17 members of the euro zone — and also a number of non-euro countries, which will have to decide on the merits once the text of the inter-governmental pact is ready (by March 2012). So, this was another step towards the full enforcement of the “Berlin consensus” on the European continent or – to be less politically correct – a German Europe.

The crucial problem is that enforcing the Berlin consensus, with its unilateral emphasis on austerity measures and its obsession with the presumed risks of inflation, kills any prospect of growth in Europe at least in the next two or three years. There is scant chance of an end to the process of economic deterioration, and to the vicious circle through which countries in difficulty sink even deeper — as they have to pay an even higher cost for capital, while their ability to sustain their debt burden declines and their GDP shrinks.

We, thus, must prepare ourselves for a deepening crisis in the European Union and an even greater collapse of confidence in the euro zone — with a full-blown impact on an already vulnerable global economy. This process may ultimately come to an end and be reversed either if growing popular revolts against harsher and harsher doses of austerity force European governments to shift course, or as and when the German business community realises that its interests are beginning to be deeply hurt by Berlin policies boomeranging on them, and puts pressure on Ms Merkel’s government to wait for another moment to achieve Berlin consensus’ full victory. We would then see a change of attitude with respect to providing the European Stability Fund the resources and status it needs to be credible, and we will see a move from the European Central Bank towards accepting a role as the lender of last resort — a key, basic, role of any central bank.

In other words, things will get much worse in Europe before they have any chance to get better. Meanwhile, a last-minute compromise in the US between Republicans and Democrats prevented – for the third time this year – a shutdown of the entire US government, also extending tax breaks and unemployment benefits in exchange for an agreement by the White House to make a decision on a controversial pipeline running from Canada to the Gulf of Mexico. Obviously, we should not expect any kind of bipartisanship on measures that would help consolidate the US economy – and thus help the global economy – in a 2012 that will be obsessively dominated by the presidential election agenda. The Russian-roulette games in which an over-polarised US Congress has indulged itself for quite some time now are definitely not the way to shape economic and fiscal policies in what remains the largest single economy in the world. But this will continue to be so.

When former US President Bush popularised the notion of “rogue states”, to characterise governments that created a threat to international peace and security because of their actions and their mindset, he certainly did not anticipate that one day this label could be applied to the US and European Union countries because of the way their internal politics and their political dogmatism put the entire global economy at risk.

To be realistic, there is nothing a country like India can do, at this stage, to force a more rational behaviour on European or American policymakers. With its impact on investment and tourism inflows, and on more difficult markets for Indian exports (22 per cent of the country’s GDP), the grim global economic outlook will take its toll on the Indian economy in 2012. And, in such a context, it is of little consolation for Indians to consider that theirs is not the only country in which the objectives of economic growth and prosperity are being subordinated to – and hampered by – narrow political interests and short-term considerations. Does that mean that the only course is to resign oneself to being the hostage of narrow-minded politics and just wait for political leaders – in India and elsewhere – to be struck by some enlightening revelation?

In fact, there is a lot that can be done to mitigate the negative impact of the looming recession, and this means strengthening the economy’s resilience and expanding its potential for growth through a revival of the reform process. This might very much sound like wishful thinking after the retail FDI debacle. However, except for India consigning itself to mediocre prospects, there are not that many alternatives, as the present situation starkly illustrates the fact that “growth on auto-pilot” – the capacity of the economy to grow on sheer momentum, in the absence of any significant additional reform – has reached its limits.

The still untapped potential of its domestic market and the share of domestic consumption in its GDP theoretically give India the capability to reduce significantly the collateral damage it will suffer from the global economic conditions. Provided that somehow, somewhere, the will emerges to stop being hostage of politics in the narrowest sense of the word.

The writer is president of Smadja & Smadja, a strategic advisory firm