Brendan Keenan: ‘Europe’s slump looks steeper and faster than the raw numbers suggest’

Europe

Much has been written about the slowdown in the EU economies but the graphics in last week’s IMF report on Europe brought it home, well, graphically. It has been quicker and steeper than a quick reading of the numbers might convey.

There has been a twin peak recovery since 2013, but the second upturn ended in 2017 with a rapid slowdown in the growth of manufacturing output last year and an actual decline in production from last summer.

Europe is a disparate region, with considerable differences in productivity between west and east, north and south. The IMF differentiates between ‘advanced’ and ’emerging’ Europe.

While growth forecasts for the former have been revised down by 7pc to 1.3pc, emerging Europe’s prospects have been ticked up 40pc to 1.8pc.

The advanced economies make up the bulk of the region but the present situation is unusual. Italian growth averaging less than 1pc a year unfortunately does not come as a surprise, but the 1pc average for Germany from 2018-22 certainly does.

Germany is still the world’s most ‘advanced’ manufacturer. A remarkable 20pc of that is production of the ultimate consumer good, the automobile. There is a serious slowdown in global sales, with the car industry accounting for three quarters of the decline in EU manufacturing in the first half of this year.

Within those figures is a strange tale – one with particular resonance on the 30th anniversary of the fall of the Berlin Wall. The German and British industries were responsible for most of the decline, but output increased in the new member states in the east.

It is a far cry from the world behind the wall in 1989, and a reminder of the oddities of German reunification, with little of that new industrial base in east Germany itself. Of course, nearly all the eastern car plants are owned by western firms.

But even if, like me, you prefer Skodas to Volkswagens, there are other signs that these are not just cheap assembly plants.

Industry reports suggest the slowdown in Germany has had a limited effect on supply chains in the east, partly because such suppliers have been able to adapt and reorient to other models, and plants outside Germany.

As for Britain, the one percentage point fall in car production over the past two years is exceeded only by Germany. It’s Brexit, stoopid. The report is a reminder that the European economy is probably in the weakest condition in six years to absorb the shock of a no-deal UK exit.

Ireland’s trade exposure to the UK of 11pc of GDP stands out like a very sore thumb in the graphics. Belgium’s 5.5pc share has a lot of tax manoeuvres in it, but there is more substance in the Netherlands’ 5pc exposure and more again in Germany’s 3pc. Quite apart from the Irish backstop, British politicians underestimated the limitations on the EU’s horse-trading capacity, but we should be under no illusions.

Should the EU economy be having the jitters when crunch time comes, there will be enormous pressure to avert even a hard Brexit, still less no deal.

And it could well be having the jitters. The report forecasts a modest recovery to 1.8pc next year for the European region as a whole. Trade tensions may ease.

The signs are that Donald Trump would prefer to be able to claim whatever victories he imagines in the trade war with China, rather than have the messy reality of it continuing during the presidential campaign.

But the list of things which will act as a drag on Europe looks more impressive than the possible gains. The car market may stay weak, with the main market – China again – looking close to saturation.

The downturn has been led by investment, which tends to be slower but more persistent than weak personal spending.

There are fears that services, which are mainly driven by consumption and make up 30pc of value-added, could follow manufacturing into decline. The IMF analysts recognise that this could happen sooner and quicker than expected.

Given the UK opinion polls, another outbreak of Brexit hostilities under an insecure government seems all too probable.

Germany is still the key, because of its size, and companies are already uneasy.

The famous ‘Hausfrau’ may not worry too much about Britain but she is very sensitive to any signs of trouble in her own land.

She also worries about what those doubtful foreigners are doing to her currency – a worry she shares with the German representatives at the European Central Bank (ECB).

The arguments so far have centred on attempts to avoid recession and stimulate growth in the euro area. They will be far more intense if the issue is dealing with an actual recession.

This is the well-recognised problem of the limits on central bank action because, in the eurozone’s case, basic interest rates are already negative, with lenders paying for the privilege of having the ECB or the German government borrow their money.

There are lots of ideas on why this strange state of affairs came about, but not many on what should be done about it.

The 2010 suggestion of ‘helicopter money’ has made a reappearance, where the ECB would create cash for the use of governments rather than banks, as in quantitative easing (QE).

Germany lost the QE battles with Mario Draghi. The politically experienced but technically under-qualified Christine Lagarde is unlikely to have the same success, even over more QE, whose effectiveness in a new recession must be doubted, never mind helicopter money.

For want of anything better, the mantra is more government borrowing, beyond the automatic increases caused by higher unemployment and slower tax revenues.

But the idea espoused by some economists, that governments should be as radical with fiscal policy as central banks have been with monetary, is still out of bounds.

Those countries with ‘fiscal space’ should borrow more if a downturn comes, says the IMF, but those already heavily in debt should pretty much stand still; even continue with debt reduction, although perhaps more slowly. It hardly sounds like a recipe for effective action.

Trump and Chinese president Xi Jinping are doing their best, with deficits of 4.5pc of GDP. Given the size of those two economies, that is a lot of stimulus (and China’s deficit may be bigger). But how much bigger could they get to combat a recession of the kind postulated by the IMF; led by falling investment, a flight from risk and a tightening of global financial conditions?

By contrast, the eurozone’s deficit as a whole is just 1pc of GDP. The half percentage point surpluses of Germany and the Netherlands contribute greatly to that, although the poor old Greeks are doing their bit with a 0.3pc surplus.

A rise in the eurozone deficit to US levels would indeed be a great help in a recession, but the countries with fiscal space are very unlikely to accept the scale of borrowing which would be required of them.

A rerun of 2010, when the eurozone response was so feeble, looks all too likely.

But at least the crisis may not be as severe – or so we hope. The alarming thought is that the methods used, especially by central banks, to combat the Great Recession may have helped create the conditions for another one.

Like 2006, there is lots of talk about the dangers but no consensus on how real they are, and even less on what should be done about them. Here in Ireland, the effect of low interest rates on property prices could not be more obvious. So are the fundamental shifts in wealth, living standards and property ownership, with unknown social consequences.

This was not policy but it is the result of other policies. Although central banks are not wholly, or even mainly, responsible for low interest rates, it is clear that they fear the effects of trying to increase them.

Understandably so. Any sharp interest rate rises, whether intentional or accidental, would crater the value of property, shares and bonds, as well as directly hitting growth. The size of the resulting damage to banks and government balance sheets can only be guessed at.

As in 2006 with its derivatives, we are left with little more than the hope that what could happen won’t. There have been many learned discourses on why this is a structural shift and the new, historically unique, conditions are permanent. Which sounds uncomfortably like ‘this time, it’s different’.

Indo Business

Leave a Reply