Europe Appears to Be Emerging from Recession – but Pitfalls Remain
The German and French economies, key drivers for Euro zone economic growth, sprung to life last week with each reporting GDP growth of 0.3% in the second quarter, which ended in June.
That was sharply different from what had been expected. In Germany, the consensus called for a 3.5% quarterly drop in GDP, and in France a 1.3% decline looked likely. The surprise turnaround caused many analysts to project positive third-quarter growth for the Euro zone overall.
Just how strong or weak any recovery may be in the Euro zone is one question. A second is whether Europe or the U.S. is likely to emerge from recession sooner. Recent economic history would suggest that the U.S. is the growth engine that helps carry other regions out of recession. Therefore, since the U.S. went into recession first, it is likely to emerge from recession before most other regions, including Europe.
Now that view is being challenged.
“I think the most important thing that is missing [from analyses of Europe’s economy] is the difference in corporate governance,” says Franklin Allen, Wharton finance professor. “In the U.S., firms are operated in the shareholders’ interest. When tough times come, managers lay off workers and maintain dividends as much as possible.” This recession is a perfect example of that approach and the effect “has been dramatic” – with the U.S. unemployment rate doubling since the start of the crisis in 2007.
Structurally, France and Germany “are much more stakeholder- and, in particular, employee-oriented,” Allen points out. “When the tough times come, [these countries] cut dividends and maintain employment.” The drop in German GDP has been much larger than the drop in the U.S., yet in Germany “unemployment is about where it was at the start of the crisis. It first actually fell and then rose.” In France, the fall in GDP was less than in the U.S, but, nevertheless, “the unemployment rate in France is again about where it was at the start of the crisis.
“In the good times, the U.S. system works well because it allows labor to be reallocated easily. The European countries have had a problem in that the adjustment is much slower,” Allen says. In the bad times, however, the U.S. risks instability because the large rise in unemployment has a chilling effect on the economy. “This is what I believe is now happening. France and Germany are emerging from the recession faster than the U.S."
Other analysts have pointed out that Europe’s extensive social safety net system can act as an automatic economic buffer – a form of stimulus that keeps more money in the hands of workers even if they were to be laid off. That reduces the need for more formal fiscal stimulus plans of the kind and size now seen in the U.S.
Meantime, while the strength of the turnaround was welcome, some observers say the surprisingly good numbers should be interpreted with caution. For one thing, Germany and France have their own temporary cash-for-clunker type auto-exchange programs – similar to that of the U.S. – which are thought to have bumped up the GDP figures. In fact, the German program is even stronger than the U.S. clunker program.
“Things have gotten so bad that almost any positive bit of news is taken as an indication of light at the end of the tunnel,” says Wharton management professor Mauro Guillén, head of the school's Lauder Institute. “As economic activity falls, it becomes more likely that the rate of decline will slow down and there will be … a rebound. The issue is how much of a rebound and how lasting?” Guillén remains “slightly pessimistic about Euro zone prospects: Banks are still experiencing growth in defaults, credit is scarce, consumers are wary and unemployment has not peaked. The recovery will be slow, long and painful.” And as for clunker-type programs and other government spending measures, Guillén adds, “the fiscal stimuli cannot last forever, and deficits are mounting. There’s too much uncertainty about when the turning points will happen; as a result, people are not making big decisions. It takes a while to deleverage. We still have a long way to go.”
Other analysts note that while German and French exports have begun to pick up, much of the improvement for the second quarter probably results from a drop in imports by both countries, which helps raise GDP numbers.