Leading Article: Time to prop up Europe

Recession is haunting Europe. The situation in Germany and France may not be catastrophic, but it is very serious. Growth is slowing, consumer confidence is falling and unemployment rising. However, the most important consequences of this downturn will not be economic, they will be political. Recession and retrenchment will test the political stability of both Germany and France as well as casting a long shadow over the European Union's plans for further integration.

The signs of contraction are unmistakable. The German economy stagnated in the third quarter of 1995 and activity is expected to fall in the final three months of the year. A big jump in unemployment, to almost 10 per cent, in December has rung alarm bells across the country.

In France, where the unemployment rate is 11.5 per cent, the outlook for 1996 is even bleaker. According to a leaked report from the labour ministry, growth could be little more than 1 per cent. Consumer confidence is at its lowest for almost 10 years.

Across Europe economic conditions have deteriorated much more and much faster than expected. One principal reason is that public spending is being cut back by governments attempting to meet the Maastricht treaty criteria for inclusion within the economic and monetary union. The race to meet the EMU 1999 deadline has led to tax hikes and spending cuts, which are taking spending power out of the European economy.

In Germany, another powerful factor is at work. The slowdown there may be in part structural: the product of the high price of unification, the highest labour costs in the world and an overvalued currency. Unemployment is rising because companies have responded to lower growth and weaker export markets by making workers redundant. Small and medium-sized companies are not recruiting. German industry is still far stronger than its British counterpart, but it is going through a bout of restructuring not unlike that enforced by Margaret Thatcher in the early Eighties, when sterling was strong and public spending was cut back.

The response to this slowdown is equally obvious. In the short term a halt has to be called to further efforts at fiscal retrenchment since they would simply deepen the downturn. At the same time, the Bundesbank should loosen interest rates. More important are structural reforms, particularly to Germany's highly regulated labour market, which would help speed its adjustment to slower growth.

The costs of inaction could be high. Already the fragility of France's political system has been exposed by the strains provoked by reining in public spending. The strikes last year were not simply in response to cuts in welfare spending, they amounted to an attack on the French elite.

The German political system is more robust. It is unlikely that change there will be accompanied by the kind of conflict we have seen in France. But there are darker clouds on the horizon. Continental Europe is probably embarking on a period of growth far lower than it has been used to. The frustration that will breed will cast a pall not just over EMU but also over the wider cause of European integration. That is why governments should take this slowdown seriously and nip it in the bud.