EUROPE COMPASS

WEEKLY UPDATE JANUARY 21, 2013 Controlling uncertainty The ECB's monthly bulletin for January 2013 includes an article on the relationship between uncertainty, confidence and economic performance. The basic finding should not come as much of a surprise. High uncertainty tends to lower confidence among consumers and investors; lower confidence tends to weaken economic performance. As with many articles in economics, the strength of this piece lies not so much in the novelty of the finding as in the elegance with which the authors demonstrate their empirical support. Nevertheless, the authors do add a wrinkle with the notion of 'uncertainty shocks' -- sudden events that confound the views of consumers and investors, with lasting consequences for economic performance. This addition is important because uncertainty is not only the result of unforeseen or unforeseeable developments, like the weather. To a certain extent, uncertainty in the markets -- as in all areas of human endeavour -- can be controlled. Awkward US Republicans The idea that some actor may be out there controlling uncertainty sounds odd in the abstract but it is easy to recognise in the debate over the debt ceiling in the United States, for example. The House Republicans control uncertainty by threatening to do something irrational, like forcing the US government into bankruptcy by refusing to authorise the Treasury to issue more debt. And the House Republicans seek to gain concessions from the Senate Democrats once they relax that control, as they did in the recent agreement to push the debt ceiling talks until after the budget. The power that the House Republicans wield through their control over uncertainty is evident in the fact that they refuse to end the debt ceiling altogether. Any effort to eliminate uncertainty would end their control and the power that comes along with it. Power of irrational threats The French sociologist Michel Crozier developed this notion of power as control over uncertainty in his analysis of social conflict in the late 1960s and early 1970s. He noticed that small groups often threaten to do something irrational in order to create uncertainty around their actions; they are able to hold more traditional social actors, like politicians, managers and trade union leaders, hostage as a result. The situation today is no different and the House Republicans in the United States are not the only example. In fact, European politics is dominated by little else. France's Eurogroup bluff Numerous examples spring to mind. French Finance Minister Pierre Moscovici's opposition to Dutch counterpart Jeroen Dijsselbloem's candidacy for president of the Eurogroup is a small-scale illustration. The French government had no other candidate and Moscovici's objection -- that Dijsselbloem had little experience as finance minister -- was not categorical. France's goal was simply to create uncertainty around the appointment in order to extract concessions from Germany on the European banking union. Moscovici was clearly bluffing and has since dropped his objections; the Eurogroup endorsed Dijsselbloem today. Pressuring Bersani The quixotic electoral campaign of the former prosecuting magistrate of Palermo, Antonio Ingroia, is another example. Ingroia draws support from the former communists and other elements of the far-left and his explicit goal is to prevent centre-left leader Pier Luigi Bersani from forming a coalition with outgoing Prime Minister Mario Monti and his newly formed centrist coalition. Ingroia's support is marginal but is enough to deprive Bersani and his allies of a majority in critical regions like Lombardy, Sicily and Campagna. If he succeeds in doing so, Ingroia will either force Bersani to form an alliance with Monti or prevent either the centre-left or the centre-right from obtaining a majority in the Senate. It is unlikely that Bersani will make many concessions in order to see this uncertainty go away. Eurosceptics' leverage The eurosceptic contingent in the UK Conservative Party is a third illustration. These backbenchers are threatening to vote against the coalition government unless Prime Minister David Cameron concedes a referendum on the UK-EU relationship. Their conviction that the current relationship is disadvantageous is not in question; it is their willingness to undermine a Conservative-led coalition that creates the uncertainty. In turn, this becomes uncertainty about the UK position in the EU and UK access to European markets. Cameron was due to address this group -- and the wider world -- in a widely trailed speech on Europe to be delivered during his trip to the Netherlands. That speech was pre-empted (it has been rescheduled for January 23) by a fourth illustration of the influence of small groups exercising control over uncertainty on European politics and economics. Algerian assault The assault of Islamic extremists on an Algerian gas-extraction facility is an extreme case. By taking hostages in response to French intervention in Mali, these terrorists have made it clear that all Westerners are at risk. They also underscored the vulnerability of energy resources that are vital to the European economy. The result has been to increase uncertainty -- about French will behind the original Mali intervention, about the effectiveness of the Algerian response to the hostage-taking and about the long-term implications for European energy security. The coming weeks will reveal how effectively all three factors can be addressed. What is apparent is that these four illustrations increase uncertainty and so decrease European confidence. In turn, that reduction in confidence is lowering growth prospects. In this sense, they are man-made uncertainty shocks that lower the prospects for European economic performance below what would otherwise be the case. The euro-area would benefit from clear leadership, Italy from a clear political mandate, the United Kingdom from a solid relationship with Europe and Europe as a whole from stability on its borders. If these things are lacking, it is because small groups want to extract leverage from depriving European investors and consumers of the economic benefits of certainty. They may have their own reasons for doing so, but they are imposing a cost on the European economy nonetheless. I trust you have found this weekly Europe Compass note helpful. The Europe Compass is one element of Oxford Analytica's Europe Practice, which provides analytical insight and advice on the changing political economy of Europe and the implications for corporations, investors and public institutions in all markets and regions. I invite you to contact me or anyone at our Europe Practice with your queries or concerns.