Europe’s Lost Decade?

by Zach Bethune, Thomas Cooley, Espen Henriksen, and Peter Rupert

Is Europe about to repeat Japan’s lost decade? Six years after the Great Recession began, the Euro area has shown little sign of sustained growth.  Japan’s so called lost decade began in 1991 after several decades of rapid economic progress and sustained increases in asset prices that were suddenly reversed.  The average growth rate of real GDP per-capita declined from about 3.5% per year in the 1980s to about 0.5% per year in the 1990s and was accompanied by  rapidly decreasing equity and real-estate valuations.  But, when we compare the performance of Japan’s economy with the European economy since the beginning of the Great Recession it is clear that Europe is in far worse shape than Japan ever was.

The following Snapshot-style comparative charts show the paths of key economic variables in Japan after the peak of its equity and real-estate valuations and contrasts these with the paths of these variables in the U.S. and Europe in the years since the onset of the Great Recession. For Europe and the U.S. we set time “0” at the peak before the Great Recession.  Judging from this and the charts that follow, halfway into the decade following the onset of the Great Recession, the performance of the U.S. and, in particular, the European economy are substantially weaker than Japan’s economy was halfway through its lost decade.

gdplostdec2014-02-26

Japan’s growth rate slowed dramatically at the beginning of their lost decade – GDP rose only 10% in the first six years and then flat-lined more or less completely.  Europe, by contrast fell by six percent in the first six quarters and then flat-lined at a level three percent below their peak.  The U.S. stands in contrast to both of these stories – after falling by nearly four percent in the first six quarters U.S. growth has been steady at a rate slightly less than before the collapse.

Consumption paints an even more dire picture for Europe. During the lost decade in Japan consumption expenditures never really slowed down. In the Great Recession, U.S. consumption fell initially for about 6 quarters and  has been rising ever since. Europe on the other hand started out similar to the U.S. for the first 6 quarters but then consumption growth stalled and has not improved since. It has not returned to its 2008 peak.

gdplostdeccons2014-01-27

The labor market picture for Europe is even more discouraging and strongly reinforces the message of a lost decade.  The unemployment rate in individual countries like Spain and Italy has been widely noted. But, here we focus on aggregate employment and the data are for the EU-28 which includes some countries, like Germany, where the labor market has not really declined. Japan, Europe and the U.S. showed remarkably similar paths of employment up until the inflection point following which there was a sharp contraction in both the U.S. and Europe. In Japan, employment like output, simply stagnated.  In terms of a recovery, the U.S. labor market, after a sharp decline, is showing slow growth while Europe looks to be stuck at a permanently lower level.

employmentlostdec2014-02-26

While the declines in employment were steep in both the US and Europe, the path of labor productivity has been very different. In the US the recession had a negligible effect on labor productivity, which has only recently started to show signs of slowing down (see here for instance). Europe on the other hand experienced a sharp drop in productivity at the beginning of 2008, when it fell by nearly five percentage points. Data until 2010 suggest that European productivity hasn’t shown any signs of ‘catching up’ to its previous growth trend. Measuring labor productivity is particularly difficult for Europe because one needs a measure of total hours worked. Ohanian and Raffo (2011) do the heavy lifting by constructing this series for many European countries, although it is only available until 2010.

prodlostdec2014-02-23

Why the Lost Decade?

Economists have offered a range of different explanations for Japan’s lost decade: (i) the government failed to deal with undercapitalized banks that were allowed to carry “zombie” loans on their books and did not have the capacity to finance new investment, (ii) a sharp drop in productivity caused desired investment to be low, (iii) frictions caused by labor law amendments in the late 1980s resulted in declining work weeks, (iv) the monetary policy response was too timid (something Abenomics is finally trying to remedy), and (v) Japan’s prospects for recovering were seriously hampered by persistent deflation.  While it is not clear that there is one compelling account, all of these elements undoubtedly played some role and all of them loom large in the current European experience.

As in Japan, European banks are most likely under-capitalized and carrying loads of overvalued (“Zombie”?) sovereign debt on their balance sheets as well as other assets of dubious quality. The European Central Bank has only gingerly approached the problem of looking at asset quality in European banks, promising to deliver results later this year. But then what? There is no plan for dealing with under-capitalized banks. In contrast to Japan and the U.S., there is no common bank regulation or resolution mechanism and there has been only tentative progress toward creating it.

As the picture below shows, investment / capital formation stagnated in Japan, both consistent with the slower growth in total factor productivity and insolvent banks that deterred lending.  The picture also shows that investment in both the United States and Europe fell relatively more at the onset of the Great Recession than investment in Japan did at the onset of the “lost decade”. In contrast to both Japan and Europe, U.S. capital formation has rebounded after an initial collapse.  Again, the European situation looks more alarming than the situation in the United States and Japan.

gdplostdecfcapf2014-01-27

Whatever the reasons may have been for Japan’s ‘lost decade’, one thing is certain: more than halfway into the decade following the start of the global recession in 2008, the European economy is far worse and deteriorating. Even though economic growth in Japan stagnated in 1991, the economy continued to grow.  In contrast, the economy in Europe has contracted and is, according to all measures of economic activity surveyed in this post, at a lower level than they were five years ago.  Unless economic growth in Europe rebounds within the next couple of years, Europe is headed for a substantially worse decade than Japan’s. Surprisingly, there has been recent optimism about a European recovery, but the data do not seem to support it except for possibly Germany and the U.K.

Just as there were no quick fixes for Japan during its “lost decade”, most likely there are no quick fixes for Europe’s economy. The challenges lie in fostering economic institutions that create individual incentives and market structures that both discourage rent seeking and encourage and allow people to use their efforts to develop and produce goods and services other people value. On this score Europe has failed. They have not reformed institutions sufficiently to make their markets globally competitive and adaptable. Until they do, Europe will continue to face the possibility of an entire decade of lost income, consumption, and jobs.

Update: Second Estimate of Q4 GDP Shows Slight Improvement

The second estimate of Q4 Real GDP, released yesterday indicates that output grew a tiny bit in the fourth quarter and there was an upward revision in the third quarter. than previously estimated at 2%. On the face of it this seems like good news but it is really insignificant and is much smaller than typical revisions. The fundamentals that we look to for evidence of a robust recovery were not encouraging.

The BEA also released January 2013 personal income and savings. Personal income declined by 3.6% compared to a gain of 2.5% in December and the personal savings rate dropped with it, plunging back down to 2.5%. As we showed last month, the effects of fiscal policies were clearly evident in the December 2012 personal income gain, as companies shifted dividend payments forward to avoid the end of the payroll tax holiday. January’s numbers reinforce this idea.

personal-income-2013-03-02

savings-monthly-2013-03-02

As always, we show the components of GDP measured from the peak of the business cycle.

imports-2013-02-28



Warning Signs! First Quarter GDP Revisions and Disastrous May Jobs Report Show a Weakening Economy

The second estimate of GDP for the first quarter of 2012 and its components shows a much weaker economy than previously thought. After robust growth in real GDP at an annual rate of 3% in the fourth quarter of 2011 the economy slowed markedly to a 1.9% rate in the first quarter. Most of the change was due to downward revisions to state and local government spending and to personal consumption, particularly durables. These were somewhat offset by upward revisions to non-residential fixed investment and exports.

The somewhat negative report from the BEA was reinforced by the Institute for Supply Management’s release of the Purchasing Managers Index, a closely watched barometer of manufacturing activity. It showed a sharp decline to its lowest level since 2009.

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Snapshot – Labor Market Update: The April Employment Report

Welcome to the Cooley-Rupert Economic Snapshot, our view of the current economic environment. This is the latest version of our snapshot of the U.S. Economy based on the new employment numbers released on Friday by the Bureau of Labor Statistics. The complete Snapshot based on the preliminary estimates of first quarter GDP from the Bureau of Economic Analysis can be found in our previous post.

As in all of our snapshots we present the data in a way that we find particularly useful for assessing where we are in the business cycle and tracking the U.S. economic recovery. The paths of all the series presented are plotted relative to their value at the peak of the respective business cycles. We use the business cycle dates identified by the National Bureau of Economic Research.

You can also find the most recent version of the entire snapshot in pdf form here. As always we welcome any suggestions for additional data that you would like to see and suggestions for how to improve the presentation of the data.

A Disappointing and Sluggish Labor Market

The latest Employment Situation report from the Bureau of Labor Statistics shows non-farm payroll employment rose by a only 115,000 jobs in April. This was very disappointing compared to 154,000 jobs added in March (a slight upward revision) and an average of over 250,000 jobs per month for the prior three months. This will provide little updraft to the stagnant labor market. The number unemployed ticked down slightly to 12.5 million but the unemployment rate remained essentially unchanged at 8.1% because the labor force participation rate trended down further to 63.6%. In twelve months roughly 2.7 million people have left the labor force. Many economists have been hoping the labor market would add about 210,000 jobs consistent with the trend earlier this year.  For comparison, as we did last month, we plot employment as reported by ADP, an association of payroll processors. Many observers view this as a useful early indicator of the BLS numbers.
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Snapshot – The Employment Report For February – Continued Job Growth, Higher Particpation

Welcome to the Cooley-Rupert Economic Snapshot, our view of the current economic environment. This is the latest version of our snapshot of the U.S. Economy based on the new employment numbers released today by the Bureau of Labor Statistics. The complete Snapshot based on the latest revisions to fourth quarter GDP from the Bureau of Economic Analysis can be found in our previous post.

As in all of our snapshots we present the data in a way that we find particularly useful for assessing where we are in the business cycle and tracking the U.S. economic recovery. The paths of all the series presented are plotted relative to their value at the peak of the respective business cycles. We use the business cycle dates identified by the National Bureau of Economic Research.

You can also find the most recent version of the entire snapshot in pdf form here. As always we welcome any suggestions for additional data that you would like to see and suggestions for how to improve the presentation of the data.

The Labor Market

The latest Employment Situation report from the Bureau of Labor Statistics shows non-farm payroll employment rose by 227,000 jobs in February. Prior payrolls were revised upwards for January and December. These indicate a continued improvement in labor market conditions but at the same modest pace of recent months. The total number of unemployed remained essentially constant. This reflects the fact that labor force participation increased in February, perhaps an encouraging sign. The household survey showed an increase in labor force participation of about 0.2%, while participation declined through much of 2011. The new participants kept the number of unemployed at the same high level but the number of unemployed because of job loss declined. For comparison, as we did last month, we plot employment as reported by ADP, an association of payroll processors. Many observers view this as a useful early indicator of the BLS numbers.
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