One of the most popular lectures at Afera’s recent Annual Conference in Dubrovnik, Croatia, was a study of Europe and the global economy at our current position in the economic cycle given by David Smith, Economics Editor of The Sunday Times (UK). With 25 years’ experience in business news at The Sunday Times and a book about the current crisis called The Age of Instability under his belt, Mr. Smith asked the question which every company along the European adhesive tape value chain ponders: Seven years after the worst economic storm in a century, are we still in the age of instability or are things improving?
European businesses take note: Emerging from the global financial crisis which began in the summer of 2007, we are set for: slightly better growth prospects in Europe although remaining subdued; gradually rising interest rates in some advanced countries in the near future; a decreasing danger of a euro breakup; and continuing emerging market growth over time.
The world has been suffering from two hangovers: the banking hangover in which rebuilding the system takes time and is hampered by a lack of lending and weak credit growth; and the fiscal hangover in which reducing large deficits requires painful cuts in government spending and tax increases. The US shows growth in GDP, but it is the weakest recovery in the post-war era.
Along with a distinct bounce in consumer confidence in the US, Europe is seeing consumer confidence edge up above its long run average despite the economic difficulties it has faced.
US economic growth is averaging around 4%, indicating that US recovery is now well-established. There is also a return to growth in Europe, but at best only 1-1,5%, which isn’t much to celebrate.
The euro zone Purchasing Managers' Indices (PMI) covering both services/manufacturing and goods production have risen to 54,1 and 51,9 (a ten-month high) respectively, indicating modest growth. UK growth in particular has picked up strongly at more than 3% due to low interest rates and other austerity measures.
Unemployment is falling, but it will be some time before euro zone unemployment gets back to pre-crisis levels. Even as the rescued, ‘peripheral’ European economies start to look a bit better, prospects in Italy and France are bleak. Political discontent, driven by slow growth and high unemployment, persists.
While France is tied up in a struggle over radical reform policies, Italy is in its third recession in the space of a few years. In its 14th consecutive quarter without any growth, Italy’s economy has only seen a 3% rise in GDP since the euro came into being in 1999. Compare this to France’s GDP which is up 17%, Germany 18%, and the UK 30% since then.
The bottom line: Mr. Smith sees this modest euro zone growth of roughly 1% continuing but widely varied. This is good news if you operate in or sell to some of these economies which have returned to growth strongly. These include Ireland, Spain, Portugal, UK, Sweden, Netherlands, Poland, Slovenia, Slovakia, Latvia, Lithuania, Estonia, Hungary, and even Greece. Of course, business opportunities lie within the markets of slow-growing countries too, but they are not as good as they might be. The weakest growth will be found in Italy, France, Germany, Denmark, Cyprus, and Belgium.
Ultra low interest rates tell their own story. The Federal Reserve began to cut rates in 2007. The Bank of England last raised rates more than seven years ago, while the European Central Bank has just cut rates again. For many countries, this is the longest period of unchanged rates in 60 years. According to Mr. Smith, how low interest rates have been, and how long they have been low, is testimony to the severity of the crisis. Even when central banks cut rates to these ultra-low levels, they did not expect them to stay so low for so long.
Markets are beginning to price in interest rate increases, although less so in the euro zone. Central bank heads have endorsed higher rates in some areas however. Central banks are emphasising a ‘new normal’ of 2,5-3% for interest rates.
The bottom line: Interest rates in some advanced economies will rise in late 2015, but only gradually, as in one-quarter of a percentage point every 3-6 months (a much lower level than we were used to in the past). The UK will probably be first, partly in response to its strong growth. This will be followed by the US and very distantly by the euro zone and Japan.
Interest rates set by central banks may eventually return to pre-crisis levels averaging 4-5%. Some countries, however, may settle at a ‘new normal’ rate level of about 2,5-3% for two reasons: 1) Even when rates are increasing, there will still be headwinds to economic recovery, and 2) The margins (which are the spreads between the interest rates set and the interest rates available at which to borrow in the markets) will probably remain high because of the ongoing convalescence of the banking system.
The euro zone turned out to be the epicentre of the global financial crisis because of the three separate crises taking place here: When the euro came into being in 1999, a macroeconomic growth and competitiveness crisis ensued when many economies lost up to 20-30% in competitiveness against Germany. Portugal, Spain, Ireland, Italy, and even France were the hardest hit countries. This was then exacerbated by the banking crisis.
For a long time, membership in the euro zone was a badge of fiscal and financial respectability. This changed when Greece defaulted on its debt, unexpectedly bringing the sovereign debt risk to the fore in Europe.
The interaction of the macroeconomic growth and competitiveness, banking, and sovereign debt crises has made recovery difficult. Plagued by high unemployment, the euro zone has seen two recessions – a deep one in 2008-09 followed by a short recovery, and another one from 2011-13 – and a current return to modest growth.
The bottom line: The breakup of the euro, which was a threat even as recently as 18 months ago, is over at least for now. The European Central Bank is aggressively acting to head off deflation and stagnation. The most severely hit countries in Europe appear to be coming through the worst.
Had things played out differently, with Greece exiting the euro and causing a domino effect with other countries coming under pressure to leave, a second major financial crisis within the space of a few years would have resulted. According to Mr. Smith, we came relatively close, but nobody really talks about the euro breakup anymore. Some of the most severely hit countries, which had to put into place the most extreme austerity in Europe, are now returning to growth and, in some cases, rather well at that.
As opposed to the 1990s economic principle that 2/3 of global growth came from advanced economies, in the 2010s 2/3 of global growth has been driven by the emerging world. Mr. Smith says that this is the pattern we should keep in mind for the future.
The bottom line: Over the next year, growth will not be driven by the emerging economies. When China, one of the biggest economies in the world, slows, that drags down emerging economies generally. China’s growth has slowed from 11-12% to a more sustainable level of about 7%, which is still very strong.
Over the medium- and long-term, both China and India, two very large and populous countries, will continue to expand rapidly and drive the global economy. Even if the period from 2000 through the crisis was considered a sweet spot for emerging economies, which grew much faster than anticipated, we may see some easing of the pace of economic growth, but it is still going to be relatively strong. In addition to Asia, during our working lives we will see continued substantial growth in Africa, Latin America, Eastern Europe, and so on. Great opportunities will continue to be found in strengthening existing markets and newly created markets in the emerging world.
How seriously could the prospect that has been described – a return to growth in the advanced world – a long-term picture in which growth is led by emerging economies, creating lots of opportunities – be affected by certain risk factors?
Mr. Smith feels that there are concerns if you care to look for them but that the world shouldn’t quite be seen as the most dangerous it has ever been. The Russia-Ukraine crisis has negatively impacted Russia’s economy more than it has hurt the rest of the world, although Germany’s business climate has taken a hit. The Baltic States could suffer slightly because of Russia’s banning of EU agricultural imports in reaction to sanctions. Tensions between EU leaders and President Putin have eased, however, and the risk at one stage of military conflict involving NATO has largely subsided.
Instability in the Middle East continues, but at the moment, it is something we observe and are horrified by, but it is not having a significant economic effect on Europe. Any sign that the price of oil is ticking up strongly would suggest that political concerns are feeling through to real economic numbers.
At the moment, unusually, growth in world trade (particularly in goods) is weaker than growth in world GDP. More internalising of trade may be part of the backlash from the global crisis, in which export credit is not as easily obtained so companies are obliged to concentrate on markets nearer to home. As growth in world trade, which is normally a driver of the global economy, is weaker than it should be, explicit protectionism should be monitored although there is currently no evidence of any.
Other risk factors include another round of euro zone crisis and/or further EU bank difficulties, slower growth in China, and Donald Rumsfeld’s famous “unknown unknowns”. Mr. Smith emphasised, however, that the balance of business opinion leans toward the optimists when it comes to the future of the European and global economies.
Since 1989, David Smith has been Economics Editor of The Sunday Times, where he writes a weekly column. He is also an assistant editor, policy advisor, and chief leader-writer. Mr. Smith has won a number of awards, including the Harold Wincott Award for Senior Financial Journalist of the Year (2004). He is a regular contributor to The Confederation of British Industry’s Business Voice and also writes a home economics column in the property section of The Sunday Times. Prior to joining The Sunday Times, Mr. Smith worked for The Times, Financial Weekly, Now! Magazine, the Henley Centre for Forecasting, and Lloyds Bank. He was born and brought up in the West Midlands and studied at the University of Wales, Oxford, and London. He is a visiting professor at Cardiff University.
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