Running On Empty

You would think Luc Williame would be beaming. After all, the chief executive of Belgian glassmaker Glaverbel saw profits jump 60% as his sales to the construction and auto industries increased 8% in the first half of the year. But that was then. Since August, sales and orders have been declining. Says Williame: "We've lost the momentum from recovery that began at the end of last year. We feel a general pessimism from all our customers."

That pessimism is spreading across Europe, and it will hurt not only European corporations looking for higher profit but also politicians desperate for more tax revenue and unemployed workers longing for jobs. Unless governments can find a way to lift the mood of consumers and investors, Europe's joyless recovery could begin to slide toward a dangerous recession.

There are plenty of factors behind Europe's growing malaise. Most important is the currency turmoil. Once just a symptom of Europe's structural problems, it is now a cause of them. Soft-currency countries such as Sweden face weakening demand, while hard-currency countries such as Germany are suffering sharp declines in export competitiveness.

Meanwhile, investors dubious that countries with weaker currencies can keep up with German-style monetary discipline have pushed real interest rates up as much as two percentage points higher than in the U.S. Those rates are stifling domestic consumption and business activity. But they've yet to reassure investors, who on Oct. 23 again piled into German marks and Swiss francs in another effort to escape from the high deficits and high debt jeopardizing other European currencies.

It's a vicious cycle that's killing growth, shrinking revenues, and stalling job creation and consumer spending throughout Europe. A weak auto market resulted in a $320 million third-quarter loss for Ford Motor Co.--far worse than expected--in its European operations. Lower-than-expected earnings sparked sharp sell-offs in market highfliers such as Finnish mobile-phone maker Nokia and German software star SAP. On Oct. 24, Daimler Benz Aerospace, which has cut 13,500 jobs since 1993, announced plans to cut 5,000 more.

The spate of gloomy corporate announcements is leading economists to lower their estimates for growth. The revisions are most brutal in Europe's biggest economies. German growth could sink to 2% next year, France to almost that level, Sweden to just 1.1%. Such anemic rates will not do much to reduce unemployment, now at 11% in the EU.

YAWNING GAPS. The economic squeeze is a disaster for Europe's politicians. Lower profits and falling employment are producing yawning gaps between the taxes governments are taking in and heavy state spending. In late October, Bonn boosted its estimates of revenue shortfalls for this year and the next by 40%, to $39 billion. France's $8 billion revenue shortfall this year will only widen next year as growth slows.

Such shortfalls will increase the pressure to cut state budgets further--which puts governments in an even tighter bind. If they cannot cut deficits, their failure will further depress consumer and investor confidence. Yet pushing through budget cuts is often an unpalatable choice. Recently announced austerity programs are prompting new calls for public-sector strikes in Italy and France in coming weeks. A nationwide strike already hit France on Oct. 10.

Slumping revenues in Germany, France, and Britain also will likely force leaders to break promises of tax cuts, leading to a further erosion in consumer confidence. Instead, the British, Belgians, Germans, and French are all being forced to accept further hikes in already high tax rates. Voters from Spain to Scandinavia are losing hope that their governments can generate needed reforms or breathe new life into their economies. "Basically, consumers and investors have given up trusting their leaders," says Peter Praet, chief economist at Belgium's Generale de Banque.

Nowhere is the collision between politics and economics graver than in France. The government of President Jacques Chirac has stronger parliamentary and regional political backing than that of any predecessor in more than a century. Yet after just six months, the new government's indecision and backsliding over budget management have left French consumers and investors paralyzed with uncertainty. Business confidence has plunged in the past year, to pre-recovery levels. Just 30% of voters now say they approve of Chirac and his Prime Minister, Alain Juppe.

European bankers are nervously eyeing the unraveling French political and economic scene. Says Hans J. Baer, chairman of Bank Julius Baer Co.: "Europe has one big problem: France." If France cannot cut its deficit enough to join a European monetary union planned for 1999, this cherished policy goal will collapse, with incalculable effects on Europe's economy and the Franco-German alliance.

Italy's political problems could eventually overshadow France's. Tax revenue isn't the issue. Receipts have soared this year by 10%, thanks to continuing strong export performance due to the weak lira. But Italy's constitutional crisis and the uncertain fate of central banker turned Prime Minister, Lamberto Dini, have held budget policy hostage. The gridlock and the 15% drop in the Milan Bourse since September could threaten the November privatization of state-owned energy giant ENI.

If this year's economic harvest in Europe looks to be a bitter one, political leaders have only themselves to blame. After the Continent's worst recession in decades, EU leaders gambled that this economic cycle would be as robust as many past ones and solve their economic woes. So even though many governments recently came to power with mandates to cut deficits, no one made a determined drive to cut spending.

Yet the current cycle hasn't bailed out any regime. The tax hikes most governments chose in place of spending cuts have kept Europeans out of shops and showrooms. And the Maastricht Treaty, which policy makers hoped would vault Europe into the monetary big leagues, has turned the tables on them, pressuring them into deflationary fiscal policies just when economies need more breathing room. Says Felix W. Zulauf, head of Switzerland's Zulauf Asset Management: "Across Europe, authorities are imprisoned by the idea of getting united." The way Europe's recovery is going now signals that the pursuit of union may lead instead to a bruising recession.


Governments that hoped economic growth would solve their budget problems now face a perilous pinch.

BRITAIN Slowing growth should expand the budget deficit by a third. Yet if the Tories forgo promised tax cuts, they could alienate voters in the national elections.

FRANCE Approval ratings for the Chirac government are below 30%, as high interest rates support the franc but smother consumer spending. A fierce budget battle is driving investors away.

GERMANY Faltering recovery has boosted the shortfall in tax revenues by $11 billion. The soaring mark is battering exports. Tax cuts look unlikely.

ITALY Exports are still strong, but the budget is unlikely to cut a national debt that now exceeds 100% of GDP.


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