The European Economy: No return to the good times?

Europe thought it would avoid the worst of the “Anglo-Saxon” banking crisis. It was not to be. Keith Harvey looks at the depth of the recession in the eurozone

Surveying the state of European capitalism in April the European Commission was frank: “The EU is struggling to overcome the deepest and most prolonged downturn since World War Two.”1

It wasn’t meant to be this way. When the credit crunch exploded in 2007, Europe’s leaders were quick to point the finger of blame at New York. Brussel’s complacently pointed out that the sub-prime mortgage mess originated there, the European Union’s (EU) responsible banking sector could not be compared to the über-deregulated financial system in the US.

Continental Europe’s consumers were high savers, households spurned high consumer debt, property bubbles were limited largely to Ireland and Spain.

But after seeming to get off lightly from the post-2007 credit crunch fall-out in the US, matters took a sharp turn for the worse after the Lehman Brothers collapse on Wall Street in September 2008. The following six months saw the economies of the EU (and those bordering it) fall off a cliff. Exports collapsed, manufacturing went into a tailspin and unemployment rocketed.2

In the final three months of 2008 the eurozone economy shrank by a steep 1.6%. But in the first quarter of this year it was even worse – contracting by 2.5%. Germany’s decline outdid all the others, with GDP collapsing by nearly 5.5% in the six months from October 2008.3 But lurking within these grim figures was even worse news. Industrial production in the 16-country region was 20.2% lower this March than a year before – the largest year-on-year drop since records began in 1991, pushing output down to 1997 levels.4

France’s President Sarkozy may blame Anglo-American neoliberalism for global capitalism’s mess and Angela Merkel may deride Gordon Brown and Barak Obama for their “irresponsible profligacy” at pouring zillions into a black hole to brake capitalism’s freefall, but they can only watch helplessly as the EU’s voters go to the polls wondering whether their jobs will be next to go.

In April the International Monetary Fund’s World Economic Outlook predicted the eurozone’s GDP would contract by 2.2% this year, a better outcome than the UK and Japan but worse than the US. The European Commission expects exports and investment to contract by 12.75% in 2009 and investment by 10.5%.

Everyone is now asking the million dollar question “After the massacre of output and jobs in the last six months is the worst over? After the slash and burn, have green shoots started to appear?”5 In Basel Jean-Claude Trichet, the European Central Bank president, insisted the recession was “bottoming out”, that the pace of decline would lessen in the summer and even give way to some recovery in the second half of the year. A raft of forward economic indicators seem to support that view. Analysts at Swiss banking giant UBS were very upbeat as May began:

“We review the business surveys published this month. They have posted the largest monthly improvement ever recorded. We derive three conclusions. First, we think it is now indisputable that we have passed an inflection point. Second, this is a very strong confirmation that the risks to our forecast are on the upside, at least for H2 this year.”6

So why has Europe’s collapse been worse than the US and can it be true that recovery is already in sight? After falling off a cliff can eurozone capitalism land on its feet? Part of the answer lies in the origins of the previous long upturn period.

Europe and globalisation

The collapse of Stalinism in eastern Europe and the USSR during 1989-91 together with the restoration of capitalism in China by the mid-1990s prepared the way for a new upward long wave of capitalist development across the globe.7 Between 1993 and 2007 there was an unprecedented 15-year capitalist expansion, based on a recovery of profit levels which by early in the new millennium was unparalleled since the early 1960s. The five years of the upswing phase of the business cycle in 2003-07 was the apogee of this expansion.

But European capitalism did not prosper immediately or all together. West Germany, which swallowed Eastern Germany whole in 1990, suffered indigestion throughout the 1990s. The re-united country continued to bear the costs of a relatively generous social welfare system while pumping huge amounts of capital into the collapsed economy of former East Germany. Yet its traditional markets for the country’s exports, the former centrally planned eastern Europe and USSR were no longer functioning. The stagnation of the European economy through the early 1990s was its direct consequence.

What’s more, unlike the US and UK, where desperation had forced the ruling class to wage savage class war against their domestic trade unions and inflict major defeats on the labour movements, in the EU and particularly France and Germany, the capitalists missed their opportunity. When France announced the Juppé plan in 1995 it was too late and the threat of a general strike was enough to scare the bosses off.

European bosses and governments have spent much of the last two decades engaged in persistent, piecemeal and generally unsuccessful attempts to erode workers’ conditions and make their economies more competitive in a globalised world. As a result European manufacturing did not experience the gains in productivity experienced in the US.

The US workers saw their traditional protections torn up, as Reagan destroyed job security and the welfare state. The unions began a three decade decline which has still to reach bottom. But this assault enabled the US capitalists to significantly raise productivity rates in their domestic manufacturing during the 1980s.8

But even this was put in the shade by the information and communication technology revolution of the 1990s, as a surge in US fixed capital investment transformed the technological base of US industry. Productivity growth doubled as US capitalists took advantage of the hi-tech bubble to raise capital at low cost and ship their low value production units abroad to new producers – notably China.

In contrast Germany and France stagnated in the early 1990s, only growing with the revival of the now capitalist east and central European nations in the late 1990s. Germany’s manufacturing revolution took place from the new millennium onwards as it was able to exploit the integration of low cost producers in countries like Poland and the Czech Republic with its own industrial base.

The overall result was that, while the US experienced the longest uninterrupted period of growth in its history between 1993-2001 with particularly high rates of expansion during the peak of the hi-tech boom from 1996-2000, the EU in contrast lagged behind (see Table 1).

The relative poor European growth through the 1990s was reflected in the relative weakness of the euro against the US dollar. This further impeded the ability of European capitalists to take advantage of the opening of the world market in the 1990s. The low value of the euro reduced its purchasing power on world markets relative to its chief rivals – the US dollar and British pound. This retarded the export of capital in the form of takeovers and new fixed capital projects. So while the geographic proximity of the EU to the former centrally planned economies of eastern Europe gave it a significant advantage over the US, this advantage was only really realised from 2000 onwards. By then the euro was stronger against the dollar and the shift of European manufacturing to lower cost sites in former eastern Europe raised productivity and profitability rates, and hence investment. Eurozone countries increased their proportion of world foreign direct investment (FDI) stock from 32% in 2000 37% in 2007, while FDI in both the UK and US declined (see Table 2).9

European trade

The resurgent export of capital was accompanied by the export of commodities. From 1999 to 2000, at the height of the dot com boom, world trade – the total volume of import and export flows – grew by 35% and reached more than C= 10tn in 2000. After recovering from the effects of the dot com crash in 2000 growth resumed, with trade expanding by 11% in 2003-04 and by 16% in 2004-55. External EU trade grew at an average annual rate of 7.8% from 1999 to 2005 compared to average world trade growth of 8.4%. By 2007 the EU accounted for 18% of world trade, the US 16%, China 11 %, Japan 7% and Canada 4%.

At the same time the direction of EU trade also changed – away from Europe’s traditional partners in North America and the UK. Between 2002 and 2007 the US proportion of total EU exports fell from 28% to 21%, and of EU imports from 19% to 13%.

In contrast EU trade with China more than quadrupled after 1999. China currently ranks first among EU import suppliers, after overtaking the US in 2006. In 2007, over 40% of EU imports came from Asian countries while the other European countries, notably the newly restored capitalisms of the former Stalinist states accounted for more than a quarter. The main destination of EU exports in 2007 was Asia with a 30% share, followed by other European countries 28% and North America 24%.

In contrast to the UK’s service dependent economy, about 85% of all EU exports are manufactured products. In 2007, machinery and vehicles made up almost half of total exports while other manufactured products accounted for 25% and chemical products for 16%bn. In 2007 the euro area surplus in manufactured products was €262bn. The majority of this was accounted for by machinery and vehicles sales.

European recession

In the summer of 2008 the world economy was slowing. The business cycle – rate of profit, growth and investment – peaked in late 2006. Through the course of 2007 the US entered a crisis, which deepened as the scale of the sub-prime fiasco became apparent. The countries in the Eurozone slowed gently while the emerging markets, benefiting from the raw materials boom, appeared immune. By the beginning of 2008 the US had entered recession. At the same time China sought to reign-in the break-neck pace of growth. Its banks had little exposure to the sub-prime mess and were now the richest and most profitable in the world. But the government raised interest rates and statutory bank reserves, and imposed limits on local government spending, because it was worried that uncontrolled domestic investment threatened runaway inflation as raw materials shortages began to bite.

By July 2008 oil prices had reached $147 a barrel. In the Eurozone the European Bank raised interest rates well into last year unconcerned by the US financial crisis, confident it could cope with any fallout. Its manufacturing exports and industries were buoyed by new sources of demand in Russia and China, whose firms were spending their booming revenues on imports from countries like Japan and Europe.

Then Lehman Brothers collapsed. The decision of Hank Paulson, the US Treasury Secretary, to allow Lehman Brothers to go under was the neoliberals’ attempt to draw a line in the sand. They wanted a limit government involvement in the economy, to enforce “moral hazard” by insisting the banks take a hit for their bad investment decisions. But when they saw the consequences the Bush administration quickly changed its mind. As AIG – the largest insurance company in the world – threatened to go bust two days later, Paulson stepped in. But it was too late.

Now, what appeared as an undiluted positive when the new millennium dawned – a big shift in foreign investment and trade flows to the newly emerging economies, turned very negative once the credit crunch went global. As the European Commission noted in April:

“The internationalisation of production over the last two decades has amplified the effect of falling demand in export markets. Limited access to trade finance and trade insurance, in particular for developing economies and small enterprises, has fuelled the precipitous decline in trade.”

After the collapse of Lehman Brothers there was an immediate “flight to quality” in the financial markets, as banks in EU, US and Japan withdrew billions of dollars in short term funds from non-domestic markets. In the first place they were under pressure to do this because they needed to build up their capital reserves against mounting losses in the collapsed property and securitisation markets. Secondly, the crippled financial institutions were unwilling to lend more generally for fear that those they lent to would default because of the “toxic assets” they may be holding.10

The financial sector in Europe, at first complacent about its stability and lack of exposure to the sub-prime market, was quick to be drawn into the maelstrom. As UNCTAD noted: “The credit crisis quickly spread to Europe, with a number of large European financial institutions teetering on the edge of collapse, such as the Dutch-Belgian bank Fortis, the French-Belgian Dexia, the British mortgage lender Bradford & Bingley, Germany’s Hypo Real Estate, as well as the Dutch bank and insurance company ING and the Dutch insurance giant Aegon. In Iceland, three major banks collapsed, dragging the country to the brink of bankruptcy as the total external liabilities of the three banks accounted for five times Iceland’s annual GDP.

The contagious effects of the crisis also spread rapidly to emerging economies. Hungary was among the first of the emerging market countries to suffer. Both Iceland and Hungary had to recur to the IMF (and other sources) to alleviate the immediate financial market stress, becoming the first two European countries to do so in over 30 years.”11

The Eurozone’s banks exposure to bad debts has been estimated at $900bn (C= 700bn, or 8% of GDP). By the end of 2008 $150bn had been written off, leaving $750bn to be written off in 2009-10.12

But the crisis very quickly spread from the banks to hit the “real economy” too as world trade seized up after 15 September. Lehman Brothers had been a critical player in the global derivatives system, a system designed to spread and lessen risk against a firm going bust. When Lehman went bust the system unravelled fast. The complexity of the system of securitisation and hedging meant that no one knew the real value of the assets they were holding.

Global trade was dependent on the ability of merchant shipping firms to insure their cargo against loss. When this faltered, shipping came to a halt. The Baltic Dry Index, a measure of the cost of shipping dry raw materials like iron ore, fell 96% between July and December. As trade halted so did industrial production. It fell at an annualised rate of 27% between August 2008 and January 2009. Capitalism was in freefall.

Consumer loans critical for the sale of expensive items like cars and trucks became unavailable overnight; the average rate of interest on a new car loan tripled between August and December.13 The European economy, dependent on the export of machinery and particularly cars, slumped.14 After growing 2.5% year on year to the autumn 2008, EU exports contracted at an -18% rate over the winter of 2008/9.

Stocks of goods produced to feed the burgeoning world market of the summer now lay unsold. And so orders collapsed alongside production15 and with it capacity utilisation in factories fell sharply. In the January EU survey, capacity utilisation fell to 75.0, the second lowest reading ever; lower than the troughs of 76.5 and 76.7 in the early 1980s and early 1990s recessions respectively, and virtually equal to the trough of 74.9 in the 1974-74 recession.16

As exports, production and profits collapsed last autumn and winter, so investment followed. European corporations slashed capital spending, which contracted at a 14% annual rate pace in the fourth quarter of last year. The ECB estimates that by the end of the recession investment will have fallen peak-to-trough by a cumulative 15%, massive compared to the 3% fall after the dot com crash in 2000-03.

Unemployment

The working class has naturally been asked to pay the biggest price for the financial crash and its effects on output, trade and investment. Wages have been frozen or cut, short-time working is widespread and closures and redundancies commonplace in industry after industry throughout the eurozone. In fact eurozone unemployment had never fallen to the levels experienced in the UK and US, remaining above 10% throughout the 1990s before slowly declining from the turn of the millennium onwards, eventually bottoming at 7.4% in 2007.

The relatively high level of EU unemployment is another result of the failure of the European capitalists to decisively defeat their domestic working classes during the 1970s and 80s. Social transfers in kind, the proportion of profits transferred from the capitalists to the workers, were twice as high in the euro area at 15.6% (2007) compared to the US’s 8% of adjusted gross disposable income. The so-called “flexible labour market”, in spite of constant counter-reform programmes in Europe, never reached the same level in the EU as in the US/UK, although the two-tier workforce (older, unionised workers on permanent contracts and new hires on temporary ones) is gaining ground through the EU.

In Germany unemployment rose 185,000 in the first quarter of 2009. Unemployment across the 27 EU countries reached 8.3% in March, up from 8.1% in February. In the eurozone itself, unemployment rose to 8.9% from 8.7%.17 And the worst is probably still to come. Unemployment in the eurozone looks set to rise to 11.5% by the end of 2010 – the highest level since World War Two (see Table 3).

European green shoots?

Desperate to see some hopeful signs for the future, many analysts and government ministers are sure they can see green shoots of recovery. Certainly, the pace of decline has slowed – and for fairly clear reasons. First, credit conditions for corporations both in Europe and the emerging markets have improved from their completely frozen state in the autumn and winter. The key interbank interest rate (Euribor) has fallen from 2% above the central bank’s rate to 0.6% above, even though this is still 0.5% above the “normal” spread.

Secondly, the massive, co-ordinated fiscal and monetary measures taken by G20 governments have had the effect of halting the decline in demand and have provided a stimulus to recovery. For example, by May 2009 the US government has spent $12.6tn on capital injections and bad debt guarantees. In addition US President Barak Obama passed a $800bn reflationary spending package in the new year. And the US was not alone. Even though it was late to act, the European Bank slashed interest rates several times this year, while Germany and France began nationalising insolvent banks.

In the first quarter of 2009 China’s banks loaned as much as in the whole of 2008 – $670bn. This was in addition to a $585bn programme of public works. All in all the world’s governments announced about $2.6tn in reflationary measures. And sure enough, as the credit squeeze eased the impact of these measures began to restore world trade and output. In April 2009 the European Manufacturing index jumped to 36.7 from 33.9 in March, the highest level since October 2008 and the biggest month-on month increase on record.18 February exports grew by 0.5% month on month from January, the first increase in exports since the crisis took its more extreme turn last September.

However, those hoping to see a sharp rebound from the recession may be disappointed. In the first place, the sharp increase in unemployment and bankruptcies in the eurozone is certain to place further stress on Europe’s banks as they have to make provision for more bad debts in the housing and consumer debt markets. This could easily lead to a further tightening of the amount of credit available, curtailing any quick recovery.

But more importantly, it is inconceivable that the export-driven boom of the last five to ten years will return in this accentuated form. There will be no return to the debt-fuelled expansion of the US economy that sucked in exports from the EU in previous years. Moreover, much of the machinery-led exports boom to Asia this decade has been to provide their firms with the equipment needed to churn out the consumer goods that have been pulled into the US market. This cannot return in this expansive form.

Replacement markets for EU exports, driven by the massive internal expansion of the Chinese market is a theoretical possibility but the time-scale needed to engineer it is so long that it can have no major short term effect on dragging the EU out of recession and back onto the path it was on during 2003-07.

And for those looking for the EU working and middle classes to open their wallets and start spending to revive EU industry there is the little problem looming of the fiscal crisis of the state.

Public finances

The EU established “strict” entry rules for membership of the club, and especially for those that seek to adopt the euro as their currency. The government budget deficit was limited to 3% of GDP and the proportion of debt to GDP was set at 60%. By 2007 four countries had already breaching the 3% limit (Greece, Spain, France and Ireland) while seven countries exceeded the debt criteria –Belgium, Germany, Greece, France, Italy, Austria and Portugal. All the EU-12 countries (with the notable exception of Finland) had a growing debt to GDP ratio.19

The deficit will grow substantially in 2009 as income from taxes dries up and the cost of anti-cyclical measures and the recapitalisation of the financial sector increases. UBS estimate that “Overall, we believe eurozone governments will likely need to provide C= 406 billion in equity to banks over the next several years, in addition to the colossal liquidity and funding resources already in place.”20As a result debt as a proportion of GDP will spiral (see Table 4).

Debt growth at these rates is probably unsustainable. It will test each government’s ability to raise long term loans in the money markets through the issuing of government bonds. Investors will increasingly seek higher rates in return for the greater risk of sovereign debt default. In turn these governments will be forced to set aside a bigger and bigger proportion of state revenues to payment of interest on the debt building up. And this in turn means that governments will insist that there is less money available for benefits, for education, for pubic sector employment, for health provision. In short, a growing social crisis will mature as weak economic growth fails to produce the revenues needed to sustain the claims on government finances.

There is every reason to be optimistic that the labour movements of the eurozone will not be idle bystanders in this process. In Greece we have seen repeated protests by unions and students as the government seeks to cut back on pensions or make education more costly to those that depend on it. In France workers have occupied plants, kidnapped their bosses and taken to the streets in their millions to demand that Sarkozy stops the nationwide cull of jobs. In Luxemburg in May thousands of workers employed by the Artel steel plants stormed their headquarters to demand an abandonment of tens of thousands of announced redundancies across Europe.

Every crisis is also an opportunity. If there is to be an economic stabilisation of sorts during the rest of 2009 then the labour movement must use it to recover from the shock of the last six months and prepare for the battles that lie ahead.  

Endnotes

1. “The cumulative output loss since the start of the current downturn is already greater than that of the 1992-93 recession, and as great as that in the 74-75 recession. Furthermore, output is expected to contract again in 2009 . . .” European Commission, Economic Forecast, Spring 2009, p26. Elsewhere in the world the picture was grim too in early 2009. Output in Japan contracted by 4% in the first three months of this year (after a 3.8% contraction between October and December 2008), or by 15.2% on an annual basis. The world’s second largest economy like Germany depends heavily on exports, and has been hit hard by the global downturn in word trade. In the first quarter of this year, Japanese exports declined by 26%.

2. There are now 20 million people out of work in the EU (9%), four million more than in spring 2008.

3. The first three months of this year was worse than the last three months of 2008. Germany’s GDP fell 3.8% in this in first quarter.

4. In the worst case, Italy’s industrial output shrank a calamitous 24% between March 2008- March 2009.

5. In the EU’s largest economy, Germany, industrial production fell by 0.4% in March compared with February, after falls of 3.7% and 6.2% in February and January. German exports rose 0.7% in March in the first month-on-month increase since September last year. Industrial orders showed a 3.3% rise too – the first monthly increase since August 2008.

7. For a full analysis of this process see the following articles www.permanentrevolution.net/files/ 7123421_36-45%20Economy%20corrected.pdf

8. In contrast in the UK the scale of destruction of domestic industry was so profound that manufacturing has never recovered from Thatcher’s assault.

9. FDI slowed and then collapsed in 2008 UNCTAD has yet to publish up to date figures but so called de-globalisation, the re-patriation of national assets to the domestic economy was astonishingly rapid in the autumn of 2008. blogs.cfr.org/setser/2009/04/06/charting-financial-de-globalization-private-capital-flows-are-falling-faster-trade-flows/

10. In April the EC noted : “The decline in year-on-year growth of the stock of credit to non-financial corporations to 7.6% in February 2009 is equivalent to a notable sequential deceleration.”

12. Eurozone banks have raised $243bn to recapitalise their core capital by the end of 2008. Goldman Sachs estimate internal operating profits will generate around $600bn in 2009-10 which will cover the best part of the $750bn expected losses.

14. Sales of car and light vans in the US market for example fell from an annual rate of 15 million units at the start of 2007 to only nine million in the winter of 2007-8.

17. Unemployment amongst Europeans under 25 is already above 17% – more than twice the overall rate – and is expected to exceed 30% in some EU countries.

18. Services increased to 43.1 after 40.9, again the highest reading since October.

 

Thu 03, September 2009 @ 18:53