The Economic Landscape of the EU After the Financial Crisis

“Growth in the European Union since the outbreak of the global financial crisis has been slower than before the crisis, and slower than the trend would indicate. Of course, there are differences among member states, but this variation is smaller than the average in the past,” says Andrzej Rzońca, PhD, hab., during the 144th mBank-CASE seminar, “On economic growth in Europe, or, EU countries’ uncertain prospects for development.”

The weakness of economic growth in Europe

Although more than seven years have passed since the beginning of the global financial crisis, the majority of European countries haven’t managed to return to their previous pace of economic growth. In 2008-2015, the GDP of European Union countries grew by barely 2.7 percent. By comparison, in the seven-year period directly preceding the financial crisis, economic growth reached as high as 16.6 percent. Since 2009, forecasts for GDP growth have been systematically reduced. What’s more, the actual results have constantly turned out to be worse than expected. The serious consequences of the crisis are also making themselves visible in the worsening relationship of EU GDP per capital to U.S. GDP per capita. This ratio has fallen to 67.8 percent, even though in 2008-2015 the United States was grappling with a significant slowdown in economic growth.

Still, it is worth bearing in mind that the dynamics of GDP have varied significantly from country to country within the EU. In 2008-2015, Poland posted the highest growth (23 percent), while in as many as 10 countries the results were worse than in the period preceding the crash. As Dr. Rzońca stressed, in none of the EU countries did GDP growth in this period exceed its level in the seven years before the crisis. The least severe slowdown could be observed in Ireland and Germany, while the worst economic situation was in Greece. In the new member countries, in recent years we have faced a significant slowdown in the process of convergence, and the countries of the “old EU” have been affected by the phenomenon of divergence. In the next few years the situation will improve somewhat, though the pre-crisis pace of growth will not be restored.

Sources of economic weakness in the European Union.

According to Dr. Rzońca, the frequent explanation of the EU’s weak growth which cites insufficiently expansionary fiscal policy has serious weaknesses. Economists point to three main factors that have supposedly put the brakes on growth in aggregate demand in the European Union: 1) excessively fast deficit reduction in public finances, 2) the European Central Bank persistently keeping inflation low and 3) the popularity of “deleveraging” in the Eurozone. In the paper he prepared for the mBank-CASE seminar, Dr. Rzońca, working with Aleksander Łaszek, demonstrated that the evidence for insufficiently expansionary policy as mentioned above is not entirely accurate, because supply-side sources of weak economic growth in Europe must also be taken into account. This approach is confirmed by the breadth of the demand gap, which when looking at the entire EU certainly was not deeply negative. In their publication, the authors applied modified econometric models, which pointed to the main sources of such large losses in potential output. Unfortunately, research does not indicate the possibility of an improvement in the general economic situation in the European Union. Weak public finances and excessive liquidity support for banks today constitute the largest barriers to growth in Europe. The continent’s worsening prospects also affect the growing support within society for anti-market parties. Growth in this phenomenon in the near future can only exacerbate the weakness of economic growth in the European Union.

Are there effective ways out of the impasse?

During the seminar, Andrzej Halesiak*, a director in the Macroeconomic Analysis Department of Bank Pekao SA, presented a commentary on the EU’s current economic situation. He pointed out that one of the main reasons for the weakness of economic growth in Western Europe in 2007-2015 is the legacy of unproductive investments from the boom time, which is compounded by institutional uncertainty. Such unproductive investments have led to growing indebtedness at companies, a higher propensity to save and/or the need for new debt to service the old debt. The results at the macro level are limited demand and growth, and, which follows, limited propensity to undertake new investments.

According to Mr. Halesiak, we can identify three ways of solving the problem of unsuccessful investments and the accompanying debt: 1) using inflation as a path to “growing our way out” of earlier debt, 2) submitting ourselves to “creative destruction” and 3) imposing balance-sheet restructuring (both assets and liabilities). The first solution can’t be counted on: monetary policy is ineffective, and what we are observing as a result is deflation (which is compounded by the drop in commodity prices). The second solution is blocked: Extremely loose monetary policy and growing economic protectionism are hampering the process of creative destruction (and as a result, we have “zombie” companies). And in the case of the third solution, a difficult question arises: Who is to bear the cost of the process of forced restructuring?

But Europe’s problems can’t be resolved without a larger role for creative destruction, and without imposing balance-sheet restructuring. This may temporarily mean higher costs (in the form of a negative effect on growth), but this should be short-lived. To protect ourselves against the temptation for abuse (at the national level), it may be necessary to redefine Eurozone (or EU) membership (e.g. failure to observe the principles that are laid out may cause a country to be placed on a path toward exit) and the related more serious reforms.

Seminar broadcast: Bankier.tv

* Andrzej Rzońca, assistant professor in the Department of International Comparative Studies at the Warsaw School of Economics; member of the Monetary Policy Council, 2010-2016; Vice President of the Civil Development Forum (FOR), 2007-2010.

*Andrzej Halesiak, director in the Macroeconomic Analysis Department of Bank Pekao SA, member of the Association of Polish Economists and the Program Council of the Civic Congress.