Originally Published 2014-01-29 06:26:31 Published on Jan 29, 2014
The euro zone's recovery is obstructed by its own structural weaknesses. And the idea of a crisis relapse cannot be discounted as yet and the consequences of it are hard to fathom. The euro zone may also need to abandon its optimistic view.
EU unemployment is likely to continue
" Unemployment usually moves in a cyclical way depending on the business growth cycle. However, the European Union (EU) has caught a longer lasting and more ominous form of unemployment -- structural unemployment which has been caused and exacerbated by extraneous factors like low growth and austerity measures. Compared with figures from November 2012, unemployment in the EU rose by 452000 in November 2013 in the euro area. Since then, the EU unemployment rate has remained steady at 12.1%, but the euro zone remains a place of economic tension as it continues to face a crisis with states coming to the rescue of banks, competitiveness of economies being threatened by the old age population coupled with strict austerity measures. While there is a strict recovery plan in place, the next few years continue to remain sensitive and the scope of the EU making a full recovery is still a wait and watch situation.

The euro zone was brutally struck with the aftermath of the global crisis of 2008 which originated in the US. Since then, the EU has faced continuous debt pressure and economic instability and has been on the path of a slow recovery. The EU's macroeconomic policy is not entirely conducive to a sustained economic recovery. With a growth rate of 1.3% and persistent austerity measures, credit crunch and a restrictive monetary stance, the EU now struggles with a stubborn rate of unemployment of 12.1%. This continuous rise in unemployment and in particular, youth unemployment, in most of the European countries over the last three years has been a source of continuous worry and is considered to be one of the greatest consequences of the crisis. Currently, the EU unemployment level stands at 12.1% and youth unemployment reaching a record high of 24.4%. The focus in the EU has now shifted to mitigating this pressing issue of unemployment that is stagnating the economy. The spread of unemployment is uneven with 4.8% and 5.2% of the workforce in Austria and Germany respectively; whereas in Spain and Greece the percentages are 26.4 and 27.4, respectively.

The euro area has had a very modest recovery so far of about 0.7% and this trend is expected to continue throughout 2014. Thus, the EU has registered its second recessionary phase in the last four years. Given the lack of growth in the economy, the level of unemployment is expected to remain stagnant if not rising. The European view on these trends remains optimistic as they believe that the combination of fiscal austerity coupled with structural reforms is working well. It is a popular belief in the EU that these policies need more time and flexible application at the country level in order to produce results. While the EU has seen positive results of this approach with countries like France and Spain, the external adjustments of current account deficits are not sustainable and the fiscal deficit is expected to persist. Improving these deficits results in a fall in domestic demand which has happened in all the highly - indebted countries like Greece and Ireland and somewhat in Italy, Spain and Portugal. This fall in demand is also one of the main reasons behind the unemployment faced by the EU and the deflation that has been looming.

Austerity has a self-defeating impact on growth when interest rates are close to zero. Coupled with the fact that an unresolved banking crisis and associated credit crunch is slowing down nominal growth this has had a negative impact on the economy and made deflation a possibility. The ECB has always been a bank with anti-inflation sentiments. Given that, the inflation expectations in the EU continue to be extremely low, hence, paving the way for deflation risk. Inflation expectations continue to remain stubbornly low and may decline even further. Combined with the fragile state of the EU economy with recovery being anaemic, this has aggravated the weakness in the aggregate demand. The ECB's mandate to maintain price inflation just below 2% and the Fed's symmetric 2% over time contributes to a higher deflation risk in the common currency area. Currently, it seems that both short- and long-term factors point towards greater deflation risk in the euro zone. At the moment, inflationary pressure appears reduced to the likelihood of a major global commodity price shock, while the deflationary forces emerge from within.

It can be surmised that the euro zone's recovery is obstructed by its own structural weaknesses. The idea of a crisis relapse cannot be discounted as yet and the consequences of it are hard to fathom. The euro zone may need to abandon its optimistic view and recognise that it still treads in uncertain waters and fix its economic and political dysfunctionalities.

It is believed that no amount of stimulation to the labour market would be beneficial due to the structural nature of unemployment. The unemployment situation in the EU is rooted in the austerity measures that were undertaken by the EU and these measures have only been prolonged recently rather than being abandoned which means the unemployment is here to stay.

The best way for the EU to face this challenge of unemployment would be by taking steps to improve the level of growth in the economy. The EU has been growing at a slow rate of 1.3% and is expected to grow at a rate of 0.7% in 2014. Hence, there is much that needs to be done at this end to improve the overall state of the economy. One of the issues being faced by the EU is the lack of domestic demand. Strategies focusing on recovery need to commit to improving demand in the near - term. The commitment by the ECB to keep the monetary stance accommodative as long as necessary is an effective step to achieve this. Expansionary monetary policy can also go a long way through its conventional and unconventional measures like credit easing, loser collateral requirements for securitized bundles of loans to small and medium-sized enterprises and a negative deposit rate.

New policies and governance is required in the EU and a reorganisation of priorities as well. In order to return to a sustainable path to economic growth and renewal will require innovation in recovery plans and policy as well as bold leadership to the private sector, public-private partnerships and improving competitiveness.

(The writer is a Research Intern at Observer Research Foundation, Delhi)

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