Wishful Recovery Thinking in Europe

Don’t get me wrong – I would be thrilled if Europe could enter a phase of solid growth and sustained recovery. But having studied the European crisis in depth over the past two years (with a book due out in July) I also know what it takes for that economy to recover. So far I do not see anything that tells me it is happening, and I certainly do not see the political open-mindedness needed for the Eurocrats to enable a recovery. On the contrary, I see Europe’s political leaders play “Where’s Waldo?” with the economic recovery. On February 25, the EU Observer declared:

The EU’s economic recovery will gather speed in 2014 and 2015, the European Commission predicted on Tuesday (25 February), indicating that the worst of the economic storm which hit Europe is over. “Recovery is gaining ground in Europe,” economic affairs commissioner Olli Rehn told reporters at the European Parliament in Strasbourg, saying that the EU economy would grow by 1.5 percent in 2014 and 2 percent in 2015. The recovery would be driven, in the main, by increased domestic demand and consumption, as Europeans and businesses become more confident about their economic prospects, he added.

Then today, EUBusiness.com reports:

The European Central Bank on Thursday raised slightly its growth forecast for the euro area this year, but trimmed its forecast for inflation. ECB president Mario Draghi told a news conference that the central bank is pencilling in economic growth of 1.2 percent in 2014, 1.5 percent in 2015 and 1.8 percent in 2016. That represent a fractional upward revision of 0.1 percentage point for 2014, compared with the ECB’s previous projections published in December, Draghi said.

Of these two sources, it would be wise to trust neither. They have both presented spiced-up growth forecasts more times in the past few years than anyone cares to keep track of. But there is no doubt that of these two institutions the ECB possesses the better tools to be fairly accurate.

That said, there are a few items in the way of a recovery, even at the very modest numbers that the ECB foresees. According to the EU Business article, the central bank predicts that

External demand would benefit from the global recovery gradually gaining strength. Domestic demand was expected to benefit from improving confidence, the accommodative monetary policy stance and falling oil prices which should lift real disposable incomes. “Domestic demand should also benefit from a less restrictive fiscal policy stance in the coming years and from gradually improving credit supply conditions,” the ECB said.

The phrase “in the coming years” is critical. So far there has not really been any change in fiscal-policy preferences in the EU generally. Greece is still under austerity pressure, and the French government has gone on a fiscal rampage through the economy, spearheaded by outright confiscatory income taxes. If the EU declared an unequivocal austerity cease-fire, then the member states would stand a chance of getting somewhere down the road of a recovery.

As things are now, it is simply not credible to forecast a recovery. Unemployment numbers point toward a state of stagnation at best, and as I explained on February 17, a more comprehensive look at the European economy suggests stagnation, not recovery.

Since then, Eurostat has released quarterly GDP growth rates for the last quarter of 2013. For the EU-28 there is a little bit of good news: growth was 1.1 percent, adjusted for inflation, over the fourth quarter in 2012. It is the highest quarterly growth rate in more than two years, but it does not give us a full picture of what is actually happening on the ground. Eurostat has so far only released state-specific data for 18 of the EU’s 28 member states, but practically every one of those states reports an increase in year-to-year growth for the fourth quarter of 2013 compared to the third quarter of 2013.

Taken together with the less-disastrous numbers for the third quarter, the fourth-quarter numbers could be interpreted as an emerging recovery trend. However, as this figure shows, EU GDP growth has fluctuated rather violently over the past few years, and even sustained above two percent for a while, without any trend emerging toward an economic recovery:

qwerty

If, as the ECB says, the recovery depends primarily on a better global economy, then we are back to the case of an exports-driven turnaround for the European economy. As I explained last summer, it is practically impossible for exports to pull a modern economy out of its slump.

But even more important than this is the fact that the Europeans have re-calibrated their welfare states. The in-depth meaning of this will have to wait until another article; the short story is that government budgets in many European countries now balance at a lower activity level. As a result, it takes less growth in GDP to generate a budget surplus, a surplus that constitutes a net drainage of money from the private sector to government – where it is not spent. This puts a dampener on GDP growth, and it also leaves more workers idle as it takes fewer workers to produce the taxes that government needs.

The re-calibration of the welfare state is a result of austerity and an important reason why Europe is facing stagnation, not a recovery.

One comment

  1. Pingback: Stiglitz Performs Inflation Raindance | The Liberty Bullhorn