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Stratfor.com: Europe, Unemployment and Instability
By: George Friedman, Stratfor.comMarch 5, 2013

The global financial crisis of 2008 has slowly yielded to a global unemployment crisis. This unemployment crisis will, fairly quickly, give way to a political crisis. The crisis involves all three of the major pillars of the global system -- Europe, China and the United States. The level of intensity differs, the political response differs and the relationship to the financial crisis differs. But there is a common element, which is that unemployment is increasingly replacing finance as the central problem of the financial system. 

Europe is the focal point of this crisis. Last week Italy held elections, and the party that won the most votes -- with about a quarter of the total -- was a brand-new group called the Five Star Movement that is led by a professional comedian. Two things are of interest about this movement. First, one of its central pillars is the call for defaulting on a part of Italy's debt as the lesser of evils. The second is that Italy, with 11.2 percent unemployment, is far from the worst case of unemployment in the European Union. Nevertheless, Italy is breeding radical parties deeply opposed to the austerity policies currently in place.

The core debate in Europe has been how to solve the sovereign debt crisis and the resulting threat to Europe's banks. The issue was who would bear the burden of stabilizing the system. The argument that won the day, particularly among Europe's elites, was that what Europe needed was austerity, that government spending had to be dramatically restrained so that sovereign debt -- however restructured it might be -- would not default. 

One of the consequences of austerity is recession. The economies of many European countries, especially those in the eurozone, are now contracting, since austerity obviously means that less money will be available to purchase goods and services. If the primary goal is to stabilize the financial system, it makes sense. But whether financial stability can remain the primary goal depends on a consensus involving broad sectors of society. When unemployment emerges, that consensus shifts and the focus shifts with it. When unemployment becomes intense, then the entire political system can shift. From my point of view, the Italian election was the first, but expected, tremor.

A Pattern Emerges in Europe

 

Consider the geography of unemployment. Only four countries in Europe are at or below 6 percent unemployment: the geographically contiguous countries of Germany, Austria, the Netherlands and Luxembourg. The immediate periphery has much higher unemployment; Denmark at 7.4 percent, the United Kingdom at 7.7 percent, France at 10.6 percent and Poland at 10.6 percent. In the far periphery, Italy is at 11.7 percent, Lithuania is at 13.3 percent, Ireland is at 14.7 percent, Portugal is at 17.6 percent, Spain is at 26.2 percent and Greece is at 27 percent.

Germany, the world's fourth-largest economy, is at the center of gravity of Europe. Exports of goods and services are the equivalent of 51 percent of Germany's gross domestic product, and more than half of Germany's exports go to other European countries. Germany sees the European Union's free trade zone as essential for its survival. Without free access to these markets, its exports would contract dramatically and unemployment would soar. The euro is a tool that Germany, with its outsized influence, uses to manage its trade relations -- and this management puts other members of the eurozone at a disadvantage. Countries with relatively low wages ought to have a competitive advantage over German exports. However, many have negative balances of trade. Thus, when the financial crisis hit, their ability to manage was insufficient and led to sovereign debt crises, which in turn further undermined their position via austerity, especially as their membership in the eurozone doesn't allow them to apply their own monetary policies. 

This doesn't mean that they were not profligate in their social spending, but the underlying cause of their failure was much more complex. Ultimately it was rooted in the rare case of a free trade zone being built around a massive economy that depended on exports. (Germany is the third-largest exporter in the world, ranking after China and the United States.) The North American Free Trade Agreement is built around a net importer. Britain was a net importer from the Empire. German power unbalances the entire system. Comparing the unemployment rate of the German bloc with that of Southern Europe, it is difficult to imagine these countries are members of the same trade group

Even France, which has a relatively low unemployment rate, has a more complex story. Unemployment in France is concentrated in two major poles in the north and the south, with the southeast of France being the largest of them. Thus, if you look at the map, the southern tier of Europe has been hit extraordinarily hard with unemployment, and Eastern Europe not quite as badly, but Germany, Austria, the Netherlands and Luxembourg have been left relatively unscathed. How long this will last, given the recession in Germany, is another matter, but the contrast tells us a great deal about the emerging geopolitics of the region.

Portugal, Spain and Greece are in a depression. Their unemployment rate is roughly that of the United States in the midst of the Great Depression. A rule I use is that for each person unemployed, three others are affected, whether spouses, children or whomever. That means that when you hit 25 percent unemployment virtually everyone is affected. At 11 percent unemployment about 44 percent are affected. 

It can be argued that the numbers are not quite as bad as they seem since people are working in the informal economy. That may be true, but in Greece, for example, pharmaceuticals are now in short supply since cash for importing goods has dried up. Spain's local governments are about to lay off more employees. These countries have reached a tipping point from which it is difficult to imagine recovering. In the rest of Europe's periphery, the unemployment crisis is intensifying. The precise numbers matter far less than the visible impact of societies that are tottering.

The Political Consequences of High Unemployment

It is important to understand the consequences of this kind of unemployment. There is the long-term unemployment of the underclass. This wave of unemployment has hit middle and upper-middle class workers. Consider an architect I know in Spain who lost his job. Married with children, he has been unemployed for so long that he has plunged into a totally different and unexpected lifestyle. Poverty is hard enough to manage, but when it is also linked to loss of status, the pain is compounded and a politically potent power arises. 

The idea that the Germany-mandated austerity regime will be able to survive politically is difficult to imagine. In Italy, with "only" 11.7 percent unemployment, the success of the Five Star Movement represents an inevitable response to the crisis. Until recently, default was the primary fear of Europeans, at least of the financial, political and journalistic elite. They have come a long way toward solving the banking problem. But they have done it by generating a massive social crisis. That social crisis generates a political backlash that will prevent the German strategy from being carried out. For Southern Europe, where the social crisis is settling in for the long term, as well as for Eastern Europe, it is not clear how paying off their debt benefits them. They may be frozen out of the capital markets, but the cost of remaining in it is shared so unequally that the political base in favor of austerity is dissolving. 

This is compounded by deepening hostility to Germany. Germany sees itself as virtuous for its frugality. Others see it as rapacious in its aggressive exporting, with the most important export now being unemployment. Which one is right is immaterial. The fact that we are seeing growing differentiation between the German bloc and the rest of Europe is one of the most significant developments since the crisis began.

The growing tension between France and Germany is particularly important. Franco-German relations were not only one of the founding principles of the European Union but one of the reasons the union exists. After the two world wars, it was understood that the peace of Europe depended on unity between France and Germany. The relationship is far from shattered, but it is strained. Germany wants to see the European Central Bank continue its policy of focusing on controlling inflation. This is in Germany's interest. France, with close to 11 percent unemployment, needs the European Central Bank to stimulate the European economy in order to reduce unemployment. This is not an arcane debate. It is a debate over who controls the European Central Bank, what the priorities of Europe are and, ultimately, how Europe can exist with such vast differences in unemployment. 

One answer may be that Germany's unemployment rate will surge. That might mitigate anti-German feeling, but it won't solve the problem. Unemployment at the levels many countries are reaching and appear to be remaining at undermines the political power of the governments to pursue policies needed to manage the financial system. The Five Star Movement's argument in favor of default is not coming from a marginal party. The elite may hold the movement in contempt, but it won 25 percent of the vote. And recall that the hero of the Europhiles, Mario Monti, barely won 10 percent of the vote just a year after Europe celebrated him.

Fascism had its roots in Europe in massive economic failures in which the financial elites failed to recognize the political consequences of unemployment. They laughed at parties led by men who had been vagabonds selling post cards on the street and promising economic miracles if only those responsible for the misery of the country were purged. Men and women, plunged from the comfortable life of the petite bourgeoisie, did not laugh, but responded eagerly to that hope. The result was governments who enclosed their economies from the world and managed their performance through directive and manipulation. 

This is what happened after World War I. It did not happen after World War II because Europe was occupied. But when we look at the unemployment rates today, the differentials between regions, the fact that there is no promise of improvement and that the middle class is being hurled into the ranks of the dispossessed, we can see the patterns forming.

History does not repeat itself so neatly. Fascism in the 1920s and 1930s sense is dead. But the emergence of new political parties speaking for the unemployed and the newly poor is something that is hard to imagine not occurring. Whether it is the Golden Dawn party in Greece or the Catalan independence movements, the growth of parties wanting to redefine the system that has tilted so far against the middle class is inevitable. Italy was simply, once again, the first to try it out.

It is difficult to see not only how this is contained within countries, but also how another financial crisis can be avoided, since the political will to endure austerity is broken. It is even difficult to see how the free trade zone will survive in the face of the urgent German need to export as much as it can to sustain itself. The divergence between German interests and those of Southern and Eastern Europe has been profound and has increased the more it appeared that a compromise was possible to save the banks. That is because the compromise had the unintended consequence of triggering the very force that would undermine it: unemployment.

It is difficult to imagine a common European policy at this point. There still is one, in a sense, but how a country with 5.2 percent unemployment creates a common economic policy with one that has 11 or 14 or 27 percent unemployment is hard to see. In addition, with unemployment comes lowered demand for goods and less appetite for German exports. How Germany deals with that is also a mystery.

The crisis of unemployment is a political crisis, and that political crisis will undermine all of the institutions Europe has worked so hard to craft. For 17 years Europe thrived, but that was during one of the most prosperous times in history. It has not encountered one of the nightmares of all countries and an old and deep European nightmare: unemployment on a massive scale. The test of Europe is not sovereign debt. It is whether it can avoid old and bad habits rooted in unemployment.

 

In an interview The Washington Post published just prior to Abe's meeting with U.S. President Barack Obama in Washington, Abe said China's actions around the disputed Senkaku/Diaoyu islands and its overall increasing military assertiveness have already resulted in a major increase in funding for the Japan Self-Defense Forces and coast guard. He also reiterated the centrality of the Japan-U.S. alliance for Asian security and warned that China could lose Japanese and other foreign investment if it continued to use "coercion or intimidation" toward its neighbors along the East and South China seas.

Abe's interview came amid warnings on Chinese cyberactivity from Washington. Though not mentioning China by name in his 2013 State of the Union address, Obama said, "We know foreign countries and companies swipe our corporate secrets. Now our enemies are also seeking the ability to sabotage our power grid, our financial institutions, our air traffic control systems." Obama's comments, and the subsequent release of a new strategy on mitigating cybertheft of trade secrets, coincided with a series of reports highlighting China's People's Liberation Army backing for hacking activities in the United States, including a report by Mandiant that traced the activities to a specific People's Liberation Army unit and facility. The timing of the private sector reports and Obama's announcement were not coincidental.

Although Washington has taken a slightly more restrained stance on theSenkaku/Diaoyu dispute, reportedly urging Tokyo not to release proof that a Chinese ship locked its fire-control radar on a Japanese naval vessel, clearly Washington and Tokyo hold the common view that China's actions are nearing the limits of tolerance. Given its proximity to China, Japan is focusing on Chinese maritime activity, which has accelerated in the past two to three years not around the disputed islands, in the South China Sea and in the Western Pacific east of Japan. The United States in turn is highlighting cyberespionage and the potential for cyberwarfare. Both are drawing attention to well-known Chinese behavior and warning that it is nearing a point where it can no longer be tolerated. The message is clear: China can alter its behavior or begin to face the consequences from the United States and Japan.


Abe drew a sharp response from Beijing, though less from his interview than from another Washington Post article based on the interview that interpreted Abe as saying, "China has a 'deeply ingrained' need to spar with Japan and other Asian neighbors over territory, because the ruling Communist Party uses the disputes to maintain strong domestic support." Tokyo responded to China's complaints by saying the second Post article was misleading but that the transcript of Abe's interview was accurate.

Although the Japanese government did not elaborate on this point, by "ingrained" Abe did not mean Chinese behavior per se, but rather the anti-Japanese undercurrents of China's education system and the use of anti-Japanese sentiment as the basis of Chinese patriotism. 
In addition to being Beijing's standard knee-jerk reaction to any less-than-flattering comments by a foreign leader, the Chinese government and media response represented an attempt to shift attention from Chinese actions toward the "hawkish" Abe as the source of rising tensions in East Asia. A follow-up Xinhua article published after the Abe-Obama meeting cautioned the United States to be "vigilant against the rightist tendency in Tokyo" and said the first- and second-largest economies, the United States and China, should work together "to safeguard the peace and prosperity of the Asia-Pacific region and contribute to global development." Other Chinese media reports suggested that Abe failed to gain support from Obama during the visit for his Senkaku/Diaoyu policies or for a unified stance against China. The undertones of China's response, however, reflect less confidence.



The Economic Threat

What Abe said in his interview apart from the Chinese media spin is instructive. According to Abe, relations between China and Japan have been suffering due to unintended consequences of moves by the Communist Party of China to retain its legitimacy. China's economic opening led to unequal prosperity, eliminating the Party's main pillar of support, equality. To counter that, the Chinese government pursued a two-prong strategy of economic growth and patriotism. Economic growth required Beijing to expand its sourcing of commodities, moving China naturally onto the sea. Meanwhile,patriotism, tinged with anti-Japanese teaching, has come to pervade the educational system and society.



Abe argued that China is pursuing a path of coercion or intimidation, particularly in the East and South China seas, as part of its resource-acquisition strategy. Anti-Japanese undercurrents in Chinese society due to the inculcation of patriotism have won domestic support for the assertive Chinese actions. But this has strained Japanese-Chinese economic relations, thus undercutting China's own rapid economic growth. And without continued economic growth, Abe cautioned, China's single-party leadership would be unable to control its population of 1.3 billion.

Within this context, Abe cautioned that it is important to make Beijing realize it cannot take another country's territory or territorial water or change the rules of international engagement. He raised the defense budget and emphasized that the Japanese-U.S. alliance is critical for regional security, as is a continued U.S. presence in the region. He also warned that China's assertive behavior would have economic consequences and that although Japanese companies profit in China, they are responsible for 10 million Chinese jobs. If the risk of doing business in China rises, then "Japanese investments will start to drop sharply," he added.

Abe's warnings were designed to strike at the core Chinese government fears of economic and social instability and military encroachment by the United States and a reinvigorated Japan. On the economic front, Japan is one of the top sources of actual foreign direct investment in China and a major trading partner. Although it is difficult to verify Abe's claims of 10 million Chinese employed due to Japanese investments, the implications of Chinese actions on bilateral economic cooperation are more easily observable. In 2012, a year when tensions ran high due to Japan's decision regarding what it called the "purchase" of some of the disputed Senkaku/Diaoyu islands from a private Japanese citizen, anti-Japanese protests flared in China, as did unofficial boycotts of Japanese goods. Total trade between China and Japan fell 3.9 percent year on year, the first drop since the major financial crisis of 2009, with exports falling more than 10 percent. Japanese foreign direct investment, although rising slightly for the year, saw a major falloff in the summer when tensions between the two countries ran high.

Other factors played a role in the decline of trade and investment, including reduced overall Japanese demand and shifts in suppliers for certain key resources (and adjustments in Japan's export markets). And Japan itself would suffer from a major break in trade relations, though Tokyo may be taking steps to cushion against fallout from economic disputes with China. Japanese firms in fact already are beginning to show an interest is shifting some of their manufacturing bases out of China even without the added incentive of anti-Japanese sentiment-driven protests and boycotts. In 2012, the gap between China and the United States as the top destination for Japanese exports narrowed further to just 0.6 percent. Abe also hinted strongly that Japan has finally decided to pursue talks with the United States over the Trans-Pacific Partnership, a trading bloc (unofficially) designed to exclude China.

Although Japanese companies are unlikely to flee China en masse, the threat of a slow reorientation toward stronger trade ties with the United States and softening investment in China strikes at one of the Communist Party's major concerns, namely maintaining social stability through employment. Like that of Japan, exports and growth have driven China's economy. This does not necessarily mean profits or efficiency; on the contrary, Beijing has harnessed the constant growth to maintain employment and provide loans to keep businesses operating, even when they operate with razor-thin profit margins or at a loss.

Employment represents China's preferred tool to maintain social stability, and the Party sees stability as paramount to retaining its legitimacy as the unchallengeable and unopposable leader of China. Both the Chinese government and Abe know this, and now Abe is threatening to target Chinese growth, upending the whole system of stability. The Japanese may not really be able to effect or afford any drastic change in economic relations with China, but with the activation of the Trans-Pacific Partnership and with a possible Japanese government emphasis on investment to Southeast Asia and Africa (with private investment likely to follow), the economic pressure on China could slowly build.

The Military Warning

The military warning is therefore more immediately troubling to Beijing. Both Tokyo and Washington are reaching their limits for tolerating aggressive Chinese behavior. The United States is pivoting toward Asia, seen by China as a constraining action. Japan is strengthening ties with Russia, Australia, India and Southeast Asia, something China regards as containment. China's emergence as a big power has not been entirely smooth. Any time a nation seeks to alter the status quo between other powers, disruption and resistance are inevitable. China's maritime expansion and its cyberespionage and emerging cyberwar capabilities are closely linked to its economic and social policies. The former is a more obvious concrete action, but one that raises the risk of creating the appearance of being ready for peer competition long before China actually is. The latter at least offers some opportunities for plausible deniability (though Washington is now removing that already-translucent veil), and reflects an attempt to exploit an area where China's overall vulnerabilities are less of a liability; it is the weak taking its best available action against the strong.

For Japan, maritime activity around the disputed islands is manageable so long as it remains in the civilian realm, but the use of fire control radar on Japanese ships and overflights by Chinese aircraft are unacceptable. (Japanese aircraft are shadowing Chinese overflights. In a recently reported case, a Chinese Y-8 surveillance aircraft and the Japanese F-15 interceptor came within 5 meters, or 16 feet, of one another, creating the potential for a collision like the one between a U.S. and Chinese aircraft in 2001.) And while the United States may have tolerated the occasional case of cybertheft and cyberespionage, as Obama noted, such activities become unacceptable in scale and when it shifts to targeting U.S. infrastructure, where it has the potential to disrupt electricity grids, communications systems and other industrial processes. 

Japan and the United States have both called their defense alliance the cornerstone of their regional policies and relations. Japan continues to evolve its interpretation of its constitutional limit on military activity, and Tokyo has pledged to Washington to take a greater role in ensuring regional security. The escalation of Chinese naval activity has given the impression of a confident and capable Beijing on its way to changing the balance of naval power in the region. China has built the impression of a strong modern navy backed by land-based missiles, with modern ships and technology and an emerging international reach. China's anti-access area denial strategy is an increasing point of contention in Japan and the United States, where there are warnings that the Chinese navy will soon outpace the U.S. Navy in the Pacific, limiting U.S. naval capabilities with its "carrier-killer" missiles and quantitatively superior fleet.



The Chinese navy has undergone a significant modernization program over the past decade. Still, it is far from ready to compete head to head with the Japanese navy, much less with Japan's treaty ally, the United States. Modernization efforts and the fleet-building program have yet to make for a superb Chinese navy, nor would having superb sailors. A superb navy requires organization, doctrine, principles and most of all experience. The main problem constraining China's navy is not its shipbuilding or recruitment, but its limited ability to truly integrate its forces for war fighting and fleet operations. This requires substantial knowledge and training in logistics, cooperative air defense and myriad other complex factors.

There really is only one real measurement for a navy: Its ability to win against its likely rival. Part of determining the quality of a navy depends upon its technology and part on doctrine, but a substantial part is actual experience. China's navy has little war-fighting experience, even in the past. This has substantially limited the number of individuals within the officer corps knowledgeable or capable of effective operations in the highly complex world of modern military engagements. The Chinese navy may have new technology and be building toward numerical superiority, but it faces off against a U.S. Navy with centuries of experience and generations of admirals schooled in combat. Even the Japanese navy has more than a century of experience and a tradition of maritime warfare. The lack of combat experience significantly limits China's naval capability.

The Chinese government officially downplays these capabilities and any talk of a potentially aggressive nature of the Chinese military. But Beijing does little to dissuade such speculation, allowing a steady stream of images and commentaries in the Chinese popular media and the strategic leaking of imagery in China's social media. Beijing likes to appear fierce while saying it is not. But the problem with this strategy is exactly what Abe has pointed out: In appearing threatening, concrete steps are taken to counter China's maritime expansion. Abe is calling China's bluff, exhorting Beijing to reassess the correlation of forces in the region before continuing its aggressive pattern.

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