Unlike India, most developed countries prepare de-seasonalised GDP data, where the seasonal effects are netted out, so as to compare any quarter with its previous one. Here’s what the numbers say. In Q2 2008 (April to June) real GDP for the euro zone fell by 0.2 per cent over the previous quarter which is an annualised of 0.8 per cent. France’s GDP shrank by 1.2 per cent (again, annualised); Italy’s by 1.1 per cent; and Germany’s by 2 per cent, though that was due to its relatively robust performance in the previous quarter. Among the big four in the euro area, only Spain managed to squeak a positive GDP growth — 0.1 per cent for the quarter, or 0.4 per cent annualised. That can hardly inspire confidence, what with Spain’s unemployment at 10.7 per cent, consumer price inflation at 5.3 per cent, a shattered real estate sector and a current account deficit that is almost 10 per cent of GDP. The economic slowdown had started some nine months earlier is now in the open, hurting badly and for all to see.

I need to explain a bit about euro zone numbers for the reader to have a better understanding of the extent of the problem. Consumer price inflation above 2 per cent is not normal in the euro zone. Currently, it is running at 4 per cent with every prospect of it rising to 5 per cent. Maintaining a common currency across 12 nations at different stages of the business cycle requires imposing strict discipline on inflation. This is done by the Frankfurt-based European Central Bank (ECB), whose current president is a hard-nosed Frenchman called Jean-Claude Trichet.

A common currency also needs a tight controls on budget deficits and public debt across all euro zone countries — which vary from a parsimonious Holland to extravagantly statist nations like France and Italy. This is allegedly imposed by the so-called ‘Stability and Growth Pact’. Adopted in 1997, it requires the euro nations to maintain their annual consolidated fiscal deficit at under 3 per cent of GDP, and places a ceiling on national public debt at less than 60 per cent of GDP. The public debt ceiling has been breached several times by three of the big four — France, Germany and Italy. But such delinquencies have occurred in better economic times. Today, amidst recession and unemployment, the stage is set for serious breaches in the 3 per cent budget deficit ceiling.

Consider France, and what its president, Nicolas Sarkozy, is facing. An annualised drop in GDP of 1.2 per cent in Q2 2008 with prospects of worse to follow; unemployment at 7.5 per cent; a trade deficit of $ 70 billion; and an angry electorate that is mad at his trying to force even limited reforms, madder still at his playboy image, and which believes in the fundamental right of “Aux Barricades” — the rallying cry of the 1848 revolution when workers and citizens blocked the streets against the government and its troops.

Sarkozy knows that if has to eventually reform France’s dysfunctional labour laws, he has to gain support from the people. That support is waning; and will disappear if the recession sets in good and proper. So, he wants to spend his way out of trouble. Sarko is arguing for even higher fiscal deficits (France’s is already 2.9 per cent of GDP), lower interest rates, a weaker euro, and a much more accommodating, reflationary fiscal and monetary regime. He isn’t alone. Silvio Berlusconi of Italy is a fellow traveller, as is Costas Karamanlis of Greece.

Ranged against Sarko and his pals is ECB’s Trichet. An inflation hawk, he hasn’t let the euro go, despite US interest rate cuts, a progressively weaker dollar and a steadily worsening economic situation. According to Trichet, ECB must ensure that inflationary expectations remain strictly controlled; and that 4 per cent inflation or more is unacceptable for the euro zone. Therefore, Trichet will remain as firm as he can. Even if he weren’t to raise rates, it is unlikely that the Frenchman will lower them to please Sarko and France.

So, we will have a battle royal with high decibel noises from the Élysée Palace matched by Trichet’s Gallic disdain from Kaiserstrasse 29 at Frankfurt. Neither stance will help. In the meanwhile, a euro zone — crippled by Neanderthal labour laws and an exchequer sapping social security system — may sink into a long term recession. The US falls. But being flexible, gets out of the hole quickly. When the Europeans fall, they stay there for a while.

Published: Business Standard, August 2008