Exports Drive Weak EU Recovery

In an article commenting on the latest Eurostat GDP numbers, Euractiv,com proclaims:

Eurozone employment rose for the second consecutive quarter in the first three months of the year in a sign the recovery was finally helping the labour market. A widening trade surplus signalled a further positive contribution to growth in April.

The article goes on to report an upward trend in economic activity for the European Union. As readers of this blog know, however, such optimism should always be consumed in moderate portions. Far too many commentators, political analysts and policy leaders have far too often declared the European crisis over, and far too many of them – all, in fact – have been wrong. Therefore, let us dive into the most recent national accounts numbers from Eurostat and see what they can tell us.

In the first quarter of 2014, the total EU economy grew at an inflation-adjusted 1.4 percent over the same quarter 2013. This is the strongest growth number since the third quarter of 2011. For the 18-state euro zone, growth was not as good: a meager 0.9 percent, which again is the best number since the third quarter of 2011.

These are not growth numbers to write home about, but the fact that they are the best in 2.5 years is at least worth a note. But what is perhaps the most remarkable news in this is that the EU and the euro zone have gone two and a half years with growth below, respectively, 1.4 and 0.9 percent. In fact, the average annual growth rate for 2012 and 2013 was -0.16 percent for the EU and -0.54 percent for the euro zone.

So does this mean that Europe is now finally seeing the light in the tunnel? Not so fast. First of all, the big problem for the European economy, the welfare state, remains in place, not unscathed by the economic crisis but vigorous enough to continue to weigh down the private sector, and in fact make life even worse for taxpayers in the future. Austerity has changed the presence of government in the economy by raising taxes and cutting spending, to a point where it will start net-taxing the economy through budget surpluses far earlier in the economic recovery phase than previously. This will stifle growth and contribute to long-term economic stagnation.

There is another, even more important reason to believe that this is not the beginning of a sustained recovery. The largest component of the European economy, namely private consumption, grew more slowly than GDP did: 0.7 percent in the EU and 0.3 percent in the euro zone. This means that households remain either heavily economically depressed by the lingering effects of austerity, or that austerity has scarred their outlooks on the future (or both). They are therefore holding back consumption as best they can. Until households recover and restore their faith in the future, there will not be any sustained economic recovery.

Business investments grow faster than private consumption: up 3.5 percent in the EU and 2.3 percent in the euro zone. With private consumption growing as weakly as it does, this investment boom must have an external reason.

And it does: exports are up 4.1 and 4.0 percent, respectively in the EU and the euro zone. This may look like a jackpot for the European economy, as sharp increases in exports should lead to significant multiplier effects out to the rest of the economy. So far, it looks like that is true to some degree, as gross fixed capital formation (investments) is rising as fast as it is. However, even if these are the largest investment growth numbers since the start of the Great Recession, it is crucial to keep in mind that investments have declined, in inflation-adjusted terms, in four out of the last five years. At some point businesses simply have to replace aging equipment.

With the European Central Bank trapping the euro zone in an abundance of liquidity, this is indeed a good time to do it. But even when you pay almost no interest on your loans, you still have to make loan payments. If it was not for the rise in exports, Europe’s businesses would have relatively weak reasons to invest. But combined with the weak numbers for private consumption this means that the exports-investment “boom” may very well be isolated from the rest of the economy.

A further indication of this is that imports have grown basically on par with exports: in the EU with its 28 member states imports and exports grew at exactly the same rate, namely 4.1 percent. In the euro zone imports grew at 3.9 percent, a tenth of a percent behind exports. Since private consumption is growing slowly – much more slowly than imports – it is very likely that the increase in imports is directly related to the growth in exports. Manufacturers in Europe buy raw materials and intermediate products from low-cost suppliers outside the EU (with north and east Africa becoming increasingly important here), bring them in, assemble more advanced products and ship them off to a slowly recovering U.S. market, but also to still-growing Pacific Asia.

Due to the direct dependency on foreign trade, this is a dicey way for an economy to recover. The Chinese economy is increasingly troubled, especially by a looming real-estate crisis. Japan is on the rebound – their annual GDP growth rate has been accelerating for five quarters in a row now – and their appetite for imports is growing even faster. However, that is not enough to sustain an exports boom in Europe, especially not since Europe is increasingly burdened by high energy prices compared to competitors in North America.

Add to that the high taxes that keep household consumption down, and the case for a sustained recovery remains as weak as I have explained before.

One last point that adds to my forecast of continued stagnation in Europe: consolidated government consumption grew by 1.3 percent in the EU and 1.0 percent in the euro zone. Compare these numbers to the 0.7 and 0.3 percent, respectively, by which private consumption increased, and we have a case of continued government dominance over the domestic economy.

With government spending growing 1.8 to 3.3 times faster than private consumption (EU and euro zone respectively) Europe is simply cementing its place in history as the birthplace of the welfare state, and the economic wasteland created by it.