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A Euro Warning Worth Heeding From Italy

A Euro Warning Worth Heeding From Italy

Sunday, 10 July, 2022 - 04:00

It’s the summer calm before the winter storm in Europe.

Tourists are back in Paris, Madrid and Rome, but they can’t save the Old Continent from the threat of recession. Strikes and staff shortages give a hint of the high inflation eating into people’s pockets -- and darkening their mood. France and Germany, the engines of European policymaking, are showing signs of slowdown.

Worse, the root cause of the pain – high energy prices after Vladimir Putin’s invasion of Ukraine – is showing no sign of being solved. Sanctions have cratered the Russian economy but have not ended the war. Putin is also exploiting Europe's dependency on his gas, with their payments subsidizing his war machine.

The next risk is that internal divisions and conflicts among European Union states worsen with tougher energy and economic conditions this winter. Interest rates are rising, and Germany is drawing up emergency plans to cut demand as gas storage remains below-target. Norway is under pressure to curb electricity exports as prices jump at home.

Enrico Letta, Italy’s former prime minister and head of the center-left coalition in Mario Draghi’s unity government, tells me that the European Union response today risks looking like the financial crisis a decade ago: tardy and inadequate, unlike the timely and bold plans unleashed during the pandemic.

“Europe has done very well in responding to this crisis at the geopolitical level,” says Letta, speaking on the sidelines of an Institut Jacques Delors conference in Paris. “But the social and economic response has been lacking.”

Letta has two main recommendations. The first is to focus specifically on capping or lowering gas prices. The direct and indirect impact of expensive gas is now obvious to factories, small businesses and households, with Germany among those contemplating emergency rationing.

The second is more financial support for households and consumers. The burden of this crisis isn’t being felt equally, with energy inflation having the biggest impact on those least able to afford it. That could eat into popular support for Ukraine, which recently won EU candidate status.

Letta has a point. Barclays Plc economists expect the euro-area economy to grow just 0.5% next year, but that could morph into a recession if Russian gas flows dry up. The recent widening of Italian bond spreads shows the risk of a repeat of the so-called sovereign-debt doom loop that spills over from governments into bank lending.

While European governments have taken some steps, they’ve been hesitant and national in character. Piecemeal measures like household subsidies, windfall taxes and market exemptions haven't given Putin sleepless nights. Attempts to relaunch Covid-era stimulus initiatives involving joint EU borrowing have stumbled as familiar North-South rifts return.

What's missing is the solidarity and leadership that would try to share the cost. “The response has to be common," says Letta. "The risk is that leaders turn a blind eye until it's too late."

Energy markets could be a good starting point for unity. Instead of waiting for more countries to trigger gas emergency plans – a fairly technical process, complete with its own algebraic formula – the EU should declare a regional emergency. Countries should be pressured to share what they have, rather than hoard. This would also mean prodding Germany and the Netherlands to keep open nuclear plants and gas fields that are now earmarked for closure.

Energy solidarity should be accompanied by financial solidarity. Simone Tagliapietra and Guntram Wolff of Bruegel have called for a compensation fund worth 20 billion euros ($21 billion) annually, financed by joint borrowing, to help pay for the costs of the crisis and lessen the chance of fragmentation as sanctions get tougher.

None of this will reduce the long-term pressure to shift away from fossil fuels and to manage debt sustainability in a post-pandemic, post-war world. Italy is itself a good example of what can be done at the national level, with Mario Draghi's government having cut its dependency on Russian gas to 25% from 40% last year.

But the short-term pressure is immense, and Letta’s warning is worth heeding. The last time an energy shock stalked Europe was 40 years ago, before the existence of either the euro or the European Union itself. If the bloc gets this one wrong, it will bode ill for the next 40.


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