What Ails Europe's Economy?
(Bloomberg Opinion) -- In the space of just two years, the euro zone has gone from the world economy’s hero to zero.
In 2017, the bloc expanded at the fastest rate in a decade, as it benefited from a combination of booming global trade and ultra-easy monetary policy. Now, the currency union has become the prime concern for those who worry about a wider downturn. The International Monetary Fund cut its forecasts for global growth mainly due to downward revisions for the euro area.
But look closely at the map, and the picture is much more heterogeneous than you’d think. Italy and Germany – ironically the sick man and the powerhouse of the bloc – are in trouble, with the former now officially in recession and the latter only narrowly missing one. But, elsewhere, there is no shortage of countries still growing at a decent clip. The monetary union may be down; it isn’t out.
The euro zone’s most consistent surprise is Spain, which grew by 0.7 per cent in the fourth quarter, marginally up from the 0.6 percent expansion seen in each of the previous three quarters. The country may be headed for an election after Pedro Sanchez’s minority government failed to secure sufficient support for its budget, but the political uncertainty has had relatively little impact. In 2018, the country expanded by less than 3 percent for the first time in four years, but growth still came in at a decent 2.5 percent.
France’s economic performance is even more surprising. The bloc’s second-largest economy has been jolted by the protests of the gilets jaunes, which shook the political system and dented investor confidence. Yet it expanded by 0.3 percent at the end of last year, in line with the previous quarter and marginally faster than in the first two quarters of the year. Growth for the full-year came in at 1.5 percent, down from 2.3 percent in 2017. But the early signs for 2019 are positive: The Bank of France forecasts the economy will expand by 0.4 percent in the first quarter.
Other countries, from north to south, also tell a more positive story. Growth in Finland rebounded from 0.5 percent in the third quarter to 0.9 percent in the final stretch of the year. Portugal expanded by 0.4 percent, pretty much in line with the other three quarters. The Netherlands also bounced back after a poor third quarter, posting a rate of expansion of 0.5 percent. For all their size as the first and third largest economies, Germany and Italy look like the exception rather than the rule.
Policy makers across Europe will take a very close look at the economic indicators at the start of this year to understand whether the downturn will worsen. In particular, the European Central Bank will be watching like a hawk: In the second half of 2018, it started to scale back its monetary stimulus, stopping its net asset purchases at the start of 2019. There are now questions about whether that was the right decision.
The ECB can take heart from the euro zone labor market, which continues to strengthen both in terms of employment and of wages. This should offer continuous support to domestic demand. However, the central bank has to balance this with risks from abroad, including a slowdown in China and the trade war between Beijing and Washington. All of this has important knock-on effects on business confidence, with entrepreneurs putting investment on hold as they wait for greater clarity.
Europe’s uneven picture suggests that there is a problem with the growth model of some countries as opposed to the bloc as a whole. In Italy, the fiscal plans of the new populist government have pushed up bond yields, contributing to a reduction in the flow of credit. Domestic demand fell in the fourth quarter, showing that consumers and entrepreneurs are being cautious. Meanwhile, Germany’s export-driven growth model is facing its biggest test in decades as Berlin discovers it is vulnerable to the global trade outlook and China’s economic fortunes. But unlike Italy, the country has scope to boost growth by raising public investment: Such spending would provide short-term relief and help to re-balance the economy towards domestic demand.
The world is right to look at Europe’s slowdown and wonder what is going on. But, as often in the past, it’s hard to find a single explanation. The strength of Europe is its variety; it can also be its weakness.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Ferdinando Giugliano writes columns and editorials on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.
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