Europe on the brink of stagnation

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27 Jan 2015

Growth in some European populations has stalled while for others, including Europe’s power-house of Germany, it is in decline. Emma Cusworth asks whether Europe is heading towards a Japan-style period of stagnation.

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Growth in some European populations has stalled while for others, including Europe’s power-house of Germany, it is in decline. Emma Cusworth asks whether Europe is heading towards a Japan-style period of stagnation.

Growth in some European populations has stalled while for others, including Europe’s power-house of Germany, it is in decline. Emma Cusworth asks whether Europe is heading towards a Japan-style period of stagnation.

“The eurozone is facing similar prospects to Japan in the late 1990s and early 2000s.”

John Vail

The eurozone shares some sobering economic characteristics with Japan in the late 1990s – low growth, high debt, bad demographics, low inflation and fears of deflation. Combined with this is a similar political landscape hampered by paralysis and a slow response rate.

During the 1990s the Japanese economy was hit with a series of shocks as stock and property bubbles burst and the Asian Crisis unfolded causing a decline in prices and wages that became self-reinforcing. High private-sector debt-to-income ratios were a significant contributing factor and as nominal income fell, the debt burden kept increasing, further dampening demand. Japan has been suffering from this debt-deflation for more than 20 years.

In the eurozone, in just a few years nominal growth has flagged from 4% to less than 2% with some countries, such as Spain, suffering far worse. Spanish nominal growth plummeted from nearly 8% on average since the early 2000s to 1% since the start of 2010, with GDP prices stagnating since 2008, according to figures from Candriam Investors Group. In addition, hourly wages in Spain have barely budged since the end of 2011, have been falling in Portugal since 2011 and in Greece since 2010 and continue to correct in France and Italy.

“The eurozone is facing similar prospects to Japan in the late 1990s and early 2000s: a mature economy with fairly rigid economic constraints and a lack of political movement towards major economic reform,” according to John Vail, chief global strategist at Nikko Asset Management.

“Wage growth (excluding Germany and some northern countries) is likely to be subdued for quite a while, thus reducing domestic consumption, and the animal spirits of Europe’s citizens have declined in a sustainable fashion, much like Japan’s did after its bubble.”

BAD DEMOGRAPHICS

In the long term, weak growth is inevitable with potential GDP low in many countries.

“It is difficult to see how many of these countries can increase their potential, given the poor demographics, weak productivity and many vested interests and protected industries in Europe,” says Patrick Campbell, global analyst at Eaton Vance.

Economists point to expectations of eurozone GPD growing at around 1-2% per year at best, down from around 2-2.5% as recently as 2000.

The eurozone growth “speed limit”, as Eric Lascelles, chief economist at RBC Global Asset Management, calls it, will be around 1-1.5% annually over the long run, he believes. “Demographics are absolutely a headwind, and Europe is next-worst after Japan in this regard,” he says.

The proportion of working age people in the total population peaked in Europe in 2004 and only France and Ireland have fertility rates above two, with the average rate being only 1.5. EUROPA projections expect the population in the European Union to increase to 520 million by 2035, but then decrease to 505 million in 2060, leaving a total increase of only 0.64% between 2008 and 2060. Germany, which hosts Europe’s largest population, is expected to decline 13.45%.

The solutions to the demographic problem are not obvious or easy to find. Immigration, the most obvious solution, is politically unpopular and increasingly so as far-right political parties gain popularity.

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