For international investors figures don’t lie. The recovery in Europe overall is grinding to a halt. The Euro-zone grew just by 0.2% in the first quarter of 2014. That would only be 0.8% at an annual rate. The bright spot at the beginning of the year was Germany. The German economy had expanded at a rate of 0 .7% in the first quarter. As the 4th largest economy in the world and the biggest economy in the Europe, growth there was vital for overall recovery. Yet the second quarter in Germany saw growth in GDP (Gross Domestic Product) decline to -0.2. This helped bring the economy of Europe to a standstill.
There were a few stars in the second quarter. The Netherlands and Portugal registered growth rates of 0.5% and 0.6% respectively. Both of these countries were able to reverse the contractions of GDP in the first quarter of 2014. Spain which had grown by 0.4% in quarter 1 was able to boast a growth rate of 0.6% in quarter 2.
France second largest economy in the common currency zone, continued to see no growth what so ever. It is important to remember that Germany’s largest trading partner is France.
Italy third largest economy in the Euro-zone has now entered a triple dip recession with GDP slipping another 0.2% in the second quarter.
Growth in Europe in general, has become more dependent on Germany. This is somewhat of a problem for the continent. The German economy is the second largest exporter in the world. One-third of the national output originates from exports. The export of high added value products has been the main driver of economic growth in the last few years. Since the rest of Europe are the major trading partners of Germany, stagnation in the leading economies in this geographic area will have a major impact on the German economy.
Analysts will look to some short term explanations to be sure. The slowdown in Germany is being blamed on a fall in construction. The decline in this sector was a result was the surge in the first quarter brought on by the mild weather of the preceding winter. Some are pointing at extra time that workers in Germany and elsewhere took in conjunction with national holidays. Although these accounts are all true, these cannot fully explain the sluggish growth in Europe.
A major hit for the economies of Europe will be the heightening tension with Russia over the issue of the Ukraine. Sanctions being placed on Russia and the retaliation that the government there is placing on trade with Europe, will definitely have an adverse effect on economic growth. This will particularly true for the Germans who are quite dependent on Russian natural gas imports. Germany is Russia’s largest trading partner in the European Union.
Britain outside of the common currency zone was able to report growth in the second quarter of 0.8%. The last time the economy in the United Kingdom (UK) grew as rapid was in the third quarter of 2007 which was before the financial crisis. The size of the GDP has finally moved ahead of what existed before the meltdown of 2008. It is only a slight gain of just 0.2% but overall growth for 2014 is now projected to be 3.1% to 3.2%. It will be the strongest growth rate in over six years. However, the question arises is growth in the UK sustainable if the rest of the continent of Europe slips into recession? This along with increasing tensions with Russia will definitely have an impact on the British economy, especially in the red hot real estate market in London. This financial behemoth has become a favored place for wealthy Russians to invest in property.
Another trend that is troubling for Europe, especially in the Euro-zone is deflation. This is true because of the large public and private debt, that exists in some many countries across the zone. It is not an idle fear, prices are already falling in Greece, Cyprus, Portugal, Lithuania, and Bulgaria. The countries of Spain, The Netherlands, Slovakia, the Czech Republic, Sweden, Italy, Poland and Ireland are flirting with deflation as well.
Countries inside the Euro-zone will find it more difficult to combat the phenomena of low inflation or worse yet, deflation on their own. Here the monetary policy of the 18 nation membership is somewhat controlled by the ECB (European Central Bank). The high debt levels become increasingly difficult to manage in an economy that is experiencing declining consumer prices and wages. The price of debt actually would increase as deflation sets in. The poor economic results and low inflation will increase the pressure on central banks in Europe, including the ECB to take steps to combat deflation and sluggish growth.
As of June of this year the ECB has already lowered the main borrowing costs to just 0.15%. It also became the first major central bank to introduce negative interest rates. Member banks in the Euro-zone are actually charged for any deposits that are left with the ECB. These steps somewhat weaken the Euro and the hope is that it will prop up the economy and restore growth. So far the results have been mixed.
The ECB has also made a pledge to lend extensive amounts of money to individual banks to encourage more lending. This will take time considering the health of European banks and the built in delay such activity has on economic growth. Other analysts insist that the time for quantitative easing has arrived. Yet the ECB President Mario Draghi insists more structural reforms need to take place in member nations, before the bank begins the policy of money printing.
It is important to consider that the simple creation of more money may create more inflation, but it does not necessarily help lift individual wages. One only has to look at what has happened in Japan to see that inflation has actually reduced domestic demand, which in turn puts a downward pressure on salaries. Worse yet, Japanese GDP actually shrank at a rate of 6.8% in the second quarter of 2014.
What is now occurring in Europe will not help reduce the high unemployment rates that exist in a number of countries including Greece, Italy Spain and France for example. There are 18 million unemployed in the Euro-zone as a whole. Austerity measures of cutting government spending and raising taxes will not help growth in the short term.
Many investors in Europe continue to purchase German sovereign debt considered to be the safest financial asset on the continent. As a result the yield on the 10-year bond actually dipped below 1% for a time. This is the first time this has happened.
What is the solution? European countries will need to continue to restructure their economies to become more investment and business friendly. Government policies will need to be revamped in a number of countries. The plan of action needs to include proposals to increase competition and productivity across many sectors of the economy. As in Germany, where business leaders from abroad travel to see how the nation organizes its middle- sized companies (Mittelstand), there has to be on new emphasis on growth. Research and development with increased investment in manufacturing, industry and services is the best answer to what ails European economies.
One cannot expect monetary policy alone, to fix the economy in the many different nations of Europe. Increases in productivity is the only real way to pay for increases in wages. Creating new markets for goods and services is only possible if there is innovation and creativity in the export sectors of the economy.
For a number of countries in Europe, with special emphasis given to France and Italy because of the size of their economies and resistance to restructuring, it will be a difficult road. What Greece achieved after 6 years of austerity, was only possible because they were forced to abandon the previous absurd government policies. That is running unsustainable fiscal and foreign account deficits, that eventually bankrupted the nation. Governments in power often pay a high price at the ballot box, when policies of non-indulgence are enacted to balance the books of a nation. It really is the only way back to sustainable growth in the long run. Balanced primary budgets, paying down national debt, eliminating trade deficits etc., is a tough sell in practice. Creating economic and market conditions for business expansion is the only way to reduce structural unemployment. It is also the only means possible, to pay for the large cost of government largesse in individual European country social programs.