By Peter G. Hall, Vice-President and Chief Economist, EDC
Claims in early 2008 that Europe had decoupled from America’s woes are now laughable. Multiple ‘cliff-edge’ panic points over the past four years have largely originated in Europe, and although now is a period of relative calm, the risk of disruption remains palpable. Europe’s manifold woes have been fuel for pervasive pessimism. Are there any signs that this ravaged region is turning around?
One look at area-wide GDP would suggest not. First-quarter data revealed that the Euro-Area recession is six quarters long and counting. Current output is one per cent below last year’s level, and based on performance to date, forecasts are again being revised down. Today’s indicators are mixed, and complicated by the ups and downs of global demand, unusual weather and the disruptive effect on output and expectations of US fiscal deadlines.
Euro-area performance looks grim until held up to the light of fiscal austerity. For the past two years, governments have been tightening fiscal measures considerably – radically in not a few cases – to the point that on average, they have outstripped regional potential growth. Under such circumstances, it is almost impossible to avoid a policy-led recession. In fact, it is remarkable that, all things considered, the rest of the economy has been able to generate enough growth to hold at bay the punishment of the public penury. Recent IMF analysis of the knock-on effects of austerity on the rest of the economy suggests that in the absence of the severe tightening, growth would be fairly strong.
This raises an interesting and critical issue. If government cuts and tax increases have had such influence on growth, what will happen when the cuts stop? If the current pattern of growth persists, the end of additional austerity – which incidentally is slated for 2014 – will bring an instant and desperately needed jump in growth. The speed, if not the magnitude, of this growth pop could be enough of a surprise to inject some badly-needed optimism at both the business and consumer levels – which would no doubt add to the growth pop, aiding upward momentum.
At present, that sounds like the stuff of dreams, but time and again it has been proven that that’s how fiscal dynamics work. A key risk is that, with the sustained decline in area-wide GDP, austerity begins to eat into core growth. On this point, the data are unclear, making the current period a defining moment for Europe – a juncture that could see the region take a turn for the better…or the worse.
Significantly, the European Central Bank last week stated amid a volley of mixed data that they believe that growth is actually showing signs of improvement. Clearly, certain economies are sporting positive performance, acting as regional growth engines. Higher US growth could also be shoring up the trade side, both directly and indirectly. But the rise could also be marking the deceleration in austerity – the growth dividend from smaller fiscal cutbacks may already be hitting the bottom line.
If so, it couldn’t come too soon. After all, the EU accounts for over 20 per cent of world GDP. Any rise in growth will be felt the world over, and while the region is a long way from taking on the role of growth engine, higher-than-expected growth will at the very least help to lift the world away from the pessimism that has persisted for a half-decade – an extraordinarily long run for the post-war period.
The bottom line? All eyes remain on Europe. Better times there are a must for a world economy that is now overdue for its next growth cycle. It may well be that data releases in the coming three-to-six month window are the most critical since the crisis hit. We’ll be paying very careful attention.
This commentary is presented for informational purposes only. It is not intended to be a comprehensive or detailed statement on any subject and no representations or warranties, express or implied, are made as to its accuracy, timeliness or completeness. Nothing in this commentary is intended to provide financial, legal, accounting or tax advice nor should it be relied upon. Neither EDC nor the author is liable whatsoever for any loss or damage caused by, or resulting from, any use of or any inaccuracies, errors or omissions in the information provided.