Eurozone Showing Economic Resilience in the Face of Trade Headwinds

FEATURE

Eurozone Showing economic resilience in the face of trade headwinds

Alexander Börsch Eurozone: Showing economic resilience in the face of trade headwinds

Resilient domestic demand contrasts weaknesses in global trade. The eurozone, therefore, continues the recent trend that combines a resilient services sector with struggling manufacturing industries. The question is: How long can this divergence last?

Diverging trends and rate was down to 7.5 percent in June, almost one moderate growth percentage point less than a year before, and the lowest since July 2008.4 The slowdown in the eurozone continues with an estimated growth rate of 0.2 percent in the second The strength of the labor market is matched with quarter,1 after 0.4 percent growth in the first quar- renewed wage-growth dynamics. While wages grew ter. Among the big eurozone economies, Spain slowly for a long time, they are now picking up showed the highest quarterly growth rate, and momentum and are growing at the strongest pace business and consumer sentiment in France since 2011.5 Combined with still-low inflation, this rebounded. Germany grew stronger than expected should continue to support private consumption in in the first quarter due to a rebound of car sales the coming quarters (figure 1). after the production delays at the end of 2018, while the Italian economy has largely stagnated.2 Powered by robust private demand, the services sector shows strong resilience and currently acts as A very positive trend cutting across the eurozone the growth engine in the eurozone. Nonetheless, relates to labor market performance—employment the industry sector remains weak, with industrial in the eurozone continues to grow. Currently, there output being on a decline since early 2018 (figure are 159.5 million people employed in the euro- 2). Therefore, the diverging trend of resilient ser- zone—the highest level ever recorded. The number vices and a struggling industry sector continues in of persons employed has increased by 10.8 million the eurozone. in the euro area since 2013Q2.3 The unemployment

2 Eurozone: Showing economic resilience in the face of trade headwinds

E Wage and inﬂation dynamics support private consumption

Inﬂation (HICP) Nominal wage growth

3.5%

3.0%

2.5%

2.0%

1.5%

1.0%

0.5%

0.0%

Source: European Central Bank. Deloitte nsights deloittecominsights

E Divergence between industry and services continues

Serices ndustrial roduction

nde anuar threemonth moing aerage

Source: rganisation for Economic ooeration and eeloment Deloitte nsights deloittecominsights

3 Eurozone: Showing economic resilience in the face of trade headwinds

The manufacturing recession However, this was probably due to temporary stockpiling in the United Kingdom in anticipation The overall weakness in manufacturing affects par- of the original Brexit deadline in late March. ticularly the manufacturing-intensive economies of Without this temporary effect, exports to the euro- Germany and Italy. Industrial output in Germany zone’s major markets would have remained flat. and Italy has been on a broad downward trend since the middle of last year. A contributing factor Without a rebound in world trade, exports alone to this parallel development could be the close inte- will not to be able to drive manufacturing output gration of German and Italian industrial supply and, therefore, growth in the eurozone. Current chains and their higher exposure to developments data and projections do not suggest a trade recov- in the United States and China.6 ery any time soon. According to the World Bank, global trade growth will fall from 4.1 percent last Industrial output in France and Spain has not year to 2.6 percent this year; the weakness in trade grown much either, but it shows a slightly positive so far has affected mainly capital goods.7 trend over the same period (figure 3). Additionally, many corporates show a decreasing While strong domestic demand supports the ser- appetite for investment. While investment in con- vices sector, it is investment and exports that struction is strong, that in equipment and usually drive the manufacturing sector. A deeper machinery is growing considerably weaker than look at the key destination countries for the euro- last year.8 In this sense, growth impulses for manu- zone’s exports reveals that exports to the United facturing from exports and investment remain States and China have stagnated since late 2018. weak at best. Surprisingly, exports to the United Kingdom saw a sharp rise in the first quarter of 2019 (figure 4).

E The manufacturing sector in Germany and Italy is strained

Sain rance tal erman

nde anuar threemonth moing aerage

Source: Eurostat Deloitte nsights deloittecominsights

4 Eurozone: Showing economic resilience in the face of trade headwinds

E Exports had a net positive contribution in Q1 mainly due to stockpiling in the United Kingdom in anticipation of Brexit in March

hina nited States nited ingdom

Source: Euroean entral an Deloitte nsights deloittecominsights Can manufacturing and labor shortage is one of the main risks for services decouple forever? European companies; in Germany, the Netherlands, and Austria, they are the most important risk.10 The divergence between manufacturing and services seen currently is surprising. While the two In this situation, companies tend to hire or keep sectors are usually driven by different kinds of more employees than they usually would to protect expenditure, several service sector outputs are themselves from the adverse effects of labor short- inputs into manufacturing; in other words, there is ages.11 This employment security, however, comes a spillover effect from manufacturing to services. possibly at the expense of productivity growth.12 However, in recent years, the correlation between Coupled with employment increases, especially in the two industries has declined in almost all major knowledge-intensive services, which are relatively economies.9 immune to cyclical trends, the services sectors were likely able to increase their resilience. The reasons are manifold, but one key factor that impedes the spillover effects involves labor market As for the economic outlook in the coming next trends. In almost all major industrialized countries quarters, this implies that any positive or negative labor markets are very tight. According to change in the labor market and private consump- Deloitte’s European CFO Survey Spring 2019, tion could directly affect growth in the eurozone.

5 Eurozone: Showing economic resilience in the face of trade headwinds

Endnotes

1. Eurostat, “GDP up by 0.2% in both euro area and EU28,” press release, July 31, 2019.

2. Eurostat, “GDP up by 0.4% and employment up by 0.3% in the euro area,” press release, June 6, 2019.

3. Ibid.

4. Eurostat, “Euro area unemployment at 7.5%,” press release, July 1, 2019.

5. European Central Bank, “European Central Bank—Statistical Data Warehouse—quick view” and “Compensation per employee,” accessed July 17, 2019.

6. Raju Huidrom et al., Trade tensions, global value chains, and spillovers: Insights for Europe, International Monetary Fund, June 12, 2019.

7. World Bank, Global Economic Prospects (Washington, DC: World Bank, 2019).

8. Eurostat, “Gross fixed capital formation with asset breakdowns,” accessed 2019.

9. Laurence Boone, “OECD Economic Outlook May 2019,” OECD iLibrary, accessed August 3, 2019.

10. Deloitte, European CFO Survey: Eyes on demand, accessed August 3, 2019.

11. Ifo Institute, “ifo Economic Forecast Summer 2019: ifo Institute affirms 0.6 percent growth in 2019,” June 18, 2019.

12. European Central Bank, “Eurosystem staff macroeconomic projections for the euro area, June 2019,” June 6, 2019.

About the author

Alexander Börsch | [email protected]

Alexander Börsch is the chief economist and head of research at Deloitte Germany. Before joining Deloitte, he worked as a senior economist in the investment management and management consulting industries. He is the author of numerous publications on topics such as the European economy, economic trends, the digital economy, Brexit, and the competitiveness of companies, cities, and nations. He holds a PhD from the European University Institute and was a visiting researcher at the London School of Economics, Warwick University, and INSEAD.

6 Eurozone: Showing economic resilience in the face of trade headwinds

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Alexander Börsch is the chief economist and head of research at Deloitte Germany.

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