The European economic stagnation is now becoming a concern for the rest of the world. The OECD – Organization for Economic Cooperation and Development – is sounding the alarm in their latest Economic Outlook. From their news release:
The Economic Outlook draws attention to a global economy stuck in low gear, with growth in trade and investment under-performing historic averages and diverging demand patterns across countries and regions, both in advanced and emerging economies.
Put bluntly, the EU with its 500 million residents and supposedly first-world standard of living is spreading its stagnation to other countries and continents. An economy that is not growing is not growing its imports; it offers fewer, and less profitable, investment opportunities than a growing economy.
Many emerging economies have their own problems to deal with, from a heavy-handed government in India and clumsy deregulation in China to dangerous political corruption and violence in South Africa. But there is no doubt that entrepreneurs in those countries who can participate in global trade would be much more able to make a difference for the better if they had a growing global market on which to sell their products. While the U.S. economy sticks to its lazy recovery – the latest job numbers are moderately good but not exciting – the Japanese upturn is still fledgling. But the big drag on the global economy is, no doubt, Europe.
The OECD notes this…
“We are far from being on the road to a healthy recovery. There is a growing risk of stagnation in the euro zone that could have impacts worldwide, while Japan has fallen into a technical recession,” OECD Secretary-General Angel Gurria said.
…but when it comes to prescriptions for what to do about this, the OECD falls short. Before we get there, though, it is important to note one aspect of the OECD report that hints of what kind of solutions they may be prescribing:
The euro area is projected to grow by 0.8% in 2014, before slight acceleration to a 1.1% rate in 2015 and a 1.7% rate in 2016. A prolonged stagnation in the euro area could drag down global growth and have knock-on effects on other economies through trade and financial links. A scenario in the Outlook shows how a negative shock could lead an extended period of very low growth and very low euro inflation, resulting in unemployment remaining at its current unacceptably high level.
I have lost count of all forecasts over the past two years that predict a rising GDP growth rate for the euro zone or the EU as a whole. The reason why so many economists make these predictions is that they base their modeling on the standard notion that every economy eventually, long term, gravitates back toward full-employment equilibrium. They are no doubt mystified by the protracted nature of the current European crisis, but instead of rethinking the fundamentals of their forecasting they stick to their default, which is a long-term full-employment equilibrium.
This is, however, not a regular crisis that allows itself to be analyzed in terms of standard macroeconomic models. It is a structural crisis, systemic in nature and by default perennial in duration. Its cause is a permanent imbalance between government-promised entitlements and the ability of the private sector to pay for those entitlements. This imbalance will remain forever unless Europe’s legislators actively reform away entitlements and alleviate the burden of the welfare state on the shoulders of the private sector.
In short: it does not take another negative shock to keep there European economy depressed forever. All it takes is absence of drastic structural reform.
That, however, is not what the OECD is prescribing:
“With the euro zone outlook weak and vulnerable to further bad news, a stronger policy response is needed, particularly to boost demand,” said OECD Chief Economist Catherine L Mann. “That will mean more action by the European Central Bank and more supportive fiscal policy, so that there is space for deeper structural reforms to take hold. A Europe that is doing poorly is bad news for everyone.”
More action from the ECB? Let’s look at some recent annual growth rates in euro-zone M1 money supply, courtesy of the European Central Bank, and current-price GDP growth, courtesy of Eurostat:
Current-price GDP growth represents growth in money demand. The liquidity pumped out by the ECB in excess of that goes straight into the financial system where, to be a bit crude, it will slush around in search of profitable investment opportunities.
For example, in 2013 the ECB printed €7.36 for every €1.00 in increased current-price GDP. Technically this adds €245 billion of liquidity into the financial system. The result of this monetary policy, zero to negative interest rates, has not made a bit of a difference to the euro-zone economy.
As for the fiscal-policy part of the OECD recommendations, this would take a complete abandonment of welfare-state saving austerity. Are the Europeans ready to do that? And more importantly: are they ready to use active fiscal policy to roll back government and provide more growth room to the private sector?
So far, neither the EU Commission nor key member-state governments have showed any inclination in that direction. But I am not even sure the OECD actually would recommend the right kind of fiscal policy; the farthest they would go is probably a traditional mainstream-Keynesian fiscal stimulus. That would only serve to preserve status quo.
With all this in mind, though, it is good that the OECD is now waking up to the European crisis. Next step is to lead them to the right conclusion as to the nature of that crisis…