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2017 fourth-quarter forecast

Sep 28, 2017 | 13:56 GMT

12 mins read

Europe

To the west of Eurasia lays Europe, a region predisposed to division. It is surrounded on nearly all sides by islands and peninsulas that make it difficult for Europe to cohere. The northern half of the continent, moreover, sits on a plain whose short, meandering rivers tend to empower countries without forcing them to work with others. The southern half is situated on more mountainous terrain that has historically impeded the creation of strong, unified economies. As a result, Europe is a continent riven by pockets of distinct cultures whose differences are all too often irreconcilable.
Europe is a continent riven by pockets of distinct cultures whose differences are all too often irreconcilable.
(canadastock/Shutterstock.com)
section Highlights
  • As EU members discuss institutional reforms, they will expose the strategic differences between the bloc's southern, northern and eastern members and offer a preview of disagreements to come next year.
  • Germany and France will try to preserve their strategic alliance throughout the discussions, which will cover issues such as reforming the eurozone and increasing spending across the bloc, but compromise will be difficult.
  • Central and Eastern European countries will face strategic decisions about their futures, while elections in Austria and the Czech Republic will test the strength of nationalist sentiments.
  • France's efforts to protect national economies from competition within the bloc and to prevent outside investors from acquiring companies in strategic sectors will meet with only limited success.
  • Differences will continue to arise between the United Kingdom and the European Union as the two negotiate the Brexit, but both parties will work to reach an agreement, even if it takes longer than expected.
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The EU Discusses Its Future

During the first three quarters of the year, elections in key EU countries such as Germany, France and the Netherlands brought the bloc's political processes practically to a standstill. Now that the electoral season is over, the European Union will hold serious discussions about its future. The issues on the table will include introducing investment programs across the bloc, completing the banking union, creating a European Monetary Fund, deepening military cooperation among EU members and retooling the eurozone. Though the negotiations won't be in full swing until next year, the fourth quarter of 2017 will offer a preview of the debates that will take place in 2018 as EU member states and institutions position themselves and present proposals to defend their interests.

Three main groups will emerge over the course of the debates. Countries in Southern Europe will push for increased spending across the bloc and the introduction of risk-sharing measures in the eurozone, such as a common deposit insurance scheme for banks in the currency area or a common unemployment insurance program. In exchange for considering the proposals, Northern European member states will request greater control over their southern counterparts' fiscal policies. Central and Eastern European countries, meanwhile, will have to decide whether to deepen their ties with Western Europe, and perhaps give up more national sovereignty in the process, or to defy the EU institutions in Brussels and risk isolation in the bloc.

The European Union and the Eurozone

Beyond intense debate among its members, the European Union will get little done this quarter. Germany and France, the countries at the European Union's political and economic core, will struggle to strike a balance among the conflicting interests in the Continental bloc. France is willing to compromise to get Germany on board with its reforms, though it is also worried that Berlin will try to water down the measures. And Germany's leaders will be too preoccupied with domestic politics in the wake of the Sept. 25 general elections to make strategic decisions in the bloc. Since the election produced a fragmented Bundestag, German politicians may spend much of the quarter trying to work out an agreement to form a government. That doesn't mean Berlin will refrain from expressing its opinion; still, it will take a while for EU politics to get back up to speed as the dust settles from the last of this year's major electoral contests.

Pushing for Protectionism

Along with institutional reforms, the European Union will discuss changes in the single market to enhance protection for national economies. The issues up for debate will include mechanisms to guard companies in strategic sectors from investors outside the bloc and ways to close tax loopholes that benefit internet-based companies in some member states. Leaders also will propose revisions to regulations that enable workers from Eastern Europe to undercut local workers in Western European countries.

France will be the most vocal advocate for the reforms, but because the measures are controversial, it probably will have to settle for toned-down versions of its proposals. The European Union, for example, likely will agree to redesign the posted workers system under which companies can temporarily hire Eastern European workers for jobs in Western Europe at lower wages than local workers would earn. But to avoid deepening the divide between Eastern and Western European countries, the bloc probably will stop short of abolishing the system, opting instead to restrict its use. Similarly, the European Union may well agree to increase vetting procedures for foreign investment in strategic sectors, but Brussels probably will leave the bulk of the scrutiny to national governments, giving the European Commission a more advisory role. The matter of closing tax loopholes for digital companies will be more complicated, because the European Union requires a unanimous agreement among its members to change tax policy. Countries such as Ireland and Luxembourg will resist the proposed reforms, which would challenge their economic models, thereby delaying a decision on the matter.

Key Dates in Europe: 2017-2024

Central and Eastern Europe at a Crossroads

During the next stage of reforms, the European Union may officially accept the "multispeed" model to enable further integration among core member states without the participation of every EU country. The system would present the nations of Central and Eastern Europe with a strategic dilemma. On the one hand, they depend on the European Union for investment, subsidies and protection, and they are interested in working with the bloc on issues such as energy diversification. On the other hand, most of the states are outside the eurozone and are skeptical of reforms that would give Brussels greater authority over their domestic affairs. EU members in Eastern and Central Europe will keep grappling with this predicament well into next year as they begin hashing out how they want to proceed.

Hungary and Poland likely will remain critical of Brussels, since neither faces an immediate decision over its future in the bloc. Even so, European integration caused strife in the Polish government recently after Poland's president vetoed portions of a controversial judicial reform package that the bloc criticized. The discord in Warsaw could intensify during the final months of the year. Other countries in the region such as Slovakia and the Czech Republic, by contrast, probably will make overtures toward deeper integration with the European Union.

The Czech Republic is preparing to hold general elections to name its next government Oct. 20-21. Because most voters and political parties in the country back its membership in the European Union and NATO, the Czech Republic's foreign policy will probably continue largely unchanged after the election. But eurozone membership is still a controversial subject among the Czech electorate. Consequently, the next government in Prague probably won't make any weighty decisions on the issue during the fourth quarter. It will, however, work to make its voice heard in the European Union's reform discussions and to strike a balance between its ties to the Visegrad Group — which also includes Poland, Hungary and Slovakia — and its connections with Western Europe.

Just a few days before Czech voters cast their ballots, Austria will hold its own general elections. The Oct. 15 vote will reveal the popularity of nationalist parties in the country. Immigration will be one of the most prominent issues during the campaign. Austrian voters are worried not only about the flood of asylum seekers who have arrived in their country over the past two years, but also about unfair competition from cheaper Eastern European labor. Apart from immigration, Brussels' authority over Austria's domestic affairs will be another focus in the election; some parties will promise to limit EU institutions' influence in the country and to protect strategic Austrian companies from foreign takeover.

Should the far-right Freedom Party enter Austria's next government, Vienna will be more willing to confront the European Union on issues such as migration, the future of the Schengen Agreement and efforts to revamp the bloc to address southern members' concerns. Austria would be careful not to jeopardize its membership in the eurozone, but at the same time, it would be warier of Continental integration. And regardless of whether the Freedom Party makes it into the government, the next administration in Vienna will try to protect Austria's borders, as well as its workers and companies. From a foreign policy perspective, the country's next government will be interested in preserving a degree of political and economic influence over the former Habsburg territories in Central Europe and the Balkans. Vienna also will remain skeptical of cooperating with Turkey and will push to enhance security collaboration among EU members.

Brexit Negotiations Continue

During the fourth quarter, the United Kingdom and European Union will continue their negotiations over the Brexit. EU leaders will discuss the status of the first phase of negotiations, covering the terms of the United Kingdom's departure, at a summit on Oct. 19. London hopes the bloc will use the opportunity to authorize the second stage of Brexit talks — discussions over their future trade agreement — though based on the lack of progress in recent rounds of negotiations, Brussels may delay the next phase. The October summit is more a symbolic date than a concrete deadline, however. Even if the European Council doesn't give the go-ahead by that time, the United Kingdom and the European Union will be keen to move on to the next phase of talks later this year or early next.

In the meantime, London and Brussels will carry on with the difficult task of sorting out what will become of the EU budget after the Brexit. The European Union needs the United Kingdom to keep paying into the budget. Otherwise, the remaining 27 member states would have to increase their contributions, something Northern Europe opposes, or agree to cut spending on items such as agricultural subsidies or development funds — an unacceptable option for Southern and Eastern Europe. London has its own economy to think about and is hoping for an implementation period before eventually reaching a permanent settlement to soften the Brexit's economic effects. Making contributions to the EU budget, however controversial among the British public, will help the United Kingdom realize that arrangement.

While the British government negotiates with its peers in the European Union, it will continue pursuing trade deals with as many countries outside the bloc as possible. London cannot legally sign any of its own free trade agreements until after it leaves the European Union, but it is working to set the stage for future deals. The United Kingdom may not get very far in this endeavor, however, since most of its potential trade partners would rather wait and see how its relations with the bloc shake out before making any decisions.

Although each side of the negotiation has its own priorities for the Brexit, both want to preserve the peace process in Ireland during and after the separation. For much the same reason, Ireland will be watching the discussions closely. The Irish government in Dublin is interested in the softest possible Brexit to safeguard its trade ties with the United Kingdom as well as its open border with Northern Ireland. Dublin will lobby in favor of an agreement on the exit negotiations and push to keep them moving apace, but its power over the talks will extend only so far.

An Intense Quarter in France, Italy and Spain

France will be focused on fiscal issues this quarter, having approved a raft of labor reforms during the last one. The French government will include tax cuts for companies and households in its budget for 2018 in an effort to boost economic growth. But it must also keep its deficit under control. To that end, Paris may introduce tax hikes and spending cuts in other areas. Whatever fiscal plans it comes up with, France's government will have little trouble passing them through the legislature, where its solid majority gives it a strong advantage over the weak and fragmented opposition. Because unemployment is still high, though, and economic growth still modest, Paris could find itself dealing with a dissatisfied public next year.

Europe's "Big Four"

In Spain, meanwhile, the political and institutional crisis generated by the independence process in Catalonia will continue. After the police crackdown on voters during the Oct. 1 independence referendum, the Spanish government will probably take additional actions to suppress the independence movement. Madrid's options include suspending Catalonia's autonomy or dissolving the Catalan government and calling for new regional elections. Either option would lead to further social unrest and renewed clashes between security forces and protesters. Prime Minister Mariano Rajoy will be playing a delicate game, because calls for his resignation will grow louder if opposition parties become increasingly critical of Madrid's handling of the Catalan crisis. The European Union could also play a significant role, as the bloc may respond to the renewed unrest in Catalonia by pressuring Madrid to open a dialogue with the rebel regional government.

Elections will loom large over Italy this quarter, too. The country has until May 2018 at the latest to hold its next election. Having failed to agree on a new electoral law before their summer recess, Italian lawmakers will spend the next few months trying to hammer out the legislation, which will influence the outcome of the next vote. Center-right and the center-left parties will push for a law that would make it harder for the anti-establishment Five Star Movement to form a government, but at the same time, most of the country's parties will criticize the European Union to appeal to voters. While some politicians will attack the euro, most will aim their attacks at the bloc's fiscal rules, arguing that they should be modified to give Italy more leeway to spend. The country's discontent with the European Union will play an important role in determining the bloc's future. An uncooperative government in Rome, after all, would make compromise even more difficult to reach in the negotiations over EU reforms and raise questions about Italy's continued membership in the eurozone.

Talking Migration and Russia

Migration will be a hot topic in the European Union during the quarter. But the bloc is more likely to come up with a compromise to manage the problem in the short term than it is to address the issue with profound reforms. To alleviate the pressure on destination countries, for example, the European Union probably will offer them more money and resources. It will also offer increased funding and logistical support to origin and transit countries in Africa, and to EU patrolling missions in the Mediterranean, to try to slow the flow of migrants onto the Continent. Substantial changes to the Dublin system, under which migrants must apply for asylum in the country where they first entered the European Union, are unlikely, however. And though nations along the main migration routes in Central and Northern Europe may agree to lift their current border controls, they won't hesitate to reinstate them in case migration picks up again.

Similarly, the bloc is unlikely to change its position on Russia. EU members will discuss their policy on Moscow as the expiration date for their sanctions against it approaches in January. But member states probably will opt to extend the sanctions until Russia has fully implemented the Minsk peace agreement, as they have in each previous vote on the matter.

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