Europe's recovery is both fragile and skewed. For one, it has been led by Germany (which expanded 0.7 per cent), the euro zone's largest economy, although a surprise result from Portugal (1.1 per cent) and a deceleration in the Spanish slowdown also helped. But full-year predictions still point to a contraction - albeit 0.4 per cent instead of the original 0.6 per cent. And, despite the growth, employment in the second quarter actually shrank one per cent year on year. Significantly, expansion in the second quarter was partly the result of European Central Bank Chairman Mario Draghi's creative bond-buying programme, which relaxed credit conditions in those countries most impacted by the debt crisis and allowed private companies to expand.
The importance of this credit-led recovery cannot be overemphasised for the world economy. As Daniel Gros argued recently, the swing in the euro zone's current account from a $100-billion deficit to a $300-billion surplus was largely the result of shrinking internal demand imposed by austerity. As a result, imports from a market that accounts for a fifth of the world's economy all but stagnated over the past five years, contributing to the widening current account deficits in emerging markets. One index: India's merchandise exports to the region declined from $42.7 billion in 2011 to $37.8 billion in 2012 and its share shrank from nearly 14 per cent to roughly 13 per cent. It is uncertain whether Ms Merkel will be in a position to respond to these signals or resist the contrarian pulls between public opinion in Germany and the rest of Europe as she searches for a new coalition partner to gain the requisite parliamentary majority. If anything, her challenge as she takes office for a third term will be to rise above narrow national interests.