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Busy highway in the Netherlands. Economic growth has picked up all around Europe, turning the continent into an engine of global trade (photo: Halfpoint/iStock by Getty Images)

• IMF Country Focus

Europe: Engine for Global Trade, but Should Prepare for Rainy Day

November 13, 2017

All European economies are growing, and the continent has become an engine of global trade, reveals the IMF’s latest Regional Economic Outlook released November 13. But countries should make some room in their budgets for maneuver so they can keep their economies afloat in worse times.

Recovery in Europe has gained speed: overall real GDP growth is projected at 2.4 percent in 2017, faster than was expected in April 2017, and up from 1.7 percent in 2016.

In the euro area, growth has not been this even across the member countries for nearly two decades. In member countries that receive EU funds to help them bring their economies up to the level of their richer peers, an uptick in the flow of funds added to faster growth. In the United Kingdom, in turn, growth slowed when households felt the squeeze of a weaker pound.

In Russia, in addition to improved consumer confidence, higher oil prices and cheaper financing will continue to support growth, while Turkey’s economy gained momentum from budget support in 2017.

European growth has been driven primarily by domestic demand, including a pickup in investment. It is now spilling over to the rest of the world through trade: Europe’s contribution to the growth of global merchandise imports in 2016–17 is similar to that of China and the United States combined.

Thanks to the broad-based growth, unemployment has decreased throughout the continent. Wages have grown slowly in many richer countries, but strongly in central and southeastern Europe in the past several years, especially in the services sector. Yet, in these countries, productivity growth has not kept up with the speed of wage growth over the last two years, a trend that could eventually chip away at emerging Europe’s competitive edge.

Mend the roof 

Imminent growth prospects for Europe are positive, but challenges remain over the longer term. Many European countries still have only a thin cushion accumulated for a rainy day, weak productivity growth, and bad loans inherited from the financial crisis of 2008. Aging population, spreading protectionism, geopolitical tensions and export loss because of a downturn in China all add to the risks threatening long-term growth. 

This is why all European governments should take advantage of the current economic upswing to help their economies adjust. 

• Advanced European economies with high public debt, such as Belgium, France, Italy, Portugal, Spain, and the United Kingdom should lower their debt, but without jeopardizing the economic uptick.
• Germany, the Netherlands and Sweden—countries with enough wiggle room in their budgets—should lift their potential growth through greater public investment in infrastructure, the integration of immigrants, and housing.
• In many emerging market economies, including Hungary, Poland, and Romania, and several countries in the western Balkans and in the Commonwealth of Independent States, budget deficits are still relatively large. They should improve the quality of their public expenditure, and modify the composition of their revenue in a way that keeps the regions’ competitiveness intact.

The currency union of the European Union, the 19-member euro area, must be more solid to avoid a domino effect in case of difficulties in one of its members. For that, the European Union needs to complete its banking union and capital markets union, including by establishing a deposit insurance system to safeguard savings in case of a banking crisis, and building a set of common budgetary tools that could increase the resilience of the euro area. In parallel, the block needs to resolve banking sector problems remaining from the financial crisis, and to adhere strictly to the common fiscal rules defining the maximum budget deficit. (On ways the legacy of the financial crisis still plagues the banking sector in the Western Balkans, see Chapter 3 of the Regional Economic Outlook.) 

Institutional reforms for better business 

In emerging Europe, convergence with the richer nations of Europe has slowed since the crisis. The way to reignite the process is through a new generation of reforms aimed at strengthening institutions, and the legal framework is a critical institution and a vital element of the business environment. (On ways countries could improve the quality of their judiciary, see Chapter 2 of the Regional Economic Outlook.)