Euro-Zone In Trouble Again
After several years of strong growth, parts of the euro-zone have slumped back into recession, or very close to it. Andrew Kenningham, of Capital Economics, looks at the region.
7 October 2021
The euro-zone economy hit the headlines in the past year as Italy fell back into recession, and Germany only narrowly avoided one.
These jitters have revived fears that the region has not yet solved the problems that dragged it into a deep crisis in 2010-14.
However, these countries’ economic prospects vary enormously, even though their fates are tied together because of their shared currency, the euro. Let’s look at some of them.
Italy – no more la bella vita
After a tumultuous few years during the euro-zone crisis, Italy saw decent growth between 2015 and 2017. However, this proved to be a false dawn. Last year, the economy shrank in both the third and fourth quarters.
Italy has been affected by the global downturn, but it also has domestic problems. Its underlying issue is that the economy has scarcely grown for the past two decades.
This is partly because its working-age population is shrinking. Italian businesses also face a multitude of legal and other problems which prevent them from reaching their full potential.
Gross Domestic Product, a measure of a country’s market value, has increased by 9 per cent since the euro-zone was formed in 1999. This is a staggering difference, compared with France and Germany’s 35 per cent and Spain’s more than 50 per cent GDP increase.
On top of all this, Italy’s populist coalition government has clashed with the European Union over plans to spend more, and to reverse some much-needed reforms.
This started a sell-off in the government bond market last May, which has since been only partly reversed. And Italy also has one of the highest public debt burdens in the world.
More recently, things have calmed down a bit as the government has backed away from confronting the EU. But the underlying causes of Italy’s problems have not been resolved.
Another debt crisis seems inevitable at some point.
Germany – engine stalling
Perhaps surprisingly, the next country which is struggling is Germany – the euro-zone’s biggest and, until recently, its most dynamic economy.
Since 2009, Germany’s growth rate has averaged 1.4 per cent, compared to the euro-zone average of 0.8 per cent.
It came as a shock last year when Germany’s economy contracted in the third quarter. At first, commentators pointed to some one-off factors to explain it, including new car-emissions tests and even low water-levels in the Rhine river, an important transport route.
In fact, the economy was stagnant in the fourth quarter too. Business surveys for early 2019 have been dire.
It’s become clear that the main cause of the slowdown is a sudden decline in demand for German exports.
That, in turn, reflects a slump in world trade as the global economy has stuttered. In fact, it makes sense that Germany has been hit harder than other countries because it’s a lot more dependent on exports than other countries.
Having narrowly avoided a recession last year, Germany’s economy will probably continue to grow this year. But it will do so only slowly.
France – better than feared
France has fared better than Germany because it is not so export-oriented. We at Capital Economics expect it to grow by around 1 per cent this year.
President Emmanuel Macron’s government has been forced to make some concessions to the high-profile “yellow vest” protestors, such as increasing the minimum wage. But the government had already implemented more reforms during its first year in office than several previous governments together.
These reforms should help to keep the economy ticking over.
Spain – star performer
The last of the four big euro-zone economies – Spain – is doing the best. Its economy grew by 3 per cent or more for three successive years, from 2015 to 2017, and has slowed only a little over the past year.
The rapid increase in household consumption over the past few years cannot be sustained indefinitely, but Spain should continue to thrive in comparison to its neighbours for a while yet.
Ireland, Portugal and Greece - bouncing back?
Finally, some of the countries which were worst affected by the euro-zone crisis have bounced back.
Take Ireland, which had a huge banking and sovereign debt crisis in 2010.
Official estimates say its economy has increased by nearly 80 per cent over the past decade. Compare that to, say, 23 per cent in Germany.
Ireland is the most exposed to risks from the UK leaving the European Union, but we think it can even weather that problem.
Portugal has also recovered, helped by a boom in tourism and exports. A tough International Monetary Fund-backed reform programme has helped it to reduce its public debt ratio, although it remains high.
And while Greece’s economy is still much smaller than it was a decade ago, it’s no longer receiving emergency bail-out loans from the EU.
Having returned to growth, it should continue to expand steadily over the next two or three years, even though there are still some major unresolved problems in the banking sector.
Slowdown may be deeper
In conclusion, the euro-zone is going through a slowdown, which is only partly due to a slump in demand globally.
Europe’s downturn may well turn out to be deeper and last longer than most originally assumed.
However, apart from a brewing Italian crisis, the euro-zone doesn’t appear to be at risk of a major continent-wide crisis any time soon.
Published 29 May 2019
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