Until recently, exports have driven growth in the Eurozone, but the recovery’s moderate pace suggests that more growth will come from consumer demand and investment.
In the first quarter of 2014, the recovery in the Eurozone that started last year continued and consolidated. That the recovery has withstood economic turbulences in the emerging markets and geopolitical crises in the immediate neighborhood of the European Union speaks for a fairly robust and intact growth trend.
This recovery will be quite different from usual recoveries, however. How it will develop and how strong it will be is substantially shaped by the legacy of the financial and euro crises. The ongoing deleveraging processes, difficult financing conditions in parts of the Eurozone, low credit demand from firms, and low investment activity are the background against which the recovery has to unfold.
Varieties of recession
One of the enduring legacies of the financial crisis is the degree of divergence in economic development in the Eurozone. Originally designed to create a unified economic area with synchronized business cycles, the Eurozone actually developed in the other direction during the crisis. The recession had a remarkably different impact on the Eurozone members, to the point that Eurozone averages have become increasingly misleading. Figure 1 shows the average GDP and employment growth over 2008–2013.
The crisis countries—Greece, Spain, Portugal, and Ireland—show an extremely negative performance on both dimensions; their economies shrank substantially and lost employment in a dramatic way. Italy too has seen a shrinking economy and decreasing employment. France and the Netherlands have, by and large, stagnated in the last five years, while the central European countries, particularly Germany and Austria, could grow moderately and build up employment.
The contours of the recovery
The recession in the Eurozone as a whole ended in Q3 2013. Disaggregating the growth performance of the Eurozone shows that the only GDP component that has continuously contributed to growth since 2009 has been exports. Investments and consumption turned negative in the first half of 2011 and remained so for more than two years. It was only in the last quarters of 2013 that investment and consumption crossed the threshold separating negative from positive contributions. Their revival in 2013, in some cases driven by rising exports, has been crucial for the end of the recession.
The good news for the Eurozone is that in 2014 the recovery will continue to broaden. Consumption and investments will increase, making the Eurozone recovery less dependent on international markets. Investment propensity is on the rise, crucially supported by a more stable environment within the Eurozone and historically low interest rates. At the same time, many companies, especially in Central Europe, have successful years behind them and increasingly see investment opportunities for their accumulated reserves. For example, German companies intend to use their accumulated reserves in 2014 mainly for domestic and foreign investments, according to the Deloitte CFO Survey.
The projected upswing for consumption in the Eurozone is more surprising, given that unemployment is still at record levels. Consumer sentiment has increased and is at a six-year high for the Eurozone as a whole (see figure 3). While German consumers are highly confident, Spanish consumer sentiment is now in positive territory, for the first time in seven years. The reasons might be due to consumers’ perception that the main part of deleveraging is over or that a turning point for the labor markets is near. Not only is consumer sentiment on the increase, but consumers are also more optimistic about their financial situation over the next 12 months.
Varieties of recovery
The diversity of the Eurozone economies, which became apparent during the recession, will not disappear during the recovery. Behind the Eurozone averages are still substantial differences. The outlook for the four biggest Eurozone economies is therefore mixed.1
Germany is likely to experience a continuing shift in growth dynamics. While exports drove German growth in the years after the financial crisis, this has been changing. In 2013 it was consumption that drove the meagre growth rate of 0.3 percent, while the growth contribution of exports and investments was negative. In 2014, exports are likely to rise, but imports will rise even faster so that the external growth contribution will again be negative. Growth impulses will mainly come from the domestic economy. Consumption will continue to increase, driven by wage increases and a very robust labor market. The main growth contribution in 2014 will come from investments. The investment propensity of German firms is increasing and should be reflected in a substantial improvement in investments. In short, growth in Germany in 2014 should hover around 2 percent.
The situation in France is different. After a strong second quarter in 2013, falling exports and decreasing investments weighed on growth. Investments and exports are likely to recover slowly in 2014 too and will only very moderately contribute to GDP growth at most, while high unemployment and low wage increases depress domestic demand. Public investment and public consumption will stabilize the economy, but this is unlikely to be enough for a strong recovery. Growth in 2014 should be mildly positive and, depending mainly on demand, be somewhere between 0.2 percent and 1 percent.
Italy faces similar difficulties as France. It has been in recession since 2011, shrinking by 1.9 percent in 2013. Difficult financing conditions and uncertainty about the future course of economic policy are holding back investments, while exports do not foster growth. Demand suffers from high unemployment and the government has very little room to stimulate the economy, given the extremely high level of public debt. As a consequence, projections assume either stagnation or meagre positive growth up to 0.6 percent.
Spain enjoys a relatively positive outlook, compared to previous years. Although the deleveraging process is far from over, and unemployment is still extraordinarily high, it seems that Spain has reached a crucial turning point. The economy stopped shrinking in the second half of 2013, and the effects of the reforms undertaken started showing results: They lowered unit labor costs, and Spain managed to increase its exports by almost 5 percent in 2013. These export successes increasingly spill over to the domestic economy, leading to small positive growth contributions of consumption and investment. Overall growth in Spain is likely to be in the region of 1 percent in 2014, meaning that Spain will grow again after several years of a shrinking economy.
The recovery in the Eurozone is ongoing and it is progressing at different speeds and degrees of strength across the region. For the Eurozone as a whole, this adds up to a moderate recovery.
The recovery in the Eurozone is ongoing and it is progressing at different speeds and degrees of strength across the region. For the Eurozone as a whole, this adds up to a moderate recovery. Whether a moderate recovery is reason to cheer or to be disappointed depends on the basis of comparison. It is a more-than-welcome development when compared to the previous recession; however, the recovery is developing much more slowly than usual recoveries due to the legacies of the financial crisis. The return to strong growth will be a long and windy road, but a consolidating recovery is a good basis.
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- For details, see “The EEAG Report on the European Economy: The road towards cohesion” by CESifo’s European Economic Advisory Group and “European economic forecast: Winter 2014” by The European Commission.