Helping Europe at our expense?

The timing of Canada’s free trade deal with Europe—as euro zone economies continue to struggle—couldn’t be worse. Some Canadian companies may benefit, but the deal’s likely winners will be low-priced European competitors expanding here
By Ian McGugan

Europe’s economic crisis is over—isn’t it? The headlines have calmed down, bond markets are tranquil, a Greek default no longer hangs over the global economy. It’s enough to make a casual observer conclude that the worst is past.

Look closer, however, and the euro zone appears more fragile than ever.

The continent has purchased stability at the price of stagnation. Germany, the industrial powerhouse of the region, is barely skirting recession and the Organization for Economic Co-operation and Development predicts the euro economy as a whole will advance a meagre 1.1% in 2015. “The euro zone is grinding to a standstill and poses a major risk to world growth as unemployment remains high and inflation persistently far from target,” according to Catharine Mann, OECD chief economist.

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For Canadian businesses, Europe is doubly important because the Conservative government appears committed to a closer relationship with the ailing region. In theory, a free trade agreement signed in September will spur the sale of Canadian goods. In practice, however, it may signal an onslaught of competition from European manufacturers desperate to find growth opportunities outside their own frozen economy.

Ottawa says the new Comprehensive Economic and Trade Agreement (CETA) is designed to allow Canadian companies to diversify their exports beyond the United States by tapping into the European Union’s vast $18-trillion economy. Maybe so, but Europe’s faltering economy seems unlikely to hoover up huge amounts of Canadian exports.

It certainly has not shown any great appetite for Canadian products to date. As a result, Canada already suffers from a merchandise trade deficit with the European Union that topped $20 billion in 2013. We import sophisticated finished goods from Europe, especially in the form of Audis, BMWs and Mercedes. We export raw materials. While Ottawa insists the deal will be a boon for Canadian producers of beef and pork, it takes a lot of tenderloins to balance the trade impact of a single Beemer.

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There will undoubtedly be some Canadian winners from CETA, but the overall impact is likely to be disappointing. Rather than finding a vast new market for their products, Canadian manufacturers may instead find themselves facing a new wave of low-priced rivals. That is especially the case if the euro zone’s condition worsens and the euro falls even further, boosting their cost advantage.

Despite the current complacency, another European crisis seems just as likely as not. Voters are already exasperated with the euro zone’s never ending austerity. In France, Marine Le Pen, leader of the National Front, is emerging as a popular alternative to President Francois Hollande. In Italy, the Five Star Movement led by Beppe Grillo is mounting a strong challenge to incumbent prime minister Matteo Renzi. Both Le Pen and Grillo want their countries to exit the euro zone.

They, like others, believe that Germany is reaping most of the benefits from the current European arrangement. The passion for austerity, for instance, reflects Germany’s attachment to “ordoliberalism,” an economic philosophy that believes government’s economic role consists purely of ensuring the conditions for vigorous competition. It allows no role for Keynesian-style fiscal stimulus, even in the event of a serious downturn.

Germany’s unswerving belief in ordoliberalism, and its dominant role within Europe, has led to a situation where fiscal stimulus remains missing in action despite a euro zone unemployment rate of 11.5%. Instead of spending to boost the economy, the EU is hectoring its worst performing members to reform their laws and regulations to make it easier to hire and fire people. The idea is that fiscal rectitude combined with more flexible economies will reignite growth.

In the short term, at least, that’s nonsense. Without any true fiscal union among its constituent countries, the euro zone has no effective means to combat the decline of its weakest members. Countries like Greece, Portugal and Spain can’t depreciate their currency to boost exports because they’re locked into the euro. But the euro zone offers them little in the way of transfers to offset the crushing financial burden of their unemployed citizens. Structural reforms aimed at unblocking their sclerotic economies may eventually put them in a better position to compete, but for now they’re fighting for customers with Germany, which is already highly efficient and now has the additional benefit of selling its goods in export markets in a currency that is being held at low levels because of the problems elsewhere on the continent.

For now, the euro zone is hoping that monetary policy can provide the stimulus that fiscal policy won’t. But the European Central Bank’s ingenious and exotic strategies, ranging from purchases of private assets to low-cost loans, can do only so much. Inflation across the continent continues to drop, suggesting that growth expectations are falling, not rising. The potential for trouble is higher than markets think.

The most benign—but highly unlikely—scenario would see the euro zone rethink its collective austerity, open its wallet and move towards a true fiscal union. Far more likely, though, is a prolonged state of near-recession culminating, sooner or later, in the defection of one or more countries from the euro. While no country is yet willing to take such a drastic step, people’s patience with stagnation has limits.

Canadian businesses counting on free trade with Europe to boost demand may want to think again. Rather than opening the door to new opportunities, the deal is likely to spur new competition for Canadian customers. The problem could grow even worse if the euro zone continues to stagnate or—much worse—if it blows apart.

Ian McGugan is an award-winning business journalist in Toronto and the founding editor of MoneySense magazine. E-mail: imcgugan4@gmail.com.

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