Can Europe Close the Growth Gap With the United States?

In recent years, Europe has joined Japan as a byword for economic stagnation, as the region as struggled to record much, in any, economic growth and has bounced from crisis to crisis during this period.  In fact, even before the region’s financial crises, Europe had fallen behind the United States and many other developed economies in terms of growth and innovation.  For example, over the past 25 years, the United States economy has grown faster than its European Union counterpart in 20 of those years, even as the US economy has under-performed over the past decade.  However, as the initial results from the first quarter of this year suggest, the inability of the US economy to reach the growth rates expected of it have allowed Europe to close the growth gap with the US.  As such, some economists believe that, should the US economy disappoint this year, the European economy might just catch up with the US in terms of growth for the first time this decade.

One side of this story revolves around the disappointing performance of the world’s largest economy in the wake of its deep recession in 2008 and 2009.  While the US has staged a stronger recovery from this crisis than most of its developed economy counterparts, this recovery has been quite disappointing and far from the strong recoveries achieved in the wake of previous recessions.  In fact, the United States has just gone an entire decade without recording at least 3% GDP growth in any year during a ten-year span for the first time in its 239-year history.  Last year, the US economy expanded by 2.4% and this rate of growth slowed to 2.0% in the first quarter of this year.  One of the reasons for this relatively sluggish growth has been the poor external environment facing US exporters, as key export markets have been weak while the US dollar has been very strong.  In addition, business confidence levels have waned in recent months, leading to disappointing business spending and investment levels.  Altogether, while a recession remains very unlikely, it appears that once again, the US economy will fall short of achieving 3% GDP growth this year.

The other side of this story is Europe, where the region’s recent economic struggles have been well documented.  Since 2008, economic growth in the European Union have averaged just 0.4% per year (as compared with 1.2% in the United States), while some countries in Europe have seen economic output levels fail to return to pre-2008 levels as of early 2016.  The initial data for the first quarter of 2016 suggests that the situation is improving somewhat, with year-on-year GDP growth rising to 1.9% in the European Union.  Much of this growth is due to the success of more dynamic and reform-minded economies on Europe’s periphery, such as Britain, Spain and Sweden.  In addition, the fall in energy prices has given a needed boost to European consumer spending, while a weaker euro has been a major factor in favor of European exporters.  Nevertheless, while some European economies are looking healthier, too many economies in the region continue to see their domestic markets shrink and their export competitiveness wane, preventing the region from recording even higher rates of growth.

While the European Union is not likely to outgrow the United States this year, the gap between the two is likely to be smaller than in previous years.  This will be due to another year of growth in the United States of around 2.5%, while the EU economy is likely to grow at around 2.0% this year.  This reflects the fact that the growth ceilings in both economies are now around 25% lower than they were prior to the global financial crisis, limited their growth potential.  On the US side, a more favorable demographic and technology climate will allow the US to continue to outgrow most other developed economies, but other factors (wage stagnation, a strong dollar, etc.) will prevent a return of 3%+ growth rates in the coming years.  Meanwhile, Europe needs for the region’s currencies to remain weak and for natural resource prices (particularly oil and gas) to remain low.  Both economies would benefit from an improvement in export demand from the world’s large emerging markets, particularly Europe, as its economy is increasingly dependent upon exports outside of Europe for much of its growth.  Altogether, neither economy will meet the more optimistic expectations of them in the coming years, reflecting the overall malaise that surrounds a sluggish global economy.