Europe: High Water, and Hell to Pay

An expensive cleanup could put a damper on growth

When a big natural disaster strikes, the economic impact is rarely surprising: Manufacturers are forced to close, tourists stay away, farm production suffers. All of this is happening in Europe as Germany, Austria, the Czech Republic, and other countries mop up from the worst floods there in more than a century. But now that the European Union has adopted strict budget ceilings for countries in the euro zone, paying for this disaster will be especially painful--both financially and politically. Facing an election on Sept. 22, German Chancellor Gerhard Schröder "has to find enough money for reconstruction without big increases in borrowing, which would give the opposition a weapon to attack him with," says Everhard Holtmann, a politics professor at Halle's Martin Luther University.

The bill for the German government could top $10 billion--and Schröder's budgeteers were already bumping up against EU rules that limit deficits to 3%. To avoid exceeding that limit and unsettling financial markets, Schröder has postponed for a year a $7 billion package of income-tax cuts that were scheduled to take effect on Jan. 1, 2003. Putting off the tax cuts could sap consumer demand and slow growth next year just as Europe's slowest-growing economy struggles to recover from recession. "Even a one-year delay will have a major impact on growth and household consumption," says Adolf Rosenstock, an economist at Nomura International in Frankfurt.

Some countries are financing the recovery by cutting military spending--bad news for EADS, BAE Systems PLC, and other defense contractors, and for suppliers such as Saab Avionics and Ericsson. Austrian Chancellor Wolfgang Schussel says he will scale back plans to buy 24 Eurofighter aircraft. The Czech Republic, which hopes to join the EU as soon as 2004, will scrap a $2 billion plan to buy 24 Anglo-Swedish Gripen fighter planes.

All told, the floods could cost up to $25 billion, making them one of the costliest natural disasters ever to strike Europe. Allianz, the Munich-based insurance giant, estimates that Germany alone will lose up to $15 billion--almost 1% of its gross domestic product--the sum of both the physical damage and lost output. Losses in the Czech Republic and Austria will each be as high as $3 billion, say their finance ministries. Slovakia, Hungary, parts of Italy and Britain, Ukraine, and southern Russia have also been badly hurt. "It's exceptional that such a vast area of Europe, from Great Britain to the coastal areas of the Black Sea, is affected at the same time," says Ivo Menzinger, head of the flood group at Swiss Reinsurance Co.

Oddly enough, insurance firms don't expect to be hit that hard. Insurers and reinsurers across the Continent may face claims as high as $3 billion, and that could mean higher premiums for both corporate and personal policyholders next year. But the companies say they can easily handle the claims. "It's too early to say what the final claims will be," says a spokesman for Munich Reinsurance Co. "But they will definitely be manageable."

Meanwhile, critics charge that the real causes of the floods are government efforts to funnel rivers through narrow channels and overbuilding on flood plains. "During the last 150 years, flood plains have been drained on a massive scale to make way for agriculture and development across Europe," says Lisa Hadeed of the WWF Living Waters Program in Geneva. "New housing, roads, and infrastructure are constructed on the very areas that would store floodwaters."

Crises often bring countries together, and at a time when the EU is close to deciding on new members, the floods are fostering solidarity between EU members and candidates such as the Czech Republic. If the floods focus attention on their causes, smooth the way for EU expansion, and let governments demonstrate their budgetary prudence, then maybe the deluge will have produced some benefit along with the destruction.

By David Fairlamb in Frankfurt

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