2012 mid-year outlook for the US and European economies
— US continues to recover; Europe continues to stagnate —
June 26, 2012
While the US economy continues to recover at a gentle place, the deterioration of the Eurozone economy is becoming clearer.
There has been a significant gap between the US and European economies in terms of their pace of recovery since the Lehman Shock. This difference in economic performance is due to (1) fiscal policies, (2) progress made with balance sheet adjustments and (3) structural adjustments to industry and labor markets. This report examines these three points as key to the outlook for the US and European economies in 2012-13.
(1) Fiscal policies
Since the Lehman Shock, the US economy has generally maintained an expansive fiscal policy. The European economies have switched to fiscal austerity before a clear economic recovery has manifested itself.
Looking to the future, the critical event in the US will be the large-scale tightening of fiscal policy (the “fiscal cliff”) scheduled for early 2013. Although excessive austerity is likely to be avoided, it should be remembered that fears of deterioration of public finances could cause turmoil in the financial markets.
In Europe, fiscal austerity continues. Faced with popular protests against excessive fiscal austerity, European leaders are beginning to shift towards a strategic stance that also takes growth into consideration, but the ability of the growth support measures put forward in Europe to sustain the economy will be limited.
(2) Balance sheet adjustments
In the US, the household sector is making steady progress with the clearing of debt. The rate of decline of housing prices is slowing as the supply-demand balance improves. The recovery of the housing market is expected to take some time yet, but the downward pressure of adjustments on the economy is beginning to ease.
In Europe, progress with adjustments in the housing market has been slow and there is still strong downward pressure on the economy. Amid growing inter-dependency between governments burdened with high levels of public debt and financial institutions burdened with high levels of bad debt, there is little prospect of increased willingness to lend, and the negative impact on the real economy through downward pressure on capital investment, among other factors, is likely to be prolonged.
(3) Structural adjustments
In the US, against the backdrop of falls in the cost of labor and the value of the dollar, the external competitiveness of manufacturing industry has seen a major rise. Steady production activity based on export growth and growing demand for domestically manufactured goods is likely to underpin the US economy by leading to growth of domestic investment. However, since the curbing of personnel costs in the manufacturing sector and rising productivity also hinder improvement in income conditions in the household sector, this may not lead to growth of consumer spending.
In Europe, wage cuts and other reforms of the labor market with a view to enhancing the external competitiveness of southern European countries are essential. However, labor market reforms in southern European countries will take some time to yield benefits and in the short term may, if anything, lead to a fall in incomes and a rise in unemployment.
Given these conditions, the outlook for the US and European economies is as follows.
US: Wit the corporate sector, especially manufacturing industry, remaining firm overall and debt adjustments in the household sector making steady progress, it is likely that the mood of economic recovery will continue. Although slow wage growth, continued stagnation of housing prices and federal government spending cuts, among other factors, will slow the pace of recovery, which is expected to remain gentle in the short term, from mid-2013, when the downward pressure exerted by fiscal policy will tail off, there are hopes that the recovery will pick up speed, centering on consumer spending.
Europe: Owing to fiscal austerity, deterioration of employment and income conditions and the deterioration in corporate and consumer sentiment due to the prolonged debt problem, Europe is likely to see its economic downturn continue into early autumn 2012. Thereafter, although there are prospects of a rise in exports as the value of the euro declines and domestic demand in Germany grows, continued fiscal austerity and continued concern over the financial system mean that there is little prospect of a recovery of domestic demand in the heavily indebted southern European countries. Economic growth in the eurozone as a whole is likely to remain slow for an extended period.
There are two risk factors in the above outlooks:
(1) Greece leaving the euro: Fears of an exit from the euro have spread to Portugal and Spain, and if these lead to turmoil in the financial markets, they may lead to risk-avoiding behavior on a global scale and exert downward pressure on the global economy.
(2) Fiscal austerity in the US: Failure to extend tax reductions and avoid the “fiscal cliff” may result in significant downward pressure on the economy.