Euro-Dollar Parity, Part 2

Earlier this week I summed up some recent observations of macroeconomic differences between the United States and Europe. Those differences, which explain why the euro has plunged from $1.39 in May last year to its current $1.06, are not going to go away any time soon. I recently did an overview of the fundamentals that constitute the strength of the U.S. economy (see part 1, part 2, part 3 and part 4); today’s article takes a closer look at the European economy.*

As the latest national-accounts data from Eurostat reports, the European economy remains in a state of de facto stagnation. According to inflation-adjusted numbers, GDP growth for 2014 stood at 1.3 percent; while much better than 0.04 percent for 2013, a closer examination shows that it is neither impressive nor sustainable.

Unlike the growth in the U.S. economy, which originates in sustained growth of domestic, private-sector activity, Europe’s increase in growth is driven primarily by exports. In 2013 exports from the European Union grew by 2.16 percent in inflation-adjusted numbers, a number that increased to 3.53 percent in 2014.

There is a sharp contrast between these growth numbers and those for private consumption: -0.1 percent in 2013 turned into growth of 1.29 percent in 2014, hardly an impressive number.

To further emphasize the role of exports for Europe, consider the strong correlation between exports and business investments, vs. the apparent absence of consumption-investment correlation:

EU C I X

Since private consumption barely moves, businesses have no reason to invest for the domestic market. They therefore tailor their business expansions – to the extent such expansions take place – to fluctuations in foreign markets.

The dependency on exports is even more apparent at the member-state level. Over the past two years, exports has been the leading absorption variable in 17 of the 26 countries included here (Ireland and Luxembourg have not yet reported fourth-quarter data). In five of the countries exports was the only absorption category that shows any growth; in Spain private consumption barely squeezed into positive territory:

Consumption Investm. Govt cons. Exports GDP avg
Greece -0.31% -3.45% -3.61% 5.37% -1.59%
Croatia -0.94% -2.55% -0.67% 4.86% -0.68%
Netherlands -0.74% -0.76% -0.15% 2.99% 0.03%
Italy -1.24% -4.58% -0.60% 1.57% -1.06%
Cyprus -2.80% -18.00% -6.54% 0.39% -3.81%
Spain 0.09% -0.21% -1.41% 4.24% 0.07%

The long-term trend of growing dependency on exports is visible across the board in the EU. From 2011 to 2014 (4th quarters), exports share of GDP increased in 23 of the 26 member states included here.

While there is nothing wrong inherently with growing exports, there is a problem when an economy almost entirely depends on exports. Contrary to prevailing wisdom among, primarily, European economists there is no lasting positive “multiplier” effect from exports to the rest of the economy – except, as mentioned, the business investments that relate specifically to exports.

The lack of positive multiplier effects from exports to, e.g., private consumption is reinforced by the fact that government spending is the strongest or second-strongest growth variable in 15 of the 26 countries. This is remarkable: for all of EU-28 government absorption grew at an annual rate of 0.6 percent per year over the 2013-2014 eight quarters. The fact that this was enough to finish second speaks volumes to the overall weakness of the European economy.

So long as this weakness remains, there will be no reversal of the long-term decline of EU economy.

*) Eurostat, 2005 chain-linked national accounts data.

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