Back in September, I explained that the European economy was moving toward a recession. Along the same line, I have pointed to the risk of a new debt crisis in the euro zone.
In October, Eurostat released new data on economic growth, inflation, unemployment, and public finances that all point in the same direction as my warnings.
I remain convinced that Europe is heading into a recession. If so, it is entirely made in Europe: the American economy looks resilient by comparison.
The signs of an economic downturn are not to be taken lightly: one thing Europe cannot afford right now is a recession. One reason why the recession bells are not ringing louder could be that most analysts only glance at the economic data. From a superficial viewpoint, the European economy looks like it is in decent shape. The most recent national-accounts numbers from Eurostat suggest that through the second quarter of this year, the European gross domestic product, GDP, was doing relatively well.
This is a statistical mirage, attributable to lingering year-to-year effects from the pandemic recovery.
This effect will no longer be in the numbers for the third quarter, but we can see the first signs of a looming recession already in GDP data for the second quarter. Table 1 compares inflation-adjusted, year-to-year GDP growth for Q1 and Q2 this year. The essential information is not in the numbers themselves, but in the slowdown of the growth rate. Green numbers indicate a lower year-to-year growth rate in Q2:
Table 1, Source of raw data: Eurostat
| Q1 | Q2 | |
| Belgium | 5.17% | 3.99% |
| Bulgaria | 4.99% | 3.98% |
| Czechia | 4.86% | 3.62% |
| Denmark | 4.93% | 3.53% |
| Germany | 3.86% | 1.77% |
| Estonia | 4.54% | 0.56% |
| Ireland | 10.78% | 11.12% |
| Greece | 9.02% | 7.76% |
| Spain | 6.76% | 6.68% |
| France | 4.83% | 4.19% |
| Croatia | 6.95% | 7.74% |
| Italy | 6.17% | 4.77% |
| Cyprus | 6.68% | 5.88% |
| Latvia | 6.43% | 2.91% |
| Lithuania | 4.78% | 1.74% |
| Luxembourg | 2.90% | 1.55% |
| Hungary | 8.19% | 6.48% |
| Malta | 8.06% | 8.92% |
| Netherlands | 6.74% | 5.15% |
| Austria | 9.25% | 5.95% |
| Poland | 9.23% | 4.73% |
| Portugal | 11.42% | 7.89% |
| Romania | 6.43% | 5.05% |
| Slovenia | 9.63% | 8.23% |
| Slovakia | 2.90% | 1.34% |
| Finland | 4.25% | 3.26% |
| Sweden | 4.34% | 3.38% |
Only three countries had a higher growth rate in Q2 than in Q1. We can expect more of this: among the few countries that have reported GDP numbers for Q3, Germany is down to one percent growth. Spain and the Netherlands also have markedly lower growth rates in Q3 than in Q2.
The growth slowdown happens when Europe has barely recovered the economic activity it lost to the artificial pandemic shutdown. To see what this means, let us compare the most recent four quarters of economic activity, i.e., from Q3 of 2021 through Q2 of 2022, to 2019, the last calendar year before the pandemic.
Adjusted for inflation, the EU economy is 1.8% bigger than it was in 2019. The euro zone’s GDP is 1.2% bigger. These are bad numbers: we are now almost two years out of the pandemic.
The lack of recovery is painfully visible in Europe’s two largest economies: German GDP is up by 0.2% and French GDP by 0.7%, compared to 2019.
Some countries have done better, but all in all, the recovery has been disappointing. To make matters worse, a closer look at capital formation—a.k.a., business investments—and consumer spending, suggest that a recession is in fact just around the corner. Nine EU member states saw investments decline in the second quarter, with three of them, Belgium, Bulgaria, and Estonia, experiencing a decline for three quarters in a row.
Investments in the past four quarters are 0.2% below the 2019 level for the EU, and 1.2% below 2019 in the euro zone. In other words, businesses have not regained confidence in the European economy, and now investments are beginning to decline again.
In Germany, businesses invested €673 billion in the past four quarters. This compares to €680 billion in the 2019 calendar year (again in real terms). France, Europe’s second largest economy, is only doing modestly better, with investments 3.4% higher now than in 2019.
Some countries did much better, with investments up 26% in Greece. That said, there is a pronounced decline in investment activity in 24 out of 27 EU states.
Numbers on consumer spending pile on the bad news. European households have barely returned their outlays to pre-pandemic levels: the most recent four-quarter total spending number is €7,128 billion (adjusted for inflation). This is a hair behind the €7,132 billion from 2019.
At least half of the EU member states show signs of stagnation or further decline in private consumption.
The American economy, in contrast, is 4.9% bigger than it was in 2019, which is respectable. The GDP growth rates themselves are not impressive, with the third-quarter growth rate of 1.85% leaving a lot to be wished for. This is close to the 1.94% rate for the second quarter. However, these numbers are just below the 2.1% average for President Obama’s second term in office in 2013-2016.
The Trump economy, counted as the three years 2017-2019 (since 2020 was the pandemic year), did better at 2.6% on average, but the proximity of current growth to the Obama number, and the 4.9% added to the pre-pandemic economy, are signs that the U.S. economy is at least moderately resilient.
Numbers on consumer spending point in the same direction. Household outlays over the past four quarters (again including Q3 of this year) are a strong 7.5% higher than in 2019. In the most recent two quarters, consumer spending has grown by 2.55% (Q2) and 2.4% (Q3)—good numbers that exceed GDP growth.
As for capital formation, U.S. businesses are currently investing at a level that is more than 5% higher than in 2019. However, the most recent numbers are cause for some concern. Fixed investments (which do not count build-up of inventories) actually fell in Q3, with construction of buildings and facilities of all sorts leading the decline.
If the decline in investments were paired with a decline in private consumption, it would be a strong signal of a recession to come. That is not the case, which suggests that the investment decline might be just a “breather” for the economy before it picks up speed again.
Unemployment is another area where Europe and America are pulling in opposite directions. The American unemployment rate was 3.4% in October and 3.3% in September; it has been below 4% since March and shows no signs of rising.
To reinforce the impression of strength in the U.S. economy, these unemployment rates are almost identical to what they were for the same months in 2019. It is worth noting that workforce participation is down almost a full percentage point from three years ago, suggesting that the ‘genuine’ unemployment rate should be in the vicinity of 4.2%. However, this number is still well below Europe, where 6.6% are unemployed in the euro zone, and 6.0% in all of the EU.
The downward trend is weakening, but the biggest concern is that 13 EU member states have a higher unemployment rate now than before the pandemic. In Estonia, e.g., there were 124 unemployed over the past four quarters compared to every 100 unemployed in 2019.
In Czechia, the same number is 123, with Sweden at 116, Romania at 115, and Latvia at 111. By comparison, the number of unemployed Americans is almost the same as three years ago, nearly 5.5 million.
The good news for Europe is that Spain and Greece, two of Europe’s most unemployed countries, have made great strides and have fewer unemployed now than in 2019. While they both have an unemployment rate of 12.5%, this is a light of hope for two of Europe’s most suffering economies.
The situation for young workers remains very problematic for almost all of Europe. In Greece, Europe’s youth unemployment leader, 32.3% of the young were unemployed in the second quarter of this year. While vastly better than 61.2% back in 2013, it is more than twice the EU average and a far cry from the American rate of 7.6%.
Greece is not alone in having a youth unemployment rate above 20%. Spain comes in second place (28.5%), followed by Sweden (26%), Italy (22.6%), Estonia (21.6%), and Romania (21.3%).
This is a persistent, and pervasive problem:
- Greece, Italy, and Spain have not been below the 20% since at least 2009;
- France, Portugal, and Romania are constantly dancing on the line;
- Croatia and Sweden have recurring episodes of 20+% youth unemployment;
- Finland and Slovakia are uncomfortably close to this line.
Last but not least, let us look at public finances. They are often the first casualty in a recession. Slow GDP growth means slow growth in tax revenue. Since slow growth also means that more people remain in lower income brackets and therefore qualify for government assistance, persistent budget gaps open up in government budgets.
This causes a problem, especially for EU member states who are constitutionally obligated to balance their budgets, come Scylla or Charybdis. If unemployment is on the rise, the legislatures of the EU states are supposed to attend to the deficit before trying to bring down the jobless rate.
In practice, most governments in the EU have shirked this obligation, and Brussels has more or less given them a green light to do so. Per decree from the EU Commission, the budget-balance requirement in the EU constitution, a.k.a., the stability and growth pact, has been suspended through 2023.
This helps member states alleviate macroeconomic pains and make less drastic fiscal-policy adjustments to sluggish growth and persistent unemployment. At the same time, investors in sovereign-debt markets are not necessarily as keen on tolerating deficits as the Eurocrats are. This can lead to problems for the European economy that America has not yet encountered.
In a recent reaction to rising yields on U.S. sovereign debt, investors moved money out of several European currencies, causing a depreciation of their exchange rates vs. the dollar. European central banks, including the ECB itself, have been late to raise interest rates, in part because of concerns about how this would affect their already-weak economies. Now that they are responding, their Johnny-come-lately attitude could hurt their confidence and cause markets to shy away from the treasury securities issued by some of the most indebted governments.
This would cause a fiscal crisis, but the risk for one is not imminent. According to Eurostat numbers, 19 EU states have run a budget deficit over the past four quarters. Fortunately, the source of these deficits is in many instances of such a nature that the deficit is not very problematic. In Hungary, e.g., the bulk of the current 4-quarter deficit is due to a huge 11.1%-of-GDP deficit in the last quarter of 2021. The most recent number is only 2.3%, which means that the Hungarian public finances are rapidly improving.
Italy and Romania exhibit similar trends, as do the EU and the euro zone in the aggregate. In other words, up through the second quarter this year, there was no reason for immediate concern about a new wave of fiscal crises across Europe.
Compared to Europe, America is a fiscal mess. This is the one variable that could spell real trouble for the American economy. The American central bank, the Federal Reserve, has pulled out of the business of printing money to pay for budget deficits, which leaves the funding entirely to Congress and the international sovereign-debt market. That is not a comfortable seat for the U.S. government to be in, so long as it uses borrowed money to pay for 15-20% of its spending.
All in all, the European economy is showing signs of a recession ahead, while the American economy remains on relatively solid ground. Two variables will be decisive in tipping the two economies in either direction:
- Inflation, which is still trending upward in Europe but down in America; and
- Debt-market reactions to budget deficits, which may turn out to be harsher in America than in Europe.
Regardless of which way the American economy is leaning, Europe’s political leaders need to take every measure they can to avoid a recession. An economy that has barely recovered from the pandemic simply cannot afford another downturn.
