The EU:
Where Does It Stand Economically?

 The European Union

© European Union, 2005-2015

The US has significant interests in the EU economy and changes there directly impact the states’ economic health. The bilateral economic relationship between the US and the EU is the largest such relationship in the world. In 2012 alone, a total of more than $1.5 trillion flowed between the US and the EU. The EU is the largest trading partner for the US in terms of merchandise and services. The complex economic ties covering numerous trade and financial activities intertwine both US and EU economies into an increasingly interdependent relationship that affects the economic outlook for the US and their citizens.

Dr. Eckhard Wurzel, Head of the Bureau for the Euro Area and the European Union, the Organisation for Co-operation and Development’s (OECD) Economics Department, reviewed the economy of the region and discussed the current economic crisis in his presentation. Dr. Wurzel reported that, up until 2007, international capital flows in the EU financed government debt and real estate investments that were not well-regulated. As the government and real estate sectors boomed, wages went up, thereby fueling increases in such sectors as goods and commodities. These factors led to a distortion in prices and a deterioration of competitiveness of several European countries in the global market.

When the US 2008 sub-prime crisis hit, the willingness to finance cross-border activities and government deficits stopped, and Europe experienced a sudden stop in capital flows. This sudden arrest caused severe problems in the credit system of the economy with negative repercussions on economic growth and unemployment. Joblessness in the EU climbed from 7% in 2008 to 12% in 2013 and has only fallen to 11% today compared with US unemployment, which now is about 5.5%.

Since 2013, employment has been slowly recovering, but the impacts continue to be felt. Those who left school during the recession will never regain the income lost over a lifetime compared with those who leave school during a boom. In Spain and Greece, youth unemployment is almost 60%, and getting the long-term unemployed back into jobs also poses significant challenges.

 GDP Volume (percentage change)Source: June 2015 OECD Economic Outlook projections

In addition to unemployment, investment recovery has been slower than in other cycles and non-residential investment remains low. Today, real total gross fixed capital formation in the OECD is at 85% of what it was in 2007. Sluggish investment results in slower potential output growth, labor scarring, stagnant incomes and rising inequality, and slower technology adoption. These factors, plus the lagging recovery from the recession, will affect future productivity and create significant economic challenges for the future.

The euro area are those Member States of the EU that have adopted the euro as their currency: Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.

Economic growth can be produced either by productivity increases or employment increases. However, for the OECD countries, labor productivity dropped from about 1.2% in 2007 to only 0.8% between 2008 and 2014, and employment growth was down from 0.9% to 0.75% over the same time periods.

On the upside, current low oil prices promise to boost consumption and investment in most OECD countries. Many currencies have depreciated against the US dollar, monetary easing is widespread, and restriction of discretionary government spending is easing.

Ordinary risks are balanced around the most likely scenarios, which include  lower energy prices, effect of monetary easing, pickup in investment, and progress in structural reform. But further unpredictable risks include the potential for rapid rebound and overshooting from exceptionally low bond yields, unfavorable resolution of Greece’s situation (at the time of this speech, the Greek question was not settled), financial turmoil in emerging market economies, and the sharp slowdown in China.

Dr. Wurzel pointed out that much has been done to implement structural reforms, but more is needed. On the level of the EU and the euro area (the countries using the euro as common currency) regulation of banks and greater fiscal governance are yet to be accomplished.

Discussion

Mr. Tom Finneran (Moderator): Spain and Greece have high youth unemployment, and that represents a risk for social and political unrest. What can be done about it?

Dr. Wurzel: Youth unemployment does breed unrest and affects the future, but there is no single action that will change it. Rather, a mosaic of actions is required. Germany is a case in point. They have increased job creation, and unemployment remains low. But there was a process to reach this equilibrium, which was largely driven by German reunification and an influx of East German workers into the west.

Initially, East Germans bargained for wages approaching the Western German levels, but their productivity was only a quarter of that of the West. After 1991, union membership strongly declined due to high unemployment and firms exited standard employers’ associations because they did not want to be bound by collective bargaining outcomes. East German companies could not attain Western-level wages. As a result, wage growth moderated and agreements allowed greater flexibility of wages and working hours. This, together with structural reforms, improved Germany’s productivity and international competitiveness.

Sen. Martin Looney (CT): Are the unions relatively similar across the EU countries? Do unions need to be more flexible in the face of global competition?

Dr. Wurzel: There is a wide variety in unionization across the EU. Germany, for example, now has highly organized labor unions in all sectors, while, in France, the unions are strong in the public but not the private sector.

Sen. Wayne Neiderhauser (UT): The way the US got out of the recession was through deficit spending. But this is a false economy. Still, the US cannot stop deficit spending. What are the better solutions?

Dr. Wurzel: The EU economies are less flexible than the US economy. Deficit spending is not an option. The only strategies for EU countries such as Greece, for example, are to increase taxes, take on austerity measures, and focus on fiscal consolidation. Ireland, Spain, and Greece have adopted the fiscal consolidation choice, keeping capital markets working and investing. Spain and Ireland had huge current account deficits, which they had to slash. Now they are stable again.

Fiscal consolidation must be a country-specific calculation. Government cannot step too hard on the fiscal brakes, or financial markets may conclude that the government is carrying too much debt. This fear could depress the value of government bonds, while the passive government obligations remain the same.

Sen. David Givens (KY): What will be the impact on the EU if Greece stays in or exits the euro area?

Dr. Wurzel: The situation for EU banks with regard to Greece is better now than a few years ago. The European banks do not have significant holdings of Greek government debt. If Greece defaults, Germany alone could swallow the whole debt, and the situation could be contained. Some even say that the exit of Greece from the euro area would strengthen the euro area, making it more stable.

However, if Greece left the EU, banks in Spain and Portugal could be negatively affected as they finance Greek businesses and would feel the downstream effects.

If Greece exits the euro area, they will have demonstrated that the euro can be reversed. This raises the possibility that other countries could also leave the euro area, a suspicion that would increase speculation against those countries. The flight of capital could exceed the ability of the banks to stabilize if this scenario played out.

We need to make more institutional regulatory changes in the euro area. In the US, the states do not expect a bailout from the Federal government. But euro area states do expect to be bailed out by the EU. Change is needed. Capital markets must know that states can default and no bailout will happen.

Speaker Biography

Eckhard Wurzel

Dr. Wurzel is Head of the Bureau for the Euro Area and the European Union of the OECD Economics Department.

Prior to heading the Bureau, he was Head of the Fiscal Policy Team, OECD Economics Department; Manager, OECD macroeconomic projections and Head of the Bureau for Germany, OECD Economics Department.

Before joining the OECD, Dr. Wurzel was an Economist at the Federal Ministry of Economic Affairs, Germany and an Assistant professor at the University of Bonn.

Other Foreign Relations articles:

Dr. Eckhard Wurzel

Head of the Bureau for the Euro Area and the European Union

Organisation for Economic Co-operation and Development (OECD) Economics Department

 

In 2012 alone, a total of more than $1.5 trillion flowed between the US and the EU. The EU is the largest trading partner for the US in terms of merchandise and services. The complex economic ties covering numerous trade and financial activities intertwine both US and EU economies into an increasingly interdependent relationship that affects the economic outlook for the US and their citizens.

 

Unemployment in the EU climbed from 7% in 2008 to 12% in 2013 and is 11% today compared with US unemployment, which now is about 5.5%.

 

The euro area are those Member States of the EU that have adopted the euro as their currency: Austria, Belgium, Cyprus, Estonia, Finland, France, Germany, Greece, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, the Netherlands, Portugal, Slovakia, Slovenia, and Spain.

 

On the upside, current low oil prices promise to boost consumption and investment in most OECD countries. Many currencies have depreciated against the US dollar, monetary easing is widespread, and restriction of discretionary government spending is easing.

Tom Finneran

Sen. Martin Looney

Sen. Wayne Neiderhauser

Sen. David Givens

Dr. Eckhard Wurzel

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