It is always exciting when Eurostat releases new data on the European economy. Its newly released numbers for the first quarter of this year are no exception, but what makes this batch of statistical information so interesting is that it is far enough away from the 2020 pandemic to give us an idea of the extent Europe is returning to its pre-pandemic economy.
For the most part, it is good news: adjusted for inflation, every European member state except Germany, Italy, and Spain now have a larger economy than they did in the first quarter of 2019 (the last year before the pandemic). Some countries, like Austria and Slovakia, are barely over the mark, with Austria’s gross domestic product, GDP, being about a half of 1% larger than three years ago. The Irish GDP, on the other hand, has grown by one third in the same period of time.
Trust the European consumer
Compared to the American economy, Europe is slow to get through the post-pandemic recovery, but these GDP numbers show that it is actually happening—almost everywhere, that is. The paltry numbers out of Germany, Italy, and Spain, three of the largest economies in Europe, tell us that these three countries have become a drag on the European economy.
The German economy is still held back by the fiscal stranglehold that Angela Merkel placed on it, while Spain suffers from a host of structural economic problems that can only be addressed with a dedicated conservative reform plan. That is not to say the rest of Europe is problem-free, but it is nevertheless encouraging to see that in most countries the economy has gone through its return-to-normal process.
It is also promising to see that in many countries, private consumption has grown consistently over the past three years. The numbers are not spectacular, but they are nevertheless positive. This is a sign of resiliency in household finances, but more importantly, it is indicative of the structural solidity of an economy when most of its economic activity is geared toward satisfying the needs of its own population.
To this point, Figure 1 reports consumer spending in the first quarter of 2022 compared to the first quarter of 2019. Adjusted for inflation, for every €100 that consumers spent in Slovenia in 2019, they now spend €112.17; in Hungary, consumer spending is €111.83 today for every €100 spent in 2019. The third-best country, Romania, has a 2022 consumer spending level of €110.15 per every €100 three years ago; Croatia is in fourth place at €108.38.
Source of raw data: Eurostat
The strong Croatian number is noteworthy, given that they are about to transition from their own currency, the kuna, to the euro. That transition will require all the macroeconomic strength that Croatia can muster; by joining the currency union they open themselves to the wrath of ECB-imposed austerity, should another debt crisis hit Europe. Solid consumer spending is an important part of that strength.
Equally noteworthy are the countries in the red zone, i.e., where private consumption still lags behind its pre-pandemic levels. We find all the three big laggards here, with German consumers spending about 2.5% less now than in 2019. Italians and Spaniards are doing even worse, but the real surprise here is Ireland: in the first quarter of 2022, Irish households doled out only €95.14 for every €100 they spent in the first quarter of 2019.
This weakness in consumer spending is completely anomalous, given that Ireland has by far the strongest GDP growth since 2019. It is so anomalous, in fact, that consumer spending is now only a minor contributor to the Irish economy. In Q1 of 2022, as share of GDP, consumption was a remarkably low 20.6% (again adjusted for inflation).
Only one in five euros spent in the Irish economy comes from households. The recommended minimum level for a healthy economy is 50%. An economy can still be healthy if that number is lower, but it would have to be compensated by a high level of capital formation; if businesses spend a lot of money building new offices, factories, and other production facilities, as well as buying all sorts of equipment, then there is promise of a strong economic future. This promise includes stronger household finances.
None of this is happening in Ireland.
While capital formation has increased since 2019, the growth is far from impressive. In Q1 of this year, business spending on productive capital in Ireland amounted to only 16.1% of the country’s GDP.
In fairness, this number is only for one quarter. More than any other developed economy, Ireland suffers from exceptional volatility in its capital-formation spending: in the last quarter of 2021 this category of spending accounted for one third of the Irish GDP.
There are extreme examples where business investments can equal more than half of the Irish economy, although they are almost always limited to an isolated quarter. In most quarters, the level of investments is roughly equal to the European average. In other words, to find out why Ireland had such an exceptional recovery, with a GDP that in real terms is one third larger now than it was before the pandemic, we have to look to foreign trade.
The Hungarian contrast
Here, Ireland is one of the exceptional economies in Europe. Irish exports have exceeded the country’s GDP for the past ten years; in plain English, the Irish use more economic resources to sell things to other countries, than they use to satisfy needs at home.
The Emerald Isle is not alone in having an exports-to-GDP ratio above 100%. Only Luxembourg and Malta are consistently in that category, but other countries also have a high exports level: Hungary, e.g., exports to a value well above 80% of its GDP.
Large exports per se is not the problem; the trouble begins when exports do not help the rest of the economy grow. Hungary and Ireland are compelling contrasts in this regard, and the primary evidence is in the aforementioned consumption share of GDP: where Irish household spending only accounts for a bit more than one fifth of GDP, it was 55.1% of the Hungarian economy.
This means, plainly, that Hungary’s large exports-driven industry actually benefits Hungarian workers and families, while the same is not true in Ireland. It is also interesting to note the long-term trend in these two countries. In Ireland, consumer spending has historically accounted for 35-40% of GDP; the share has declined in the past 8-9 years, falling below 30% in 2019. It plummeted to 20% during the pandemic and there are no signs of a recovery from there.
By contrast, in Hungary, consumer spending accounted for 55-60% of GDP in the late 1990s and early 2000s. This was a time when the Hungarian economy remained relatively poor. The share dropped to about 50% with the Great Recession and remained there for a few years, but that was not the result of a decline in the standard of living for Hungarian families. Over the 2010s, businesses invested heavily in capital formation and Hungary rapidly became a significant exporter.
The results have shown up in Hungarian national-accounts data, in particular as a GDP that consistently grows above 4% per year, in real terms. Even more impressive is that as the economy grows, household spending grows with it: in 2018 and 2019, consumer spending accounted for 51.5% of GDP, in real terms.
When paired with strong GDP growth, this means that Hungary’s households increase their standard of living on par with economic growth. Unlike Ireland, families in Budapest, Debrecen, Székesfehérvár, and other parts of Hungary consistently reap the benefits of a strong economy.
Troubling Irish investments
We find a similar stability in business investments. As mentioned, the Irish economy suffers heavily from high, almost extreme, fluctuations in business investments. The volatility is comparable to that of poor, developing economies: total business investment spending can increase by 111% in one quarter, on a year-to-year basis, only to plummet by 40% the next quarter.
In the fourth quarter of 2018, Irish business investments fell by 68% on an annual basis, only to rise by 151% the fourth quarter of that year. These extreme investment fluctuations suggest that a very small number of large corporations entirely dominate the Irish economy. I will not go as far as to call the Irish economy a banana republic, but one has to ask how an industrialized, European economy of reasonable size (we are not talking about Luxembourg with 650,000 residents) can apparently become so dependent on a narrow set of corporations.
The contrast to Hungary is stark. Business investment growth is entirely within the realm of normal for an economy with 4% real annual GDP growth. Regular cyclical tops with 20-25% year-to-year investment growth are followed by equally regular declines.
As mentioned, both Hungary and Ireland export very large amounts of their domestic product. Consequently, they have substantial imports, largely of input products that are then assembled into finished products and exported. (The net between exports and imports is what counts toward GDP.) Ireland’s foreign trade is only to a small degree oriented toward Europe.
Before the pandemic, 40-45% of Irish exports went to the European Union, with about the same amount of imports coming from the EU. Since the pandemic broke out, and counting through the first quarter of this year, only about 30% of Irish exports have EU destinations on them, and just over 20% of their imports originate in the EU.
While Ireland is largely independent of the EU for its foreign trade, some 70-75% of Hungary’s exports and imports have EU countries as their destinations and origins.
It is a given that both countries have purposely pursued exports as a source of economic growth. As this comparison shows, the results are vastly different, with Hungary as the undeniable winner—and not only this comparison. From 2015 to 2019, with 4.6% on average, Hungary had the third-fastest growing annual private consumption expenditures in the whole of the EU. Only Romania (7%) and Malta (5.1%) did better.
From the start of the pandemic in Q1 of 2020, through Q1 of this year, Hungarian consumers increased their spending with, on average, 2.1% per year. This number is a bit dicey, as it includes the artificial swings that came with the forced shutdown of the economy, but it is nevertheless tied with Bulgaria and Poland for the third-best number in the EU.
One cloud on the Hungarian horizon
All in all, the Hungarian government runs its economy with firm yet thoughtful policies. The only concern on their horizon is the persistent deficit in their consolidated public finances, which eventually will become a burden for Hungarian taxpayers. This is not a problem that is unique to Hungary, but one that the vast majority of EU member states are struggling with. The widespread problem with budget deficits is in itself not positive, but since the Hungarian economy is so healthy otherwise, a sovereign-debt investor has less to worry about when it comes to the solvency of Hungarian treasury securities than those issued by countries with stagnant economies.
So far, Hungarian government debt is not of any concern to investors, and there are no reasons to believe it ever will be. The Hungarian government’s professional management of both the economy and government affairs is a source of confidence for the future.
However, should the debt become a problem—perhaps as a contagion effect from worse-off countries—Hungary has one asset that most EU member states do not: they are not part of the currency union. This leaves the Hungarian government with more policy options, and monetary independence, that hard-hit Greece, Italy, and Spain did not have a decade ago.
Let us hope that a new debt crisis does not intervene with Hungary’s economic success.
Let us also hope that it does not hit any other part of Europe. The continent deserves to move forward with a relatively good economy and a positive outlook on the future.