2018 second-quarter forecast

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.

9 MINS READMar 9, 2018 | 15:58 GMT
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
  • The European Union will negotiate ways to boost spending, share financial risk, tax technology giants, and overhaul the bloc's agricultural and cohesion funds in the coming quarter.
  • However, the divided bloc will water down, postpone or only gradually implement the proposed measures.
  • Italy, saddled with a hung Parliament, probably won't make disruptive moves that would precipitate a eurozone crisis. By the same token, it will have a tough time enacting reforms meant to stave off trouble for the currency area down the line.
  • Though the United Kingdom and the European Union will negotiate the terms of their trade relationship once the Brexit is complete, they won't reach a firm deal in the next three months.
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Debating the Future of Europe

The European Union has long suffered an identity crisis, but this quarter the evergreen debate about where the bounds of national sovereignty end and supranational authority begin will consume most of the Continent's attention. The bloc's members and institutions will present their grand designs for reform, offering plans to increase spending, share risk, overhaul governance structures and fill in budgetary gaps left by the United Kingdom's eventual departure. All of these ideas aim to deepen European integration, but thanks to the enduring divisions within the bloc and an abiding resistance to transferring more power to Brussels, members will struggle to move any closer together on the issues creating such controversy among them. So although plenty of proposals for change will be made, most won't be implemented within the next three months.

Many of the suggestions will come from France and Germany, the European Union's leading political and economic powers. Driven by a growing economy and its own plans for reform back home, France will push for an ambitious road map to greater cohesion. But Germany, whose government is split between a center left that supports many of Paris' views and conservatives who are skeptical of its intentions, will do what it can to moderate French proposals.

In addition to their own differences of opinion, the two powers will have to wrestle with wider rifts among European Union members. Like France, Southern European states want to increase EU spending, protect their economies from foreign competition and more evenly distribute financial risk within the eurozone. Their neighbors in Northern Europe, however, are eager to make the bloc smaller and less bureaucratic, lift barriers to trade and investment, and reduce financial risk in the currency area. Concerned about the compromises Germany might make with France, some hard-liners, such as the Netherlands and Austria, will pressure Berlin not to give too much ground to Paris. (Anxiety stemming from political instability in Italy will only reinforce these members' desire to effect change with care.) As a result, Southern Europe appears to be headed for disappointment as the European Union will likely focus on measures that will take years to introduce, require reducing financial risk before sharing it, and settle on a lower spending cap than France and its allies hope for.

Money will be on many members' minds as the European Commission presents its proposal for the bloc's next multiyear budget. The plan will probably ask members to contribute more funds, suggest new sources of revenue for the commission and offer ways to adjust how money is spent in the bloc. Unsurprisingly, the European Union's net contributors (most of which are in Northern Europe) will push back against calls for higher payments, while net receivers (most of which are in Eastern Europe) will throw their weight behind the motion. Meanwhile, countries across the Continent will resist the idea of strengthening the bloc's institutions, fearing that their sovereignty would weaken in the process.

The EU Budget

Budget talks will naturally lead to discussions about agricultural subsidies, which account for the biggest portion of the bloc's spending and can be a hot-button issue, given the industry's propensity for actively defending its interests. The European Union will probably alter how it uses agricultural funds, but states in Southern and Eastern Europe will staunchly oppose any deep spending cuts in the sector. Countries in Eastern Europe will also be reluctant to link the disbursement of cohesion funds to recipients' respect for the rule of law. Because the next multiannual budget won't enter into force until 2021, both debates will extend well beyond the quarter.

Corporate taxation will be high on Europe's agenda as well, especially with regard to the digital realm. The European Commission and countries with large economies, such as Germany and France, will try to make sure that internet companies pay higher taxes to the states in which they operate. But countries with smaller economies, such as Ireland and Luxembourg, believe such taxes run counter to their economic models, which rely on special tax deals with multinational firms. This issue, too, will likely go unresolved in the months ahead. Should the European Union fail to reach a unanimous decision on the matter, a smaller group of members could choose to closely coordinate their tax policies — an approach that will not be as effective, particularly if many countries with low taxes opt out.

The Fate of the Eurozone

Tricky negotiations will also take place in Italy this quarter. After general elections on March 4 produced a divided Parliament, the country's mainstream parties will have to come to terms with the strong performance of their anti-establishment opponents — and their subsequent demands for a say in the next Italian government. Until a government emerges (coalition talks will take months to complete), a caretaker administration will run the country. The interim body will be limited in its ability to introduce economic and political change, and the delay in much-needed reforms could create problems for Italy down the line. However, the country's parliamentary fragmentation will also reduce its chances of severely disrupting the eurozone in the coming months — and temporarily drive down the financial risk that the elections posed to the bloc. Once Italy has cobbled together a ruling coalition, however, Rome will test Berlin's resolve by advocating the revision of EU fiscal rules.

Greece, too, will try to figure out what its future looks like this quarter. The country's lenders will insist on maintaining some degree of oversight over the Greek economy once Athens' bailout program expires in August. Greece will try to minimize that supervision as much as possible, and it will likely reach a compromise with its creditors toward that end, accepting light oversight that lacks the stringency of a bailout program. In addition, the parties will talk about the future of Greece's debt. Though lenders won't agree to write down a portion of it, they will be open to the idea of extending repayment periods or linking payments with Greece's economic growth. Considering the complexity of these issues, negotiations will probably stretch past the first half of the year.

Brexit

As the European Union tries to knit itself closer together, the United Kingdom will work to cut itself free from the bloc. Over the next few months, the two parties will negotiate the future of their trade relationship after the Brexit is complete. London will angle for a comprehensive free trade agreement and a special customs deal that would protect the United Kingdom's access to EU markets while preserving its independence in trade and immigration policy. But Brussels, determined to safeguard the integrity of the single market, will argue that the United Kingdom cannot participate in some parts of the bloc and not others. Coupled with the European Union's reluctance to include the financial services sector in any trade deal, the dispute will probably prevent London and Brussels from reaching an agreement this quarter.

British Trade

Meanwhile, questions about the future status of the Irish border are getting harder to ignore. The United Kingdom and European Union still have time to hash out a settlement that keeps the border open in the wake of the Brexit, but it will be tough to do in the face of London's contradictory desire to leave the EU customs union. Though calls from within the United Kingdom to remain in the customs union will spread, the British government won't heed them. All the while, the Republic of Ireland will threaten to veto the Brexit process unless a satisfactory solution is found.

One thing could stall the talks between London and Brussels: the replacement of the British prime minister. Disputes within the governing Conservative Party about how to handle the Brexit as well as displeasure with Theresa May's performance could prompt the change in leadership. Though May seems unlikely to resign within the quarter, the possibility can't be ruled out.

EU: Regional Blocs

To the east, Central and Eastern Europe will face their own dilemmas. If left unchecked, the European Union's ongoing friction with such countries as Hungary, Poland and Romania could someday reduce their influence in EU decision-making and threaten their access to bloc funds. But because these dangers aren't imminent, the countries won't feel pressured to change their ways.

Hungary's policies, for instance, probably won't change much after the country holds general elections on April 6. The polls will certainly test the popularity of the ruling center-right Fidesz party and the right-wing opposition Jobbik — both of which hold nationalist and Euroskeptic views. But in the likely event that voters re-elect the Fidesz party, Hungary's strategy at home and abroad won't significantly shift. To maintain the support of its constituents, Poland's government will stick to its guns as well. Though Warsaw will try to balance the defense of its domestic policies, such as a controversial judicial reform, with the easing of tension with the European Union, its overtures to Brussels and Berlin will likely be cosmetic. Finally, in Romania, the government's biggest challenge will come not from the European Union but from the streets, as its people stand ready to demand a stronger effort to combat corruption.

Divided EU Foreign Policies

The European Union's lasting divides will be clear in how it handles the ever-pressing issue of immigration. The Continent will work with countries of origin in Africa and the Middle East to try to prevent migrants from reaching its borders. EU members will also mull plans to modify the Dublin system, which stipulates that the country of a migrant's first entry is responsible for processing his or her application for asylum, and to more proportionally distribute asylum seekers throughout the bloc. Southern Europe will lobby for greater solidarity, while Eastern Europe will reject proposals for migrant relocation. Though a compromise is possible, Central and Eastern Europe won't be able to stomach the introduction of a system that automatically spreads asylum seekers across Europe.

So, the Continent will keep relying on Turkey as a means of stemming the tide of migrants reaching its shores. To ensure Ankara's continued cooperation, the European Union will balance its criticism of Turkey's domestic policies with talks aimed at deepening bilateral trade. But tension may flare amid Turkey's brewing territorial dispute with Cyprus over the energy resources of the eastern Mediterranean Sea. Should a Turkish drill ship enter Cyprus' exclusive economic zone, Europe would have no choice but to react. However, because the Continental bloc lacks the appetite for a showdown with Ankara, it would limit its reaction to symbolic moves, such as the suspension of bilateral summits or temporary cuts in financial aid to Turkey. 

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