Europe's Four Big Challenges in 2019
By: Analysis | Stratfor.comJanuary 10, 2019
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Europe's Four Big Challenges in 2019
Highlights

Domestic constraints in the eurozone's four largest economies will limit their ability to cooperate at the Continental level.

2019 will test the health of nationalist and populist political movements, which represent the main threat to the continuity of the European Union in its current form.

This year, the bloc will face three sources of economic risk: trade disputes with the United States, Brexit and economic fragility in Southern Europe.

The European Union will be under domestic and external pressure to limit Chinese access to strategic technology and resist Beijing's investments in infrastructure.
 

2019 is just over a week old, but it's already shaping up to be a busy one for Europe, which has a long to-do list to address as it grapples with political turbulence, slowing economic growth and tense relations with the world's superpowers. European leaders will contend with a host of issues, including Germany's unstable political coalition, the staying power of populism, Italy's economic woes, and concerns about China and Russia's looming presence over the European Union. Here are four trends that will shape Europe's political, economic and social agenda this year.

Trend 1: Trouble in the EU's Top Four

In 2019, the governments of the eurozone's four largest economies will encounter a raft of political troubles that will limit their room to maneuver at home, as well as their ability to offer cohesive leadership in the bloc as a whole. In Germany, Angela Merkel's decision not to run for re-election in 2021 will force the members of her coalition government to prepare for a political environment without her. Even if Merkel manages to complete her term, her authority within the center-right Christian Democratic Union (CDU) will progressively weaken as the party plans for her succession. In the meantime, the center-left Social Democratic Party (SPD) will seek to distance itself from the CDU, its coalition partner, in a desperate bid to improve its popularity. This could make Germany's government increasingly dysfunctional, reducing Berlin's desire to introduce structural reforms at the EU level. As a result, proposals to establish a common deposit insurance scheme for eurozone banks or create a large eurozone budget to stabilize countries in financial distress (both of which require strong German backing) are unlikely to move forward anytime soon.

The French government, for its part, is entertaining a number of ideas to enact domestic and European reforms, yet it also faces significant limitations. At home, the yellow vest protests have served notice to all that French citizens are more than willing to hit the streets to protest any economic policies they oppose. Seeking to avoid new demonstrations, President Emmanuel Macron's government will likely take a more cautious approach to reform this year. This could mean watering down plans to simplify the country's pension system and tighten the eligibility criteria for unemployment insurance. At the EU level, meanwhile, opposition from Northern European countries proved strong enough last year to dilute Paris' proposals for greater risk-sharing and higher spending in the eurozone. In the end, another year marked by domestic constraints will restrict Paris' ability to influence the European Union's policy direction.

 

Italy will be another country to watch in 2019. Late last year, the Italian government acceded to pressure from financial markets to tone down its criticism about the euro and reach an agreement with the European Commission over its budget plans. But the combination of a heavy debt burden, fragile banks and meager growth means the Italian economy is not out of the woods. Moreover, the governing League and Five Star Movement parties find it hard to conceal their ideological differences on a host of issues ranging from immigration to infrastructure projects — a trend that will continue in 2019. Unsurprisingly, an early election would only increase uncertainty about Italy's future. Meanwhile, the eurozone's fourth-largest economy, Spain, suffers from too many domestic problems (ranging from a minority government that struggles to get things done to persistent separatist rumblings in Catalonia) to even consider shaping the bloc's future direction.

These domestic problems are occurring at a time when the European Union must take decisive action on policy. One of the Continent's most heated debates this year will revolve around the European Union's next seven-year budget, which must enter force in 2021. The discussions, which will focus on the size and distribution of agricultural subsidies and development funds, will lay bare the competing strategic interests within the union. The bloc's members that are net recipients of funds (most of which are in Eastern Europe and, to a lesser extent, Southern Europe) will push to increase or at least preserve the current levels of spending, while the net contributors (most in Northern Europe) will drive for spending cuts. The negotiations to appoint the new members of the European Commission and the new presidents of the European Central Bank (ECB) and the European Council will also lead to ideological and strategic disputes among EU governments. These negotiations are worth following closely, because the future of the European Union's economic, foreign and monetary policies will be on the table.

Trend 2: Populism Is Here to Stay

In recent years, populist and nationalist forces have made serious inroads in many member states. In 2019 — and beyond — such forces will continue to exert influence on the bloc's politics for a simple reason: The factors that contributed to their rise are still present. Issues such as low economic growth, skepticism about the ostensible benefits of globalization, rising wealth inequality, anxiety about immigration, demographic changes and concerns about the loss of national sovereignty will continue to provide fertile ground for political forces that question the current political and economic order in Europe.

Naturally, these forces face significant limitations. Most voters still want their countries to remain in the European Union and the eurozone — even if in many cases this desire stems not from any innate love for the Continental project but from the fear of the unforeseeable consequences of leaving it. The same applies to politicians, who often tone down their anti-European rhetoric once they assume power and have to make concrete policy choices. Nevertheless, the rise of populist and nationalist forces is the single greatest threat to the survival of the European Union in its current form. Ultimately, the union cannot count on fear of the unknown or on institutional restrictions to perpetually prevent these parties from winning an election or, if they do, soften their Euroskepticism. Compounding the issue is the fact that the emergence of populist and nationalist forces has made many moderate political parties adopt similar stances in order to compete with the upstarts.

2019 will present a stern test for these political movements. The good news for the European Union is that there aren't that many general elections scheduled on the Continent this year. In late May, however, the entire bloc will hold elections to appoint lawmakers to the European Parliament. This will give voters a low-risk opportunity to punish their national governments and support anti-establishment parties. Pro-EU forces will retain control of the Parliament, but the legislature will become more fragmented, meaning policymaking could become more difficult. The elections will also have domestic repercussions, as political parties (both in government and in the opposition) will convene to map out their political futures after the vote. The Europe-wide polls could precipitate early general elections in places with weak governments (like Spain) or awkward coalitions (like Italy and Germany). One particular vote to watch will be Poland's general election in November, when voters will have to decide whether to re-elect the current government, which is one of the loudest critics of the European Union's federalist efforts.

Trend 3: Economic Risk Isn't Going Away

The eurozone will also have to deal with at least three sources of economic risk in 2019. The first stems from trade issues with the United States. U.S. President Donald Trump's administration is still considering whether to introduce higher tariffs on European automobiles. A report by the U.S. Department of Commerce on whether automobile imports represent a threat to national security in the United States is due by mid-February; once released, the White House will have 90 days to decide on what action to take. As the main producer of vehicles in Europe, Germany stands to lose a lot if that threat materializes, but so do the many of the EU countries that constitute Germany's supply chain. In the end, the European Union will find it difficult to sign a comprehensive free trade agreement that includes agriculture — which is what the White House will likely seek in exchange for not introducing higher tariffs on European cars. Moreover, should the White House introduce higher tariffs on EU-produced vehicles, Brussels would retaliate with its own countermeasures, resulting in an overall reduction of bilateral trade between two of the three largest economic players in the world.

Brexit poses the second big source of economic risk in Europe. The British government can avoid a disorderly exit from the European Union even if the House of Commons rejects the plan that Prime Minister Theresa May's government negotiated late last year with Brussels because it can request an extension of the negotiation period (which would require unanimous support from the rest of the European Union) or withdraw its request to leave (which London can do unilaterally). But suspending the United Kingdom's exit will have little meaning unless London drafts a strategy to follow that delay. This could take the form of an early election, a new exit agreement or even a second referendum on European Union membership (especially if the Labour Party takes over the government). While any of these options would postpone Brexit, they would also create new sources of uncertainty and anxiety, both in the United Kingdom and abroad.

The final source of risk is an old one: Southern Europe's economic fragility, which will manifest itself in many ways in 2019. One cause for concern is a vicious circle, known as a "debt doom loop," between countries with high levels of debt and the banks that hold that debt. Over the past decade, lenders have purchased more and more public debt from eurozone countries, but the banks holding these bonds suffer if debt prices fall. Once more, the main country to watch in 2019 will be Italy. Even if Rome has reached a truce with the European Commission, it has failed to assuage the doubts about the sustainability of its public finances, while some banks still own billions of euros in sovereign Italian debt, as well as large amounts of non-performing loans.

But there are additional issues that complicate the economic picture in Southern Europe. Now that the ECB has ended its bond-buying quantitative easing program, there will be one less source of demand for eurozone debt this year, meaning borrowing costs, especially for weak economies in Mediterranean Europe, could go up without the central lender's intervention. At the same time, countries like Italy, Spain and France have announced budget plans for 2019 that will lead to higher deficits. This is a risky move for countries with already high levels of public debt. When the next recession comes — and many eurozone economies are already slowing — these countries will have little fiscal room to deal with the problem.

Trend 4: Ambiguous Ties With China and Russia

In addition to the trade disputes with the United States, the European Union will have its hands full with the other two key powers in the international system, China and Russia. At present, the trade war between China and the United States creates an opportunity for the European Union, since Brussels can increase pressure on Beijing to open its market to European investment. Europe wants China to grant European investors an equal footing with its domestic companies and remove subsidies for Chinese businesses. While China is unlikely to significantly alter its economic model, any further downturn in U.S.-Chinese relations could make Beijing more receptive to Brussels' pressure.

But the European Union is also worried about China's increasing presence on the Continent. Brussels is especially concerned about Beijing's investment plans in Central and Eastern Europe, arguing that some of the proposals flout EU rules on public procurement and state aid in addition to lacking a sound cost-benefit analysis. The bloc also fears that Beijing's rising economic clout will ultimately translate into political influence — something that would only exacerbate the union's political fragmentation. To some extent, these fears are already coming true, as rich EU countries, wary of Chinese investment, have begun to clash with poorer ones, which welcome whatever foreign investment they can get.

At the same time, the bloc is wary about Chinese investment in sensitive technologies. Germany, France and others have already introduced mechanisms to screen foreign — that is, Chinese — investment on critical technology and infrastructure, although the union has failed to introduce a common mechanism at the Continental level. At the same time, the United States is increasing pressure on its European partners to introduce stronger barriers to Chinese investment, which will affect research and trade in areas including artificial intelligence and the development of 5G networks.

Likewise, ambiguity will mark Europe's relations with Russia this year. The European Union recently extended its economic sanctions against Moscow until mid-2019, and it will probably do so again before the end of the year given that the prospects for a resolution to the conflict in eastern Ukraine appear dim; if anything, frictions could even escalate as the rivals compete for control around the Sea of Azov. Countries in Central and Eastern Europe will continue their demands to maintain a tough stance on Russia, while regional leaders like Poland will look to strengthen political, military and economic ties with the United States, which they see as the region's ultimate protector against potential Russian aggression. Poland, Romania and others will also seek ways to diversify their sources of energy through measures such as infrastructure projects and purchases of liquified natural gas. But not all European countries perceive a Russian threat at their doorstep. Germany, for one, defends the controversial Nord Stream 2 pipeline, which will bypass Ukraine in transporting Russian natural gas to Europe, while several other EU member states have also insisted on pursuing a detente with Moscow so as to foster trade and find common ground on issues ranging from Syria to Iran.

A Confluence of Problems

The European Union is not facing the same types of immediate threats that it did during the height of the financial crisis earlier this decade, when the economic woes of Greece, Ireland, Portugal and others put the continuity of the eurozone in question. The threats facing the union today are more structural in nature, including shortcomings in the eurozone's setup, the lingering social and political repercussions of the recent financial and migration crises, and the ongoing competition among the global superpowers. This might mean that Europe's problems are not as urgent as they were a few years ago, but that doesn't make them any less dangerous for the Continental bloc.








Europe's Four Big Challenges in 2019 is republished with permission from Stratfor Worldview, a geopolitical intelligence platform.

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