The European fallout from the Paris attacks

Friday, Nov. 13, 2015, the day that the Islamic State in Iraq and Syria (ISIS) attacked Paris, will long live in infamy. Sadly, it might also go down in history as a major reversal in Europe’s long march toward closer economic and political integration. This is not so much because of the damage that it might have inflicted on the French and European economies. Rather, it is because it is likely to have totally undermined the Schengen agreement on free movement within Europe and to have unleashed domestic political forces in both France and Germany hostile to closer European integration.

{mosads}Early indications are that the French economy has been significantly impacted by the terrorist attack. The tourism industry, which accounts for 7.5 percent of the French economy, has suffered a body blow, while it also appears that both investor and household confidence in the French economy have been meaningfully hit. However, subject to the important proviso that there is not another terrorist attack anytime soon, there is every likelihood that the damage to the French economy will be short-lived. After all, the U.S. economy bounced back quickly in 2001 after 9/11, while the same was true of London after the 7/7 attacks in 2005.

Another reason for optimism about an early French economic recovery is that the terrorist attacks will very likely prompt the European Central Bank to substantially expand its already ample quantitative easing program. That in turn will keep European interest rates low for a long period of time and will drive down the value of the euro, which should prove to be a tonic to European exporters.

While the economic impact of the Nov. 13 attacks might be short-lived, it is likely to have caused considerable damage to Europe’s longer run process of economic and political integration. Among Europe’s greatest achievement to date on the integration front was the 1985 Schengen agreement. That agreement has succeeded in eliminating borders between most European Union member countries, which has facilitated the free movement of European citizens within Europe. In the immediate aftermath of the attacks, however, borders are now being sealed not only in France, but also across many other European states. It seems highly improbable that those borders will be reopened anytime soon.

The attacks are also likely to complicate the task of many European countries to comply with their commitments to the European Commission to reduce their budget deficits. Security expenditures will likely have to be ramped up significantly to finance greater police protection and border enforcement at a time that most European countries are suffering from a weak economic recovery and austerity fatigue.

An even more troubling long-run fallout from the Nov. 13 attacks is likely to be on the political front, especially in France and Germany. In France, President François Hollande is already coming in for intense domestic criticism for France’s ill-preparedness to prevent a terrorist attack of such a magnitude on French soil. Meanwhile, the anti-immigrant nationalist message of Marine Le Pen’s National Front Party seems to be resonating with the French electorate. This is hardly good news for European integration, considering Le Pen’s open hostility toward the euro.

At least of equal concern for the European project is the domestic political troubles of German Chancellor Angela Merkel in the aftermath of the Paris attacks. This is particularly the case considering how pivotal Merkel has been in holding Europe together over the past five years throughout the European sovereign debt crisis. It now appears that the Paris events have triggered a domestic political backlash against Merkel’s commitment to allow 1.5 million Syrian refugees to enter Germany over the next few years. This is now sowing discord within Merkel’s ruling coalition, is seeing her popularity drop to record low levels and is putting wind in the sales of the far-right Alternative for Germany Party.

Before the Paris attacks, there were already pressing reasons for Europe to boost its anemic economic growth through far-reaching structural economic reforms and through fiscal stimulus in those countries that had the budget room to do so. After Nov. 13, it would seem that Europe cannot afford to delay such policies. Hopefully Nov. 13 will have galvanized European policymakers to act not only on the security front, but also on the economic front in order to arrest Europe’s steady drift toward a greater degree of populism.

Lachman is a resident fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.