As the European Parliament elections approach, economic issues are playing a subdued role in public opinion. This could be due to the fact that European economies are altogether performing relatively well at the moment, but should voters be more concerned?
During the last European Parliament elections back in 2014, the European Union’s (EU) overall economic situation, unemployment, inflation and public finances dominated the public debate. This time round, recent polling results suggest that climate change, immigration and terrorism have now moved to the top of the list of voters’ main concerns. This is not entirely surprising since issues such as migration have been prominent in headlines for years, while the EU economy is performing much better than five years ago. The Gross Domestic Product (GDP) has been growing reasonably steadily for seven years and is forecast to continue to expand in 2019.
Figure 1: The EU’s GDP Growth since 2007, Source: Eurostat.
Similarly, inflation levels are again in positive territory at around 1.5 percent and unemployment has declined to 6% across the EU, with some countries, such as the UK and Germany, reaching historical lows.
Figure 2: EU Inflation (Base Year 2015) Source: OECD
Figure 3: Unemployment in the EU, Source: Eurostat
Of course, the headline figures for the EU as a whole tend to gloss over often stark disparities between individual member countries. For instance, unemployment rates in countries such as Greece and Spain remain staggeringly high. Nonetheless, it is interesting to note that countries have converged in some indicators. In a 2018 report, a team of IMF economists found that there has been a nominal convergence in inflation and interest rates while there has only been some real convergence of per capital income levels among recent joiners to the Eurozone.
Manufacturing Sector Slowdown
Despite strong core statistics, there have been signs of a slowdown dating back to last year, notably the contraction of manufacturing output in Germany and neighbouring countries in light of new vehicle emission test standards and a decline in Chinese demand. Focusing on the Eurozone countries, Alexander Boersch, chief economist at Deloitte Germany, comments that “the overall weakness of the Eurozone is mainly driven by the industrial sectors – the very sectors that normally power economic growth in Europe. Industrial production has been on a downward trend since 2018, especially in chemical and automotive sectors.”
In the meantime, the much less export-dependent services sector has been thriving, which leads Boersch to conclude that it is yet too early to tell whether the slowdown in the industrial sector will translate into a full-blown recession or just a temporary downturn. In a recently completed assessment of the German economy – the EU’s largest – IMF staff offer support to this view, noting that “the underlying momentum of domestic demand is still robust, driven by low unemployment, solid wage increases and investment, and supportive fiscal policy.”
Strong External and Internal Headwinds that Could Tilt the Balance Toward a Recession
There is widespread consensus among economists that the UK’s possible disorderly departure from the EU without a deal laying the groundwork for a future trading relationship continues to pose a serious risk to the trading bloc’s economic health. Since the UK is the bloc’s third largest trading partner and has closely intertwined supply chains with other EU member countries, a so-called “hard Brexit” is expected to cause significant disruptions to economic output across the region.
Another major political risk threatening the community of states’ economic health is the current US government’s willingness to wage a trade war against its trading partners. The US has in the past threatened to impose tariffs on key European exports, such as cars and other manufacturing goods. It has already increased tariffs from 10 percent to 25 percent on $200 billion worth of imports from China and is currently threatening to impose tariffs on another $300 billion worth of US imports from China.
This, in turn, has resulted in slightly more restrained retaliatory tariffs from China.
The dispute between China and the US is currently taking centre stage and has only had a limited direct impact on EU economies. However, Uri Dadush, Non-Resident Fellow at Bruegel, a think tank, warns that the systemic effects of an escalating trade dispute between China and the US “significantly increase the likelihood of a global protectionist surge and a collapse in the rules-based international trading system, for which the beleaguered World Trade Organization provides the bedrock.” The greatest risk here would be “a return to a power-based instead of rules-based trading system” under which the EU would likely stand to lose the most.
Although things have gone relatively quiet around EU member state’s public finances, several countries’ debt problems have not gone away. Greece’s public debt rose to 181.1 percent of the GDP in 2018, while Italian debt now stands are 132.4 percent of GDP and is set to rise further. Commenting on the Greek government’s budget, Klaus Regling, managing director of the European Stability Mechanism (ESM), the EU’s bailout fund, stated at a news conference on May 16th: “We are worried about that. Our preliminary assessment indicates that with these measures, the primary surplus target of 3.5 percent this year might not be reached by a significant margin”.
Italy’s budget plans, on the other hand, were initially rejected by the EU commission last year and remain controversial, with the Italian government showing willingness to break fiscal rules. More fundamentally, little to no progress has been made to advance the integration of the Eurozone, although elements such as a Eurozone budget and a common deposit protection scheme are widely considered key to preventing another debt crisis.
Clouds on the Horizon?
Last year’s economic slowdown highlighted once again the EU’s vulnerability to external shocks. Growing trade tensions and flagging demand abroad could thus hit member countries hard in the near future. Few of them would be prepared for a recession as their governments lack room for counter-cyclical fiscal measures. Within the Eurozone, the European Central Bank’s (ECB) fire power remains similarly limited, with Euro area inflation still below its target and long-term interest rates near or below zero.