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Splits in Euro Zone Emerge Amid Debt Crisis

Even as Europe struggles to contain its latest debt crisis, fresh fissures are emerging that show the euro zone diverging into two — or even three — different economic parts that threaten to compound the problems even further.

After publication of new figures Monday, a senior European Union official acknowledged for the first time that a two-speed euro zone might now be developing, with Germany racing ahead while debt-laden countries on the Continent’s periphery battle stagnation.

“It has to be admitted, there is a certain dualism in Europe,” Olli Rehn, the European commissioner for economic and monetary affairs, said Monday while announcing the commission’s autumn economic forecasts.

A trader sits in front of a board displaying Germany's share index DAX at the stock exchange in Frankfurt/Munich, western Germany.
Martin Oeser | AFP | Getty Images
A trader sits in front of a board displaying Germany's share index DAX at the stock exchange in Frankfurt/Munich, western Germany.

Germany has “rebounded very forcefully from the financial crisis and economic recession with a strong growth of exports — increasingly spilling over to the domestic demand,” Mr. Rehn said. Ireland and some countries in the south of Europe, by contrast, “have faced significant difficulties,” he said.

Adding to the complexity, other European officials say, is a third group of economies that includes France and Italy, which did not suffer as much during the recession because they are not as reliant on global trade — but have not recovered as well, either, as trade has rebounded.

Significant economic differences have always existed between the euro zone’s northern and southern countries. But some economists now believe that, exacerbated by the shocks of the financial crisis, these multiple differences threaten the future of the euro itself.

“I don’t think it’s sustainable in the absence of a much greater degree of political and economic integration,” said Simon Tilford, chief economist at the Center for European Reform, a research institute based in London.

Financial markets gave a largely negative reaction Monday to the €85 billion, or $111.2 billion, bailout package for Ireland announced Sunday night, and to the announcement of new rules for dealing with debt crises in the euro zone after 2013. E.U. officials had hoped the Irish rescue, and greater clarity on future rescues, would quell market fears of contagion spreading to other heavily indebted euro countries, like Spain and Portugal.

Unlike Iceland, which pulled out of its own debt crisis in part by devaluing its currency to increase exports, euro countries like Greece, Portugal and Ireland cannot use devaluation as a way to stimulate growth. That makes their prospects for escaping a debt crisis look bleak because the cuts needed to control budget deficits also depress growth.

“It’s very hard for any economy to flourish in the teeth of fiscal austerity of this magnitude — let alone those that can’t devalue,” Mr. Tilford said.

E.U. officials do not entirely accept that analysis, though neither do they hide the challenge posed by the diverging economic performances of euro-zone nations.

The economic forecasts announced Monday show that Germany and “some smaller export-oriented economic have registered a solid rebound in activity, while others, notably some peripheral countries are lagging behind,” according to the report.

“Looking forward, the expectation remains for a differentiated pace of recovery within the E.U., reflecting the challenges individual economies face and the policies they pursue,” the report said.

Overall economic growth in the euro zone is expected to be 1.5 percent next year, slightly lower than the projection for 2010, and 1.8 percent in 2012.

But the divergence in performance is striking on a range of measures.

In 2012, general government debt as a proportion of gross domestic product is due to hit 156 percent in Greece, twice the level of Germany and more than seven times that of Luxembourg.

In 2011, gross domestic product will shrink 3 percent in Greece and 1 percent in Portugal. In Ireland it is projected to grow, but by under 1 percent — less than half the rate of Germany.

According to one European official not authorized to speak publicly, the picture is more like a three-speed than a two-speed currency area.

“The euro zone was hit by a crisis and a number of countries have been through an adjustment,” the official said. “In this crisis, different countries were affected in different ways.”

Because Germany is an open trading economy, it was hard hit by the collapse of global trade during the recession. But its competitiveness has helped a rapid, export-led recovery. Some smaller North European nations like the Netherlands, Finland and Austria have had similar rebounds.

Meanwhile, the French and Italian economies were never as open and therefore were not as hard hit by the slump in trade. But, having made only limited structural changes, they have not gained the competitiveness to take advantage of recovering conditions as the Germans. Worst affected have been the countries that suffered overheating and asset bubbles, and that are still struggling with a painful adjustment.

European officials concede that, for euro-zone nations unable to devalue, the process of adjustment may be long and painful. Their strategy is to push structural changes and new rules based on the lessons of the crisis, in hopes of preventing such divergences in the future.

In his remarks Monday, Mr. Rehn stayed upbeat about Ireland’s prospects of achieving projected growth of 1.9 percent in 2012. “The Irish are smart, stubborn and resilient people and they will overcome this,” he said.

The European Union also hopes that Germany’s recovery will prove the motor for the rest of the euro zone, particularly if domestic demand starts to pick up. That could help resolve the issue of trade imbalances within the euro zone by reducing Germany’s trade surplus.

Mr. Tilford, of the Center for European Reform, is skeptical of that argument. He said Germany would experience “reasonable export-led growth” but not as strong as assumed by the European Commission. It was, he added, too early to assume that domestic demand was taking off in Germany.

The result, he said, really could mean two speeds of growth — and rather low ones at that. “It could mean weak economic growth across the euro zone as a whole and economic stagnation and debt deflation in the periphery,” he said.

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