Forget fiscal cliff. Europe is the biggest threat to world's economy: OECD

Bank of Canada Governor Mark Carney has his work cut out for him once he moves across the pond.

The Organization of Economic Co-operation and Development warned Monday that faltering Europe is a bigger threat to the world’s stability than the much-hyped U.S. fiscal cliff — a combination of $600 billion in tax increases and cutbacks set to automatically begin at the start of next year.

“We believe the euro area remains the largest risk to the global economy,” said Pier Carlo Padoan, the OECD’s chief economist, during a teleconference.

Global markets are expected to make a “hesitant and uneven recovery” in the next two years, according to the 34-country organization.

The failure of policy-makers in Europe to clean up the Greek, Spanish and other flailing economies could cause recessionary “spillover” effects that could have a further reach than the American fiscal cliff, Padoan said.

“The euro crisis itself has been and continues to be a drag on growth that is longer than necessary, largely reflecting insufficient or delayed policy action,” he said.

For several years, the European Union has struggled under common-currency woes and a debt crisis that has left Germany’s Angela Merkel championing bailout plans. Austerity measures, combined with unemployment rates in some countries hovering at 25 per cent, are sparking increasingly violent protests in many European states.

There are nearly 50 million jobless people in the OECD area and unemployment is set to remain high, the organization said.

Carney, 47, surprised many Monday when it was announced he would be leaving his post to succeed Mervyn King at the Bank of England. Carney told reporters it is a “decisive” time in the history of the Bank of England, which takes on new responsibilities as the European situation worsens.

While spending and debt reduction are desperately needed in the United States, many say the legislated tax hikes combined with deep government cuts set to kick in Jan. 1 could cause an immediate, nearly 4 per cent contraction of the deficit. But cutting too much, too fast could send the U.S. into a recession.

U.S. President Barack Obama and the Republican-dominated House of Representatives must agree on a deal by the end of the year to prevent the economy from sloping downward.

In the past couple of days, some Republicans have indicated they may break with the Grover Norquist no-new-taxes pledge and work with the Democrats. Norquist is a powerful Washington lobbyist who, for years, convinced Republicans to follow the pledge. Non-followers are often vilified.

What is troubling, Padoan said, is if the European crisis deepens and the fiscal cliff dive takes place as government leaders lack the political will to stop them.

“In both cases, there is a possibility for policy-makers to take decisive action which would avoid the worse, but also boost confidence,” he said. “This is a common message we’d like to share.”

In the next few years, the balance of economic power is expected to tilt eastward to Asia, especially toward China. But a slight slowdown in record growth rates in China, combined with troubles in Japan, could also drag down global markets, the OECD warns.

The organization also said the main future risks for the Canadian economy appear to be external, with the stalemate over fiscal policy in the U.S. and European instability.  TheStar