Another View of the Lost Continent

I have been warning for a long time that Europe is in long-term decline, losing its position alongside North America, Australia and North East Asia as the world’s most prosperous regions. I have warned that Europe is turning into an economic wasteland and explained that nothing is going to change so long as the governments of Europe’s welfare states continue to use austerity to defend their big, redistributive entitlement systems.

This trend of stagnation and decline is not new to the current economic crisis – in some countries it began showing itself as early as the 1980s – but the last five years have put enough nails in Europe’s prosperity coffin to transform the continent into a new South America.

I have been pointing to this serious, structural decline for almost two years now. So far, my warnings have not been heard very widely, but now some people are beginning to see the same pattern. One example is Dan Steinbock, research director at the India, China and America Institute, who just published an opinion piece in the EU Observer. He starts out with a somewhat hopeful observation:

The second quarter GDP figures for the Euro-area economies indicated growth, for the first time in 18 months. Some fund managers and market observers argue that positive new developments could unleash a long-term rally for the continent.

And those fund managers are wrong. Taxes have gone up and government spending has gone down. The private sector has to replace what government is no longer spending money on, with higher-taxed incomes, while still maintaining all its other spending. How is that a recipe for a “long-term rally”?

Steinbock seems to want to agree, at least in part, with the fund managers:

While there are some signs of possible recovery, Europe’s debt crisis has not gone away. … The US economy may soon be ready for a gradual, multi-year exit from QE. Southern Europe certainly is not. And yet, current forecasts portray 2013 as the magical year when everything will turn for the better.

Go back and look at forecasts over the past 3-4 years. Eurostat, OECD and others have consistently been over-optimistic as to where the European economy was heading. The main reason is that they think austerity is good for the economy. So long as they believe that they are going to continue to portray every “next year” as the one where the flowers start blooming again in Europe.

The reason why economists continue to miss the forecasting mark is that they have not done their theoretical homework. They know how to run all kinds of regressions, up and down, sideways, inside out, even in zero gravity, but they treat the economic system as mechanical pieces in hydraulic interaction, not the complex social, cultural and moral system it really is.

Steinbock again:

In the past year or so, the backlash against austerity in Southern Europe has resulted in policy shifts, which, in turn, have supported greater stability, less severe contractions and an improved sentiment across the region. None of these gains indicate a major turnaround, but alleviation of single-minded austerity measures that have added to European challenges.

Again, he is too optimistic. The Greeks are still pushing more austerity measures, and Portugal is in political turmoil over more austerity. Not to mention France – which Steinbock does:

Despite the shift from the conservative Sarkozy to the socialist François Hollande, the competitiveness of France continues to erode. While Paris is slowly moving toward reforms, it is lingering in contraction and can hope for weak growth in 2014, at best.

May I recommend this article, which I published two days ago.

Back to Steinbock, who continues his somewhat optimistic review before eventually turning pessimistic:

Italy has been ridden by contraction for nine consecutive quarters. Enrico Letta’s government has been strong enough to stay in power, but too weak to achieve major changes. The more flexible approach to austerity across the Eurozone has benefited Italy and may allow Rome’s exit from the excessive deficit procedure (EDP) in 2014. But Italy suffers from structural challenges, which translate to continued decline of industrial production and the end of the Letta government by 2014. After half a decade of recession, Spanish conditions are now bad but not devastating, as the austerity obsession has given way to more realistic policies. … In Portugal, the recession will continue until 2014, which means that unemployment will remain close to 20 percent. In July, the resignation of two ministers led to a new cabinet. Greater flexibility in austerity measures and rising sentiment are softening the contraction impact.

Let’s not get ahead of ourselves here. The prime fiscal policy directive in Europe, and especially in Spain, Portugal, Italy, France and Greece, is still to balance that pesky government budget. This means that all other policy goals, such as growth in GDP, reduced unemployment or increased private consumption, are ranked below that goal. Every policy measure is evaluated first and foremost on its potential for bringing down the deficit, and only secondarily on whether or not it can help the economy grow.

Whatever leniency Steinbock is detecting in terms of austerity is more political trickery than signs of a real change in fiscal policy. This means that the economies in Southern Europe will still be under great pressure.

Steinbock then turns to Greece, which, he says…

will be in recession well over the mid-2010s, despite additional funding by Brussels. Unemployment is over 26 percent. Political turmoil is likely to increase toward 2013/2014. A government collapse could pave way to the radical left coalition Syriza, as the leading political party.

Probably. But don’t disregard the possibility that Golden Dawn will team up with the Greek military and force an equally radical political change onto the country.

And now for the more pessimistic, bigger view of the Lost Continent:

[The] Eurozone is suffering a lost decade, which could have been avoided with more sensible policies. During the past half a decade, prosperity levels, as measured by per capita incomes, have stagnated or fallen across Southern Europe. In this way, they have amplified the historical trend line. … By the end of the 2010s, a new hierarchy will prevail in Southern Europe. In France, per capita income is likely to be slightly behind that of Germany. In turn, income per capita in Italy (80% of French GDP per capita) and Spain (70%) will fall behind. Before the global recession, prosperity levels in Greece and Spain were not that different. However, the past half a decade has been devastating in Greece. By the end of the 2010s, Greek per capita income will be close to that in Portugal. In these two countries, prosperity will be barely half of that in France.

This is a bit vague, as Steinbock does not explicitly define the term “prosperity”. It appears to be per-capita GDP, in which case it makes a great deal of sense to compare countries. However, even more important than the relative growth in GDP is the performance of each country: the Greek loss of 25 percent of its GDP in a matter of a few years is completely devastating and unheard of in the Post-World War II industrialized world. It is examples like Greece that can teach us something about what we should and should not try to do to fix an economic crisis.

Steinbock’s main point, again, is that economists are overly optimistic in forecasting Europe’s future. This is a point worth repeating, and the consequences of erroneous forecasts definitely deserve a mention:

At Brussels, the current forecasts – including projections of per capita income, debt, unemployment – are predicated on the idea that 2013 is the year of the great turnaround, when debt will start to decline, recovery will broaden, per capita incomes will climb and high unemployment rates are expected to decrease by some 20 percent by 2018. These gains are anticipated, even despite the impact of aging populations on productivity and growth, and thus on prosperity. In reality, Southern Europe is coping with long-term erosion, which has been compounded by excessive reliance on austerity, at the expense of fiscal support, pro-growth policies and structural reforms. There is no easy way out anymore.

That is entirely correct. The solution lies in those “structural reforms”, the most important of which means dismantling the welfare state – it is the only way out of the prosperity shadow-realm where Europe now finds itself.