Ignacio de la Torre. Professor. IE Business School
30 October 2014
The current state of the eurozone economy is like a mirror image of that of Spain a year ago, which means we can reasonably expect to see growth in the coming year.
Almost a year ago we predicted in an article published at the time that in 2014 Spain would grow faster than the Eurozone. Spain had just come out of its worst recession since 1959, and its credit stock continued to plummet as unemployment rose. Reactions to the abovementioned prediction came thick and fast. The kinder among them considered that said forecast must have come “straight from Mars”. The fact is that in 2014 Spain will have grown by 1.3%, while the Eurozone has grown at approximately 0.7. In other words Spain has not only grown faster than Europe, it has grown at twice the speed.
Now weak data is starting to appear on the outlook for the Eurozone, due to scant activity and an environment plagued by low and volatile prices. Media reactions have not been slow to appear – there is a threat of deflation in the Eurozone, there will be a lost decade, a catastrophic scenario like that of Japan since 1990, and in general a setting in which Europe will progressively lose its economic and political status which will shift toward “emerging” economies” like China. These media voices are the same ones that announced the imminent breakup of the euro, the return to the peseta or the bankruptcy of Spain (which managed to get through the 20th century without going bankrupt, unlike Germany).
When examining why Spain managed to surprise the world in such a positive way in 2014, I find many factors similar to those which, in my opinion, explain why the Eurozone will show surprising growth in 2015. They are as follows:
Funding has played a crucial role in fueling this economic growth. Levels of funding improved in Spain sooner than expected, and this partially explains the increase in investment and levels of consumption. In the Eurozone preparations are being made to ensure that in 2015 the mechanisms needed to bring about a surprising increase levels of funding will be in place. Hence, where demand is concerned, the latest reports issued by the ECB seem to indicate that demand for credit has stopped going down, which will be key for reactivating credit. With regard to supply a triple process is being launched in these last months of 2014 which will activate credit in 2015: First, the results of the stress test will come out, which will provide a snapshot of solvency levels, thereby dissipating uncertainties so that good banks can expand their balances; Second, the massive liquidity provided by the ECB, linked to the flow of new credit, which will presumably grow in December after the results of the stress tests come out; and third, the reactivation of the securities and bond markets supported by the ECB, which will foreseeably provide banks with the incentive of demonstrated creditworthiness needed to lend more to SMEs.
Also, the Eurozone has made an enormous effort to bring about fiscal consolidation in recent years, and this consolidation has exacerbated the economic cycle. In 2015, this consolidation process will be far less intense than that seen up to 2014. It will therefore be possible to see a definite relaxation of fiscal deficit objectives, which will lessen its impact on the economic cycle. Moreover, the new European Commission has announced that it will be investing 300 billion euros in public and private infrastructures in the near future. This quantity will bring serious impetus to the Eurozone’s GDP over the next two years, and will dynamize investments, which are currently a little depressed. The dynamizing effect of this change in fiscal policy will be key when it comes to calculating economic growth.
Additionally, the energizing effect that the weak euro will have on exports is another thing that must be born in mind. The Eurozone is big on exports, underpinned mainly by the export sectors of Germany, Spain, France and Italy (in that order, they are the greatest export powers in terms of percentage of GDP). The Eurozone, for example exports almost three times as much as the US in terms of percentage of its GDP. Hence, the big depreciation in the euro seen since June will have two major effects: first it will make export levels rise fast, which will further add to the Eurozone’s GDP (In July we saw very positive figures for German and Spanish exports), and second, it will import inflation, which will help the CPI to rise faster than its current scant rate.
Lastly, part of Spain’s surprise growth in 2014 has been due to the normalization of consumption and investment activity, which were at unusually low rates. Something similar is happening in the Eurozone. When funding is activated, these activities tend to return to normal levels, and this makes for a significant rise in GDP. Hence, the good consumer figures for France and Germany in the summer are an incipient example of a trend that could become more solid in 2015.
Recently the Aspen Institute, headed in Spain by Jose María de Areilza, organized a productive meeting in Madrid with Germany’s Vice Minister for Finance. The meeting highlighted the patent risks facing Europe, but also the willingness to react, take action, and implement initiatives. If we analyze, in perspective, the enormous efforts made by Europe over the last five years to contain a possible financial cataclysm, we will give credit where it is due to our governance. As Europeans we should be proud of how we have been capable of reacting in the face of a crisis as difficult as that seen in our continent over the last few years. That governance is now focused on generating growth by laying the foundations needed to bring funding back.
The results will surprise us. Just as Spain managed to surprise everyone this year.