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Tough challenges ahead for Europe

European governments face tough challenges over the next three to five years to resolve imbalances in the region, says Iain Begg, a professorial research fellow at the London School of Economics.

Speaking at Fund Strategy’s Investment Summit in Dublin today, Begg said unemployment would be the next key issue that the authorities would have to resolve. “We know about the collapse in growth rates in the last 18 months and the slow growth forecast for the next two years at least. But the focus will shift from the growth rate to unemployment, which takes longer to react,” he says. “It will become the most sensitive element in policy-making.”

At present the pattern of GDP growth in Europe is mixed, with Poland, for example, seemingly relatively unscathed, while some of its neighbours have been badly hit by the recession. “But the unemployment rates tell a different story,” Begg says. “Holland has a very low rate of 3.7%, while Spain’s has rocketed from 10% to 20% over the course of the recession. It faces a big problem.

“The second reaction to the recession is that fiscal debt will rise by tens of percent of GDP over the next few years,” he says. “There has [already] been a huge jump in debt as a percentage of GDP across Europe. Latvia went into the recession with 0% and will be up to 50% in a year’s time. Governments will have to sort out their fiscal deficits, but the timing is crucial,” he adds. Begg warns that if the authorities “take their foot off the gas too soon” in terms of quantitative easing, this could be just as damaging as waiting too long to withdraw their supportive measures.

Begg also points to certain sectors of the market which have contributed to Europe’s imbalances. “The volatile construction sector in Spain is behind several of these trends in European countries,” he says.

“Dealing with imbalances will be a major policy challenge over the next three to five years. There are no easy solutions,” he adds.

Future problems triggered by the recession may include the erosion of human capital and the withdrawal of investment in Europe, leading to a decline in future growth rates. Other pressures such as oil and commodity prices, competition in key markets, and how quickly governments are able to restore public finances may also contribute to slow growth.

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