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Europe: Pent-up Demand…Where?

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By Peter G. Hall
Vice-President and Chief Economist Export Development Canada

Doomsayers have had no lack of pet issues over the past few years. Their favourite zone of the world has been Europe. The ill-fated Zone has provided a continually replenished smorgasbord of structural chasms, failed fixes and debilitating events, enough to feed pessimists’ apocalyptic fancies and convince their readers that the end must indeed be nigh. Against such an onslaught, it’s a miracle that the Eurozone has made it this far. But does its recent path suggest that all the future holds is a continuing Sisyphean struggle, or will the Zone break free?

Let’s review some of its key challenges. Nobel laureates claimed that the single-currency area would not survive its first recession. It’s a credit to leaders that after the Great Recession, the structure is still intact…for now, at least. On the other hand, there were the key officials who boldly pronounced in 2008 that Europe had decoupled from the US malaise, only to fall headlong into it. The malaise revealed key vulnerabilities in the European financial system. Then the stimulus required to prevent a meltdown produced a fiscal crisis that ushered in crippling austerity long before there was sufficient growth to support it. To make matters worse, there were the repeated panic points of financial impasse between borrower and lender states that are still very much with us. Add to this an economic area with sorry demographic fundamentals and chronic under-investment, and it looks even today like a pretty hopeless case.

In this context, mere survival could be seen as a noble goal. But can Western Europe actually look forward to better times? In spite of recent slow growth, austerity is actually doing its work. By some measures, Greece actually posted a balanced budget during 2014. It’s not structurally balanced yet – the number remains volatile – but progress to date is years ahead of expectations. Scan the remaining fiscal sinners, and their progress is also obvious. The banking system has also gone through a re-vamp, and is well on its way to greater stability. Again, that’s quite an achievement in a low-growth context.

If there are already key successes, it stands that higher growth will accelerate the structural improvement. But is higher growth in the forecast? Note that many pundits are actually revising up their European outlooks. Current data does seem more upbeat. But do the doomsayers have it right? Is this just setting us up for another round of the serial let-downs Europe has had to endure?

One key ingredient suggests not. Years of low activity have actually created a groundswell of potential demand in Europe, much as it has in America. Housing markets have been buried in the depths since the onset of crisis, and have traced out a path almost identical to America’s – except it has yet to recover. Building permits are far below household requirements, and have been stuck there for seven long years. That’s plenty of time to work off the pre-crisis surplus, and create a pretty substantial deficit. Maybe that explains soaring property prices in key markets. Although a small sector of the economy, this is a prescient one: It’s very closely attached to region-wide consumer spending, which as a share of GDP is still close to cyclical lows.

Linked to this is business investment activity. It has also been much lower than normal, and has yet to post anything close to a recovery. But years of under-investment are actually beginning to reveal impending capacity issues. Capacity utilization rates are on the rise, and increasing orders – boosted by the revival in the US economy – will put additional pressure on the system. When it does, look for long-sleepy investors to wake up and part with their cash-stash.

If it all seems too good to be true, take solace in the fact that at the near end of a growth cycle, it always does. Cynics can be forgiven – this has been an unusually protracted downturn. But pessimists butt up against general European sentiment. Confidence indicators suggest that in general, Europe’s businesses and consumers anticipate better times.

The bottom line? Long tossed on to the top of the developed-economy ash-heap, it seems that the Eurozone is poising to rise from the ashes. Given its economic heft, this is good news for the global economy.

© EDC

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