Expert View; This shot in the arm will hurt - but Europe needs it

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The Independent Online

A wintry day in Frankfurt. Tiring of my Tafelspitz, I nestle back into my corner of the Operncafe, and observe the gentleman at the table next to me. He is looking concerned, as well he might.

A wintry day in Frankfurt. Tiring of my Tafelspitz, I nestle back into my corner of the Operncafe, and observe the gentleman at the table next to me. He is looking concerned, as well he might.

It was not a good week for Europe's banker, Jean-Claude Trichet. The extraordinary revelations of Citibank's activities in the Eurobond market - the "Dr Evil strategy" - were bad enough. Worse were Germany's unemployment numbers and the EU's abandonment of its ambitious plan to outstrip the US economy. Ulcer-popping stuff.

Germany's unemployment numbers were appalling. The rise of some 573,000 in the month of January took the total through the five million barrier to its highest post-war level. Domestic reaction was close to panic as pundits assessed the political fallout; Gerhard Schröder's re-election pledge to cut unemployment to 3.5 million is certainly looking soggy. Some also cited the frightening rise to 9.2 per cent in the neo-Nazi vote in Saxony's regional elections.

What is going on? The long-overdue labour market reforms may be having some side-effects, but the main cause of the rise in the jobless remains the sluggish macro-economy. Germany continues to underperform, not just the US and the UK but its dullard sister France, with 2 per cent GDP growth proving a struggle at the best of times. Mr Trichet's tough monetary stance is certainly not helping, but he can't take all the blame.

The ongoing consequences of integrating East Germany have been well aired, but we should not overlook the effects of the massive expansion of the EU eastwards. The accession of the new economies - most importantly Poland, Hungary and the Czech Republic - has led to 74 million new EU citizens and sparked a boom in the East that would give the Asian tigers a run for their money.

The long-term prospects for "emerging Europe" are excellent. With national GDP per capita statistics that average out at only 25 per cent of Western Europe's, we could see catch-up growth for many years to come. The trend growth of the "Slavonic Tigers" is already 3 to 5 per cent per annum, or more than twice what mainstream Europe can manage on a good day. This has given their immediate, anaemic neighbours a shot in the arm. Indeed, one wonders how much worse things would be without them. Pre-accession, nearly 7 per cent of Germany's total exports were to the east (in Austria it was even higher).

The problem is that, post-accession, the economic effects may be flipping over with devastating results for particular regions or indeed countries. The cost of labour is a key factor. Across the EU this averages €22.70 (£15.70) per hour, and Germany is much higher at €26.54. In the east these numbers are blown apart: €4.48 in Poland or a mere €1.35 in Bulgaria. No wonder the German press was full of horror stories last week about the country's manufacturers relocating.

Much has been made of the effects of migration of labour from the new accession countries westwards, and politicians have reacted in different ways across the West. But it is this migration of capital that could prove much more significant.

On a macro EU basis, this need not be a bad thing. It is ironic that the new president of the EU Commission, Jose Manuel Barroso, should be choosing now to throw in the towel on the "Lisbon pledge" (for Europe's economy to overtake the US by 2010). The target date may indeed be laughable but the prospect is not impossible - backed up by our booster engines in the east.

Cheap labour and massive returns on capital could raise Europe from its hospital bed, but not without some painful social and political adjustments.

No wonder Mr Trichet shared my indigestion.

christopher.walker@tiscali.co.uk

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