The artificial economic shutdown of 2020 caused a major global disruption of commerce. Although the event is sometimes referred to as a “recession,” it was nothing of the sort. A recession organically emerges in free economies; the shutdown of 2020 was entirely the work of government.
Without it, both Europe and America would have been better off economically. The worst outlooks at the end of 2019 pointed to a brief cooling-off on the American side, following three years of strong Trump-economy expansion.
Europe was not doing as well as America at the time. Most of Europe (outside of Hungary and one or two more countries) had a hard time producing any meaningful economic growth at all. That said, there were no signs of a recession in the EU. In short, had the 2020 shutdown not happened, it is likely that after a brief pause the international economy would have been in another growth period by now.
Fortunately, by now Europe and America have almost recovered the economic activity lost to the shutdown. Unfortunately, there are signs that the European recovery is unfolding with a problematic sectorial imbalance. While exports are rising, domestic spending by households and businesses is lagging behind. By contrast, the U.S. economy is not suffering from the same bias.
The American recovery
Based on season- and inflation-adjusted gross domestic product data from the Bureau of Economic Analysis (BEA), in the first quarter of 2022 the U.S. economy was 2.8% larger than it was at the end of 2019. An extrapolation of the growth trend under the Trump economy before the artificial shutdown (2017-2019) suggests that the economy had been another 2.2 percentage points larger by now. In other words, the U.S. economy has recovered a bit more than half of the growth it lost to the shutdown.
Household consumption was 5% higher in Q1 of this year than at the end of 2019 (again adjusted for inflation) while business investments—more commonly known as capital formation—were 12.9% higher. These are solid numbers that exhibit a high level of economic resiliency: the economic expansion is driven primarily by private-sector spending.
When the BEA released its first-quarter GDP estimate, conservative-leaning media outlets pointed not to the pre-to-post pandemic recovery, but to the quarter-to-quarter numbers. Adjusted for inflation, the American economy was 1.4% smaller (in annualized numbers) in Q1 of 2022 than it was in the preceding quarter, Q4 of 2021.
The purpose, understandably, was to put the Biden administration and the Democrat congressional majority on the defensive in the emerging campaign for the November elections. However, not even the negative quarter-to-quarter number is a sign of economic weakness: while GDP as a whole shrank, private consumption expanded by 2.7% (again in annualized, inflation-adjusted numbers) with fixed capital formation—investments in everything except inventories—increased by 7.1%.
Households substantially increased their spending on services (4.1%) and on durable goods (4.1%). The latter is usually a sign of strong consumer confidence, but in this case it could just as well be the expression of a desire to beat inflation: if we buy a new car, home appliances, or computers now, we don’t have to put up with the price hikes that 8-10% inflation will add over the coming year.
Businesses increased their spending primarily on equipment (up 14.6%), which is also a sign of confidence: you use equipment to implement production plans. There was a similarly confident increase in spending on so-called intellectual property products, primarily computer software (7.8%).
While businesses put new production into gear with new equipment, they divested themselves of inventories. According to national-accounts standards, the item ‘inventories’ counts as negative when adding up total business investments. It is a salable asset that you get rid of—but the combination of new production lines and less inventory suggests that businesses want to be ready for an economy with rising spending.
Also on the negative side, government spending declined by 2.8% (again annualized) while the trade deficit widened. When imports exceed exports, the difference subtracts from GDP simply because the imported products weren’t produced domestically.
The combination of reduced government spending and rising imports (while exports declined) was big enough to outweigh the positive contributions from private consumption and business investments. In other words, the core of the U.S. economy is strong. The caveat, of course, is inflation, which according to the BEA’s numbers for GDP is at 7.1% for the first quarter of this year. Estimates based on the consumer-price index places it at 8% for the same period.
All in all, therefore, the U.S. economy looks strong. However, this could change quickly, one reason being persistent inflation. Another factor is the rise in interest rates resulting from the Federal Reserve’s tapering of its monetary accommodation. The combined effect could be that consumer and business expectations turn pessimistic; if this happens simultaneously, the currently resilient U.S. economy could make a turn for the worse in relatively short order.
The U.S. economy is also wrestling with long-term structural problems, two of which are large government spending and regulatory uncertainty. A less-often discussed problem is that productivity has declined in recent years. Measured as GDP per private-sector employee, workforce productivity grew at only 0.6% per year in the last decade. This was the lowest number on record: the second-weakest rise in productivity, 0.8% per year, was in the 1970s.
In plain English, low workforce productivity means that there is less economic growth coming out of every hour worked in the economy. With less growth comes a heavier burden on the employed workforce to feed the non-working population as well as to pay all the taxes, fees, and charges that government asks for. The latter often leads to increases in the burden of government, which contributes to a troubling trend toward economic stagnation.
The European recovery
Eurostat, the statistics agency of the European Union, does not release the same packet of comprehensive national-accounts data as the U.S. BEA does. Its most recent numbers are based on a limited number of EU member states, and there is not a very good level of detail in those numbers. We can, e.g., not get an EU- or even euro-zone-wide picture of how consumers spend their money or how businesses allocate their investments.
The closest we can get is a sample analysis of two of the largest euro-zone economies: France and Spain. More on those in a moment. First, a quick review of Eurostat’s numbers for GDP for the whole of the euro zone.
From the last quarter of 2021 to the first quarter of this year, the euro-zone economy expanded by an inflation-adjusted, annualized 0.8%. Compared to the -1.4% for the U.S. economy, this looks strong, but we have reasons to believe that the realities on the ground in the economy are very different.
First of all, if the U.S. trade deficit had not widened, the quarter-to-quarter growth would have grown at an annualized 1.6-1.8%. This is, of course, a purely hypothetical number, as a smaller trade deficit would require other adjustments in the economy, but it nevertheless hints of an underlying strength.
We do not find the same strong foundation in the euro-zone growth number. In lieu of complete GDP data for all currency-union members, we use France and Spain as proxies for a look behind the scenes of the economy.
French GDP contracted in Q1 2022 compared to Q4 2021. The annualized rate was a minuscule -0.2%, but the biggest negative contribution came from private consumption: French households spent €3.7 billion less, in real terms, in Q1 this year than they did in Q4 last year. After recovering from the artificial economic shutdown for the better part of last year, French consumer spending is now below where it was in early 2019.
Government spending also contributed, albeit marginally, to the decline in GDP. On the upside, business investments expanded by a comparatively strong 7.9% in annualized terms. We will have to wait for more detailed Eurostat numbers to see whether or not this rise in capital formation is of the same kind as in the U.S.; for now, it is worth noting that investments on growing the French business capital stock compensated for 73 cents of every euro of reduced consumer spending.
France also saw a sharp rise in exports: an extra €2.6 billion in Q1 over the previous quarter equals a 6% rise on an annualized basis.
This rise in exports is also visible in the Spanish economy, where in fact it is even more pronounced. While consumer spending dropped by €5.5 billion, exports rose by €3.5 billion, or an annualized 13.8%. Thanks to a €1.6 billion increase in business investments and a small rise in government spending, Spanish GDP expanded by €926 million, or an annualized 1.3%.
In other words, it looks like in both France and Spain, the economy benefits primarily from sales to foreign countries; the expansion of the capital stock could in both cases be the result of investments for even stronger exports in the future. It is important to not draw too far-reaching conclusions from one quarter’s worth of numbers, but it is also a fact that over the past four quarters, Spanish exports have grown on average four times faster than consumer spending.
As I pointed out in a recent review of the Spanish economy, this is a trend that over time could contribute to the impoverishment of the country.
A similar, but less pronounced trend is visible in the French economy. In the long term, both France and Spain have a problem with exports outpacing consumer spending. Over the seven years 2013-2019, again adjusted for inflation,
- In France, exports grew 340% faster, on average, than consumer spending; GDP grew 16% faster than consumer spending;
- In Spain, exports grew 33% faster, on average, than consumer spending; GDP grew 35% faster than consumer spending.
Focus on the family: a recipe for European prosperity
By contrast, in the U.S. economy, consumer spending grows on par with or ahead of GDP, averaging a 12.2% edge on the economy as a whole for the 2013-2019 period. While the U.S. has its economic problems, the runaway government debt being an ominous example, its unending reliance on domestic spending for domestic prosperity is a winning recipe over time.
A full analysis of the European economy will have to wait until Eurostat has released numbers for all the components of the euro-zone’s GDP. In the meantime, while France and Spain admittedly do not represent all of the euro zone (and certainly not all of the EU), the two economies are good examples of a troubling trend in the European economy.
It is, plainly, not sound to let any economy become reliant on foreign markets to generate growth and prosperity. A review of a longer period of time will verify that this is an ongoing problem across the continent (again with notable exceptions), which suggests that the relative rise in exports is not due to intra-EU trade. It is a trend that is making Europe increasingly dependent on foreign markets for any meaningful economic growth. This, in turn, means that international business cycles will exercise more and more influence over the economic stability, resiliency, and prosperity of the European continent.
Dependency on foreign economies also leads to delicate political problems. Export markets, and the benevolence of their governments, get more and more of a say over the economy—even life in general—in Europe. So long as there is global peace and everyone is committed to free trade, there are no apparent threats to the European economy, but as we have seen in just the last couple of months, that peaceful environment for global trade can easily be disrupted.
The best way to future prosperity in Europe is paved with policies that promote stronger families with better opportunities to build prosperity on their own, without dependency on either distant exports markets or government.
Is there perhaps an example close to home that European countries could learn from?