European economic growth, or uncertain prospects for development

(homie00001, CC BY-SA)

The Gathering Storm

Andrzej Rzońca, PhD, a member of the Monetary Policy Council, and Andrzej Halesiak from Bank Pekao S.A. analyzed the state of the European economy post-2008 and gave their forecast on future growth.

Both argued that the European project is in danger as a result of the repercussions of crisis management in the post-global economic crisis era. The lack of determined leadership in the EU may lead to the further rise of particularistic tendencies in individual European countries and also the rise of far-right protectionist parties with attendant social and political tensions, they argued.

Rzońca outlined contemporary problems – growth in the EU lower that pre- crisis levels and slower than the 1960s. He contrasted this with the USA and Japan; the EU growth rate is slower than in these two countries. As an example of relative decline in Europe, he stated that France (excluding Paris) has the same percentage GDP per head of population as the former East Germany.

A major factor contributing to this situation, he cited, were the austerity programs implemented in the wake of the crisis and especially the policy of quantitative easing in 2010- 2013. Countries that didn’t apply this policy seemed to perform better than those that did. Greece is the prime example of the latter.

The problem of public debt expenditure is also a major factor (consuming 95-100% of GDP), they suggested. This arose mainly out of the policy of fiscal stimulation – higher rates of public expenditure were not covered by the income generated from these investments. Expenditure costs were higher than costs of servicing, in other words.

The fall in the levels of inflation is chiefly due to a fall in world-wide energy prices.

Rzońca also stressed the differences in competitiveness between the peripheral countries and Germany. Ireland and the Baltics, for instance, recorded slower rates of growth as a result of poor demand and a higher levels of supply

Convergence and Divergence

The safeguards in ‚Old Europe’ have led to a slowing of growth in ‚New Europe.’ The new members are not as important as they once were.

According to Rzońca, there has been a „stiffness” in the market since 2008. Social mobility is also slowing and the gap between rich and poor growing. “This could lead to increased support for anti-market political parties,” Rzońca added.

There was, according to Rzońca, an imbalance in the system before 2008, which was exacerbated by financial stimulation between 2007-2009; the extraordinary financial support given to banks as well as the ‚stiffness’ in the market after the crisis exploded.

The problems are worsening with far-right and anti-market parties on the rise. These trends are strengthened by divergences between countries.

Halesiuk’s investigated macro and micro examples, identified key problems and offered potential solutions. He argued that EU investment is lower than in the USA, which is itself returning to pre-2008 levels. EU15 has seen a fall in investment post-2008 especially in southern and eastern Europe. There has been a fall in productivity despite a greater accumulation of capital.

Halesiuk sees a divergence between the EU and US. The pre-2008 boom in Europe was less effective than in the US in that the latter invested in modernization and new technology during 2002-2007. In the EU, this was directed towards more traditional areas such as real estate and housing. So the question was not how much but where best to direct investment. The EU in this regard is in stagnation despite its targets. The US and Japan show higher levels of investment in R&D and China and Korea higher still. Scandinavia and Germany are exceptions to this trend. CEE is dragging down the rest in this area.

Southern Europe is the real problem especially regarding incomes. On the micro level, the EU does not have a very well developed capital market.

Demographic trends

Since demographic trends are linked to demand, with the EU showing the worst in this regard. Asia and Africa show high levels of demographic growth with a fast growth of the middle class. In Europe this is in regression or even stagnation.

Halesiuk outlined this trend using the automobile as an example. In 2000, China was producing 2m cars pa. In 2010, this rose to 15m and by 2030 this is expected to rise to 55m. Design of automobiles is no longer geared to European aesthetic tastes but to Asian. Europe is in a hopeless position as the centre of gravity switches to Asia. This is where the new sources of demand are with new factories are being set up in China, and Africa North. The paradigm is now Chinese.

Uncertainty – the new normal

In the EU there are intrinsic factors leading to uncertainty- Brexit, Eurozone and Grexit. The EU ranks higher than the US in the Economic Policy Uncertainty Index.

EU firms before the crisis were more highly leveraged than US ones and also had problems with access to credit especially (start-ups and innovation companies). Private equity and venture capital is not as developed as in the US.

During the boom of 2002-2007, firms ran at 40% capacity, investments in housing, airports, roads all of which carried large amount of debt. A prime example was the Spanish housing boom of the 1990s and 2000s: servicing debt, both private and public, drained expenditure on assets that weren’t in themselves productive and couldn’t generate the income necessary to service their costs.

Solutions

Halesiuk suggested three possibilities:

• Inflation – using a hammer to crack a nut

This is one road leading out from past debts, but the default European mechanism is deflation especially given the world raw material prices. He suggested that this could work, but there would be damage in the short term.

• Creative destruction – letting zombies die

Creative destruction is the term Halesiuk used for letting market forces solve the problems of Europe – letting lame duck industries restructure themselves under pressure of market forces. The problem has been loose monetary policy and growing protectionism in the EU.

European capital is being exported. An enforced restructurisation on the Greek model could be the answer, but who would bear the costs?

Money needs to be productive, which is no longer the case in the EU, although the CEE is largely  self-financing Halesiuk said.

• Convergence

The divergence of incomes in the EU is leading to a major crisis that threatens the Euro project itself.

We are in a vicious circle

Resources need to be freed up leading to increased productivity, growth and new investment. At the moment we are in a vicious circle. There is ‚institutional uncertainty’ in much of the EU.

There is no classic economic text book solution either through monetary or fiscal policy. Halesiuk called for the release of market forces to do their job – creative destruction. This is not realistic in the EU. There is no central direction and a rise in particularism. Who would bear the cost? The greater problems lie in not addressing the issue, although the Italians have started with their bad debt fund.

There is a moral hazard present and perhaps a redefinition of the EU on new principles. The important thing is not to be in or out but to feel part of the EU.

The ‚zero option’

The two speakers agreed that there was more to unite than divide them. Rzońca  disagreed with Halesiuk that inflation could be part of the solution and  suggested that a new stage of the crisis was more than probable.

Restructuration from the top down was not practical. An expansive macroeconomic policy is like war, Rzońca said: easy to start and difficult to stop and that the initiators of any such creative destruction would still be held accountable by their electorates.

Q&A – not even cold comfort

The speakers argued that there was a problem with credibility of statistics generally. China’s slowdown in demand for European exports (its GDP contracted from 25 per cent growth in 2011 to 7 per cent) could be  a factor in strengthening extreme parties, Rzońca said. He continued that dictatorships usually conduct a worse economic policy than previous governments.

Halesiuk and Rożna called for Poland to learn from the mistakes of others. Maybe the problem is  even worse in Poland and that analysis was needed of more than just the 2008 crisis to find a solution.

Rzońca maintained his idea that countries that introduces a policy of monetary and fiscal stimulus fared worse since they stimulated differences in restructuration between the individual countries of the EU.

The comparison between the failed investments of Ireland, Spain, Portugal and Italy (domestic housing, high speed trains, regional airports) and Poland was made. Many municipal investments are vanity projects that have to be paid for in the end. Investment is wrongly directed. „Yes build a road,” Halesiuk argued. „But build it to a factory.” Municipal authorities need to ask questions about how to attract jobs with investments.

On a macro level, Halesiuk went on, the gap between rich and poor is widening. Capital is being accumulated in the hands of an elite whose demand alone cannot sustain a diversification of income.

There is a structural inability to solve problems. Poland and Europe are losing the dynamic for growth in innovation and demographically.

Conclusions

Rożna concluded that Europe does indeed face difficult years ahead and the long term indicators are very bad, not only for Europe but the US. Countries that adopt short-term solutions to crisis management will face similar problems.

Halesiuk focused on competitiveness through correct investment such as education and research and development.  He argued that the EU had failed the test of leadership and individual countries will form their own answers. The collapse of the Schengen area is possible in this regard.

The two economists agreed strongly on one thing – that they are both pessimists.

More information on the seminar may be found here.

(homie00001, CC BY-SA)

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